In this article we will discuss about the Inclusion of Interest:- 1. Arguments For Inclusion of Interest 2. Arguments Against Inclusion of Interest.
Arguments For Inclusion of Interest:
(i) It is argued that interest on Capital is a reward of the capital invested in the business and should be treated as an element of cost like wages.
(ii) If interest is excluded comparison of different operations and processes would be different which may lead to erroneous conclusions.
(iii) Inclusion of interest would take into consideration the time element, for it is one of the most important factors in production. Where a considerable amount of capital is locked up for quite a long period the interest factor is of utmost importance in the calculation of total cost.
(iv) Carrying cost of inventory cannot be ascertained without taking into consideration the effect of interest on capital involved.
(v) Where old plant and machineries are replaced by modern machinery the result of such replacement cannot be accurately ascertained or decided without studying the interests on capital borrowed for the purpose. Advantages that can be derived from such replacement should be compared with the amount of interest which is likely to be lost on the capital locked up.
(vi) If interest is paid it should be included in cost accounts for expenditure incurred is taken into account at the times of cost ascertainment.
Arguments Against Inclusion of Interest:
(i) It is argued that payment of interest is a matter of finance and hence is not in any way connected with the cost of production. Payment of interest does not affect the manufacturing cost but affects the quantum of profit.
(ii) The reward for capital is covered by profits. Interest paid on borrowed capital should be included in cost but not the interest payable on owned capital as a reward.
(iii) Actual expense is considered for the determination of total cost. Therefore, interest not payable should not be included in Cost.
(iv) If interest is included in cost accounts, the value of closing stock and work-in-progress is likely to be inflated.
(v) Cost accounts will unnecessarily become complicated if interest is included because for the purpose of computation of interest it is difficult to determine the exact capital employed as well as the fair rate of interest.