Journal Entry for Return of Capital

Return of capital is the return that investor receives from their investment which excludes the profit. The return does not include the income or capital gain that from the investment. It is the payment that investment provides to the investors, it may be a portion or full investment.

Investment is the amount that investors invest into a business or other instruments such as bonds, stock, and so on. The investors expect to receive the principal plus interest, dividend, and other returns. The return of investment is the difference between the total of investors receiving the initial cost. The return of capital includes only the principle of investment.

The returns are not taxable as they include the principle only. The tax is calculated based on the profit from the investment. It does not make sense to tax the amount of cost that investors receive back. If the amount received is more than the initial investment, we have to calculate the profit and tax only that amount.

Journal Entry for Return of Capital

The amount of investment that investor pays will record on the balance sheet at cost. The cost includes all relevant expenses to acquire the investment.

The journal entry is debiting investment and credit cash.

The investment will be present as assets on the balance sheet. It may be different depending on the type of investment. The cash will reduce as the company has to pay to acquire investment.

Subsequently, the initial investment will remain at cost on the balance sheet. So when the company receives the return of capital, we simply reverse the transaction. It will recognize cash and remove investment from balance sheet.

The journal entry is debiting cash and credit investment

It will increase the cash on balance sheet and remove the investment. The amount may de different depending on the actual reason.

If the return amount is higher than the initial investment, investors need to recognize the profit. This profit will be taxable depending on the local tax law.

The journal entry is debiting cash and credit gain.

Note: In this article, we ignore the revaluation method in which the company measures the investment at a fair value every accounting period.

Journal Entry for Return of Capital Example

Company ABC makes an investment of $ 200,000 into a start-up company. ABC records the investment on the balance sheet at the initial cost.

5 years later, a giant company purchase the whole start-up. ABC receives $ 300,000 for all the investment in the startup. ABC has no longer control or ownership in the start-up. Please prepare the journal entry related to the return of capital.

When ABC invest in the start-up company, we do not know the exact percentage so we are not sure about the treatment such as subsidiary or associate.  So we simply record it as an investment.

The journal entry is debiting investment of $ 200,000 and credit cash of $ 200,000.

The investment will increase by $ 200,000 and cash reduces by $ 200,000.

When ABC receives the capital back, it is more than the initial investment, so it means that company makes some profit over the investment.

First, we have recorded the return of capital by debiting cash $ 200,000 and credit investment $ 200,000.

The amount of cash that is more than the investment is considered as the gain on investment. The company needs to debit cash $ 100,000 and credit gain on investment $ 100,000.

The cash will increase as the company receive from the new acquirer. The gain on investment will be present in the income statement. It is subject to tax on profit.