Accounting Online Program Certification Practice Test

What journal entry is appropriate for recording interest earned on partners' capital account balances?

1. Dr Partners CA and Cr Profit and Loss

2. Dr Profit and Loss and Cr Partners CA

3. Dr Interest Income and Cr Partners CA

4. Dr Expenses and Cr Capital Account

The correct answer is: Dr Profit and Loss and Cr Partners CA

The appropriate journal entry for recording interest earned on partners' capital account balances involves debiting the Profit and Loss account and crediting the Partners' Capital Accounts. This reflects that interest is being recognized as an expense to the partnership, thereby reducing the overall profit, which impacts how profits are distributed among partners. When interest is credited to the Partners' Capital Accounts, it signifies that the interest earned is being allocated to individual partners based on their capital contributions. This method ensures alignment with the partnership agreement and proper treatment of financial performance. In this context, the Profit and Loss account serves as a temporary holding account that captures all income and expenses, including interest. The transaction ultimately reflects the partnership's overall operations and ensures that each partner receives credit for the interest earned on their investment, in line with partnership equity structures.