Question

Answer in brief: Explain the features of Interest.

Hint:

Think of interest as 'rent on money'. It's a fixed, mandatory payment a company must make for using someone else's capital, and it's a cost of doing business.

Answer 1

Interest is the payment made by a borrower to a lender for the use of borrowed funds. It is the return paid to the creditors (like debenture holders and depositors) for the capital they provide to the company. The key features of interest are:

Price for Using Capital: Interest is essentially the price or cost of borrowing capital. It represents the opportunity cost for the lender who could have used the money elsewhere.
Fixed Rate: The rate of interest is typically fixed and pre-determined at the time of borrowing. This rate does not change with the profitability of the company.
Charge Against Profit: Interest payment is treated as a charge against the profit of the company. This means it must be paid irrespective of whether the company makes a profit or a loss. It is a business expense and is debited to the Profit and Loss Account.
Legal Obligation: A company is legally obligated to pay interest on the borrowed capital. Failure to pay interest can lead to legal action against the company by the creditors and can even force the company into liquidation.
Tax Deductible: Interest paid by the company on its borrowings is a tax-deductible expense. This means the company can deduct the interest amount from its profits before calculating its corporate income tax liability, which lowers the effective cost of debt.