The sole proprietorship is a business that is unincorporated and owned by a single person. The owner of the business invests capital in the business in the form of cash, any asset or stock, or in any other form. In, sole proprietorship owner and business are inseparable. Interest on capital is the aRead more
The sole proprietorship is a business that is unincorporated and owned by a single person. The owner of the business invests capital in the business in the form of cash, any asset or stock, or in any other form. In, sole proprietorship owner and business are inseparable.
Interest on capital is the amount paid by the entity/business to the owners. It is an expense to the business and income for the proprietor, and interest is adjusted in the owner’s capital account. It is calculated on an agreed percentage and for a certain period. It is paid before calculating net profit.
If there is a loss, no interest will be paid on capital.
Journal Entry for Interest on Capital in Sole Proprietorship:
- Interest on capital entry
Interest on Capital A/c | Debit | Debit the increase in expense. |
To Owner’s Capital A/c | Credit | Credit the increase in income. |
2. Closing interest on capital account
Profit and Loss A/c | Debit | Debit the increase in expense. |
To Interest on Capital A/c | Credit | Credit the increase in income. |
In sole proprietor’s Profit and Loss A/c interest will be recorded as an expense on the debit side and will be added to the owner’s capital in the Balance Sheet is considered as an adjustment to the capital account.
For example, A invested Rs 1,00,000 in a business. He wants to adjust 5% interest on his capital, then the entry will be:
- Interest on capital entry
Interest on Capital A/c | 5,000 |
To Owner’s Capital A/c | 5,000 |
2. Closing interest on capital account
Profit and Loss A/c | 5,000 |
To Interest on Capital A/c | 5,000 |
In the case of a partnership, the treatment is the same as done in a sole proprietorship. The interest rate is agreed upon by the partners and is mentioned in the partnership deed. No interest is provided on the capitals of the partners if not mentioned in the deed.
If in a particular period, the partnership firm incurs a loss, then no interest will be provided to the partners.
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Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc. FORMULA Current Assets - Current Liabilities = Working Capital Zero workinRead more
Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc.
FORMULA
Current Assets – Current Liabilities = Working Capital
Zero working capital is when a company has the exact same amount of current assets and current liabilities. When both are equal, the difference becomes zero and hence the name, Zero working capital. Working Capital may be positive or negative. When current assets exceed current liabilities, it shows positive working capital and when current liabilities exceed current assets, it shows negative working capital.
Zero working capital can be operated by adopting demand-based production. In this method, the business only produces units as and when they are ordered by the customers. Through this method, all stocks of finished goods will be eliminated. Also, raw material is only ordered based on the amount of demand.
This reduces the investment in working capital and thus the investment in long term assets can increase. The company can also use the funds for other purposes like growth or new opportunities.
EXAMPLE
Suppose a company has Inventory worth Rs 3,000, Debtors worth Rs 4,000 and cash worth Rs 2,000. The creditors of the company are Rs 6,000 and short term borrowings are Rs 3,000.
Now, total assets = Rs 9,000 ( 3,000 + 4,000 + 2,000)
See lessAnd total liabilities = Rs 9,000 ( 6,000 + 3,000)
Therefore, working capital = 9,000 – 9,000 = 0