State the two situations under which interest on capital is generally provided.
State the two situations under which interest on capital is generally provided.
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The following are the reasons for allowing Interest on Capital:
1) When the Capitals of Partners are different but Profit Sharing Ratio is Equal:-
If a partner invests more capital as compared to other partners and the profit-sharing ratio is equal, interest allowed on capital compensates his or her for more investment. In case, interest on capital is not allowed, the share of profit of a partner investing more capital will be equal to the share of profit of partners investing less capital.
2) When the Capitals of Partners are not the same and the Profit sharing Ratio is also not Equal:-
In this case, partners investing less capital may get more share of the profit, and partners investing more capital may get less share of the profit. Interest on capital will compensate the partner who has contributed more capital.
Note:- At the same time, where profit is shared by the partners in proportion to their capitals, interest on capital should not be allowed because partners investing more capital get more share of the profit.
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