Loan by Partner to Firm
A Complete Guide to Accounting Treatment & Journal Entries
Loan by Partner to Firm - Overview
Nature
External liability for the firm
Accounting
Credit balance on liability side
Interest
Expense for the firm, income for partner
Journal Entries
Specific entries for loan transactions
Loan Flow Diagram
This diagram illustrates the flow of loan and interest between a partner and the firm:
Partner (Lender)
Provides loan to the firm
Receives interest from the firm
Firm (Borrower)
Receives loan from partner
Pays interest to the partner
Understanding Loan by Partner to Firm
When a partnership firm requires additional funds beyond the partners' capital contributions, a partner may provide a loan to the firm.
Key Concept: The loan represents an external liability for the firm, separate from the partners' capital accounts. A partner's loan is a debt that must be repaid with interest as per agreed terms.
Accounting Treatment: From the firm's viewpoint, the loan received from a partner is recorded as a liability. Interest paid on this loan is an expense, reducing the firm's profit.
Key Points of Loan by Partner to Firm
Important Note: We are making the accounts of the firm, so we will always think from the angle of the firm.
| Aspect | Details |
|---|---|
| Loan by | Partner to Firm |
| Who gave loan | Partner |
| Who received loan | Firm |
| Interest paid by | Firm |
| Interest received by | Partner |
| For firm, interest is | Expense |
| For firm, loan is | Liability |
| Firm shows in Balance Sheet | Liability side |
| For firm, the balance is | Credit |
Journal Entries for Loan Transactions
Important: If interest is payable more than once during the year then make interest entry more than once. But the transfer to P&L entry is always made only once at the end of the year.
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| Sr. | Transaction | Journal Entry | Account Type | Effect |
|---|---|---|---|---|
| 1 | Loan received by firm |
Cash/Bank A/c Dr. To Loan from Partner A/c |
Asset to Liability | Asset ↑ (Debit) Liability ↑ (Credit) |
| 2 | Loan repaid by firm |
Loan from Partner A/c Dr. To Cash/Bank A/c |
Liability to Asset | Liability ↓ (Debit) Asset ↓ (Credit) |
| 3 | Interest due by firm |
Interest Expense A/c Dr. To Loan from Partner A/c |
Expense to Liability | Expense ↑ (Debit) Liability ↑ (Credit) |
| 4 | Interest paid by firm |
Loan from Partner A/c Dr. To Cash/Bank A/c |
Liability to Asset | Liability ↓ (Debit) Asset ↓ (Credit) |
| 5 | Closing Entry (year end) |
Profit and Loss A/c Dr. To Interest Expense A/c |
Nominal to Nominal | Transfer to P&L |
Calculation of Interest Example
Important: Interest is always calculated for the period for which money is used
Scenario:
Rashi gave loan to Jiya of Rs 1000
Date of giving loan: 1-Jan-25
Date of returning the loan: 31-Jan-25
Interest rate agreed: 10% per annum
Calculation: Since Jiya has used money for 30 days, so interest will be paid for 30 days only.
Interest = Principal × Rate × Time
Interest = 1000 × 10/100 × 30/365
Interest = 1000 × 0.1 × 0.08219
Interest = Rs 8.22 (approx)
Alternative monthly calculation: For 1 month at 10% p.a.
Interest = 1000 × 10/100 ÷ 12 × 1
Interest = 1000 × 0.1 ÷ 12
Interest = Rs 8.33 (approx)
Frequently Asked Questions (FAQs)
Partner's capital represents the owner's equity contribution to the firm and is not repayable during the firm's existence. Partner's loan is a debt that the firm owes to the partner, which is repayable as per agreed terms and bears interest.
Yes, interest paid on partner's loan is an expense for the firm and is debited to the Profit & Loss Account. For the partner receiving the interest, it is income.
Partner's loan appears on the liability side of the firm's balance sheet, usually under the heading "Non-Current Liabilities" or "Long-term Borrowings" if the loan is for more than one year.
Yes, unless the partnership agreement states otherwise, a partner is entitled to charge interest on loans made to the firm, typically at an agreed-upon rate.
Interest is calculated on the principal amount for the period the loan is outstanding, using the agreed interest rate. It's usually calculated on a time-proportion basis if the loan is for a fraction of a year.
Test Your Knowledge - MCQ Quiz
Question 1: When a partner gives a loan to the firm, for the firm it is:
Correct Answer: A liability. The loan represents money owed by the firm to the partner, making it a liability for the firm.
Question 2: Interest paid by the firm on partner's loan is:
Correct Answer: An expense for the firm. Interest paid reduces the firm's profit and is therefore recorded as an expense.
Question 3: The journal entry for receiving loan from a partner is:
Correct Answer: Cash/Bank A/c Dr. To Loan from Partner A/c. This records the increase in cash (asset) and the increase in loan liability.
Question 4: Where does "Loan from Partner" appear in the firm's balance sheet?
Correct Answer: Liability side. As the firm owes this money to the partner, it is shown as a liability.