Interest on drawings

Drawings refer to the money withdrawn by owners/partners for personal use from the business. The drawings, in accounting terms, can be of any type. It can be cash withdrawn from business or furniture or car etc. Drawings are money or assets that are withdrawn from a company by its owners for personal use and must be recorded as a reduction of assets. It’s paid back to the business with some interest.

Interest on drawings is an income for the business and reduces the capital of the owner. Interest on drawings is the amount of interest paid by the partners, calculated concerning the period for which the money was withdrawn.

• It’s an income for the business. Hence, credited to P&L Appropriation A/c.
• It’s an expense for the owner/partner. Therefore, debited to owner’s/partner’s capital a/c
• Interest on drawings is charged to the partners only when there is an agreement made among the partners in this regard or if it is mentioned in the Partnership Deed.

Formulae for Interest on drawings

There are three formulae used for calculating the interest on drawings. They are:

1. Simple Method: In this method, as the name suggests, the amount of interest on drawings is calculated simply for the time the amount has been utilized.

Interest on Drawings = Amount of drawings × Rate/100 × No. of Months/12 

2. Product Method: This method is used when-

• Drawings are made of unequal amounts at irregular intervals of time. Then this formula is used-

Interest on Drawings = Total of Products × Rate/100 × 1/12

• When drawings are made of equal amounts at regular/equal intervals of time. Then interest on drawings can be calculated on the total of the amount drawn, for the average of the period applicable to the first and last installment.

Interest on Drawings= Total amount of drawings × Rate/ 100 × Average Period/12

Also, note-

Average Period = (No. of months left after first drawings+ No. of months left after last drawings)/2

Example:

Harish withdrew equal amounts at the beginning of every month for 9 months. Total drawings amounted to ₹6,000. Calculate the interest on drawings charged if the rate was 6% p.a.

Solution:

Average period = (No. of months left after first drawings+ No. of months left after last drawings)/2 = (9+1)/2 = 5 months 

Interest on Drawings = Total of drawings × Rate/100 × 5/12