Raj and Neeraj are partners in a firm. Their capitals as on April 01, 20 19 were Rs. 2,50,000 and Rs. 1,50,000

Numerical Questions · Q23

Q. Raj and Neeraj are partners in a firm. Their capitals as on April 01, 20 19 were Rs. 2,50,000 and Rs. 1,50,000, respectively. They share profits equally. On July 01, 20 19, they decided that their capitals should be Rs. 1,00,000 each. The necessary adjustment in the capitals were made by introducing or withdrawing cash by the partners'. Interest on capital is allowed @ 8% p.a. Compute interest on capital for both the partners for the year ending on March 31, 2020.

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Concept understanding — Partnership Profit Distribution Rules

Partnership Capital Accounting — A First Look

Think of a partnership like a group of friends pooling money to start a roadside food stall. Each friend brings in some cash — that’s their capital. But unlike a simple piggy bank, a partnership needs a clear record of who put in how much, because profits (and losses) are shared in a fixed ratio, and partners may withdraw money, lend extra funds, or take a salary.

That record is what Partnership Capital Accounting is about.

What It Really Means

In accounting, capital is the amount a partner contributes to the firm. But it’s not just a one-time number. Over time, a partner’s capital changes due to:

Additional capital introduced
Drawings (money or goods taken out)
Share of profit or loss
Interest on capital, interest on drawings, partner’s salary, commission

The Capital Account of each partner tracks all these changes. It answers: What does the firm owe to this partner at any point?

Why It Matters

Without proper capital accounting, you cannot:

Determine each partner’s claim on the firm’s assets
Calculate interest on capital correctly
Prepare the Profit and Loss Appropriation Account
Settle accounts when a partner retires or dies

The NCERT textbook emphasises that capital accounts are personal accounts of the partners — they show the firm’s liability towards each partner.

Two Methods of Maintaining Capital Accounts

The NCERT Class 12 Accountancy textbook (Part II, Chapter 2) describes two methods:

1. Fixed Capital Method

Under this method, the capital account remains constant (except when additional capital is introduced or capital is withdrawn permanently). All other transactions — share of profit, drawings, interest, salary — are recorded in a separate Current Account.

Note

In the Fixed Capital Method, the Capital Account shows only the permanent capital. The Current Account shows the fluctuating balance.

2. Fluctuating Capital Method

Here, all transactions are recorded directly in the Capital Account. The capital balance changes every year.

Accounting Treatment — Which Account is Debited/Credited

Let’s take the most common entries. I’ll show the journal entry first, then explain.

Entry 1: Capital Introduced

When a partner brings in cash or assets:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Cash/Bank A/c	Dr.	xxx
	To Partner’s Capital A/c			xxx

Why? Cash comes in (asset increases — debit), and the firm’s liability to the partner increases (capital is a liability — credit).

Entry 2: Drawings

When a partner withdraws cash or goods for personal use:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Partner’s Capital/Current A/c	Dr.	xxx
	To Cash/Bank/Purchases A/c			xxx

Why? The firm’s liability to the partner decreases (debit the capital/current account), and cash or goods go out (credit).

Entry 3: Interest on Capital

This is an appropriation of profit. The formula (as per NCERT) is:

Interest on Capital = Capital × Rate of Time × Time (in months)/12

Journal entry:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Interest on Capital A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Then, at the end of the year, Interest on Capital is transferred to the Profit and Loss Appropriation Account:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Interest on Capital A/c			xxx

Entry 4: Partner’s Salary

If the partnership deed allows a salary:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Salary to Partner A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Again, this is transferred to the Profit and Loss Appropriation Account.

Entry 5: Share of Profit

At the end of the year, after all appropriations, the remaining profit is distributed:

Date	Particulars	L.F.	Debit (Rs)	Credit (Rs)
	Profit and Loss Appropriation A/c	Dr.	xxx
	To Partner’s Capital/Current A/c			xxx

Formats as per NCERT

Format of Capital Account (Fluctuating Method)

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Raj's interest on capital is ₹11,000 and Neeraj's interest on capital is ₹9,000 for the year ending March 31, 2020, calculated on their fluctuating capitals after the July 1 adjustment.

The key concept here is that interest on capital is calculated on the capital that actually remained in the business for the specific period it was available. When partners change their capital amounts during the year, you cannot simply take the opening balance and apply the full year's rate. You must split the year into periods before and after the change, compute interest for each period separately, and then add them up.

Raj and Neeraj share profits equally, but that ratio is irrelevant for interest on capital — interest is always computed on each partner's individual capital balance, not on the profit-sharing ratio.

The treatment follows the Partnership Deed (or the default rule under the Indian Partnership Act, 1932, if the deed is silent). Since the problem explicitly states "Interest on capital is allowed @ 8% p.a.", it is a charge against profits (an appropriation), meaning it is calculated regardless of whether the firm earns a profit or loss. The capitals here are fluctuating (not fixed), because the partners introduced or withdrew cash to adjust their capitals to ₹1,00,000 each on July 1, 2019.

Let us break down the periods:

Period 1: April 1, 2019 to June 30, 2019 (3 months) — capitals are at their original amounts.

Period 2: July 1, 2019 to March 31, 2020 (9 months) — capitals are at the adjusted amount of ₹1,00,000 each.

Now, we compute interest for each partner separately.

Working Notes

Working Note 1: Interest on Raj's Capital

Period 1 (3 months): Capital = ₹2,50,000. Interest = 2,50,000 × 8/100 × 3/12 = 2,50,000 × 0.08 × 0.25 = ₹5,000.
Period 2 (9 months): Capital = ₹1,00,000. Interest = 1,00,000 × 8/100 × 9/12 = 1,00,000 × 0.08 × 0.75 = ₹6,000.
Total Interest for Raj: ₹5,000 + ₹6,000 = ₹11,000.

Working Note 2: Interest on Neeraj's Capital

Period 1 (3 months): Capital = ₹1,50,000. Interest = 1,50,000 × 8/100 × 3/12 = 1,50,000 × 0.08 × 0.25 = ₹3,000.
Period 2 (9 months): Capital = ₹1,00,000. Interest = 1,00,000 × 8/100 × 9/12 = 1,00,000 × 0.08 × 0.75 = ₹6,000.
Total Interest for Neeraj: ₹3,000 + ₹6,000 = ₹9,000.

Watch out

A common mistake is to calculate interest on the opening capital for the full year (e.g., Raj: 2,50,000 × 8% = ₹20,000) and then adjust for the withdrawal. That is incorrect because the capital changed mid-year. You must treat each period's capital as a separate principal amount.

Tip

A shortcut: For each partner, compute interest as: (Old Capital × Rate × Old Period) + (New Capital × Rate × New Period). Always express the period as a fraction of the year.

Solution: Journal Entry for Interest on Capital

The journal entry to record interest on capital is:

Date	Particulars	Debit (₹)	Credit (₹)
March 31, 2020	Interest on Capital A/c Dr.	20,000
	To Raj's Capital A/c		11,000
	To Neeraj's Capital A/c		9,000
	(Interest on capital allowed @ 8% p.a. for the year)

Explanation: Interest on Capital is an expense (appropriation) for the firm, so it is debited. It is a gain for each partner, so their capital accounts are credited. …

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Working Notes

Solution: Journal Entry for Interest on Capital

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