In a partnership firm, the partners may withdraw certain amounts from the firm for their personal use. Such amounts withdrawn by the partners are called drawings. This amount is usually deducted from their capital. The partners are required to pay an amount as interest, based on the time period forRead more
In a partnership firm, the partners may withdraw certain amounts from the firm for their personal use. Such amounts withdrawn by the partners are called drawings. This amount is usually deducted from their capital. The partners are required to pay an amount as interest, based on the time period for which the money was withdrawn. This amount is called Interest on Drawings.
The journal entry for interest on drawings is as follows:
Since interest on drawings is an income to the firm, it is credited based on the rule that “increase in incomes are credited”. Since the partner has to bear the interest amount, his capital account is debited as a “ decrease in capital is debited”.
FORMULAS
The basic formula for interest on drawings is:
Interest on drawings = Amount of Drawings x Rate/100 x No. of months/12
- When equal amounts of drawings are withdrawn at the beginning of every month, then
Interest on Drawings = Total Drawings x Rate/100 x (12+1)/2 - When equal amounts of drawings are withdrawn at the end of every month, then the Interest on Drawings = Total Drawings x Rate/100 x (12-1)/2
- When the date of the drawing is not specified, it is assumed to be withdrawn evenly. Hence Interest on Drawings = Total Drawings x Rate/100 x 6/12
The calculations in 1,2 and 3 are done so that drawings can be calculated for the average period.
EXAMPLE
Jack is a partner who withdrew $20,000 on 1st April 2020. Interest on drawings is charged at 10% per annum. If we have to calculate interest on drawings as of 31st December, then
Interest on Drawings = 20,000 x 10/100 x 9/12 = $1,500
(Here, interest on drawings is outstanding for 9 months, that is from April to December)
Interest on capital is the interest provided on the capital invested in the business. It is calculated as a percentage on the capital invested. Interest on capital is provided if there is any rule established by the owner of the capital. Otherwise, it is not provided. We generally encounter ‘InteresRead more
Interest on capital is the interest provided on the capital invested in the business. It is calculated as a percentage on the capital invested. Interest on capital is provided if there is any rule established by the owner of the capital. Otherwise, it is not provided.
We generally encounter ‘Interest on capital’ in partnership accounting but a sole proprietorship can also provide interest on capital.
Interest on capital is charged or appropriated from the profits of the firm. Hence, it appears on the debit side of the profit and loss account.
The journal entry is as follows:
The partners, in case the firm makes profit, are provided interest on their capital balance apart from their share of profit if provision of interest on capital is mentioned in the partnership deed.
Hence, interest on capital is an appropriation of profit in partnership accounting. The journal in case of partnership account is as follows:
The Interest on capital is credited to the capital/ partners’ capital account thereby increasing the capital balance. The journal is as follows:
In the balance sheet it is shown as an addition to the capital account.
Numerical example
P, Q and R are partners. Their firm reported a net profit of ₹ 20,000. Their capitals are ₹30,000, ₹45,000 and ₹60,000. It is in their partnership deed to provide the partners 4% interest on capital and a salary of ₹5,000 per annum for Q. Calculate the interest on capital.
Solution:
Interest on capital to be provided to the partners:
P – ₹30,000 x 6% = ₹1,800
Q – ₹45,000 x 6% = ₹2,700
R – ₹60,000 x 6% = ₹3,600
This interest will be credited to the partners’ capital. The journals are as follows:
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