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Interest on Drawings

The amount withdrawn by the partners for their personal use out of the firm is known as drawings. On these drawings, the partnership agreement may provide for charging interest. Drawings may be against profits or against capital.
 

Interest is computed on the basis of the period for which the money remained outstanding from the partners during the course of the accounting year.
 

Interest on drawings is to be calculated with reference to the time period for which the money was used by the partner. The various situations are discussed under:

Steps for Calculating Interest on Drawings under Product Method

Step 1: Compute the number of months or days from the day of drawings up to the end of year.
 

Step 2: Multiply the amount withdrawn with the corresponding months/days computed in step 1.
 

Step 3: Find out the total of the products computed in step 2.
 

Case 1- When the step 1 above is calculated in months

 

Interest on drawings = Total of the product (calculated in step 3 above) x Rate of interest/100 x 1/12
 

Case 2- When the step 1 above is calculated in days

 

Interest on drawings = Total of the product(calculated in step 3 above) x Rate of interest/100 x 1/365

 

Note: Interest on drawings is to be charged from the partners only when the partnership agreement provides for the same.

 

Average period should be used only when the amount of drawings is uniform and the time interval between two consecutive drawings is uniform.
 

Interest on drawings is an income to the firm, and hence it is credited to the profit and loss appropriation account. On the other hand, interest on drawings is an expense to the partners, and hence it is debited to their capital accounts. The journal entries to be passed for interest on drawings are as follows:
 



Illustration 2

 

Calculate the interest on drawings of X at 10 per cent p.a. for the year ended 31st December 2013 in each of the following cases:

  1. If his drawings during the year were ₹ 12,000.
  2. If he withdrew ₹ 1,000 at the beginning of every month.
  3. If he withdrew ₹ 1,000 at the end of every month.
  4. If he withdrew ₹ 1,000 every month.
  5. If he withdrew the following amounts: 31st January ₹ 3,000; 31st March ₹ 2,000; 1st July ₹ 4,000; 30th September ₹ 1,500; 1st November ₹ 2,500.
  6. If he withdrew ₹ 3,000 at the beginning of each quarter.
  7. If he withdrew ₹ 3,000 at the end of each quarter.
  8. If he withdrew ₹ 3,000 during the middle of each quarter.

Solution:
 

Case (a): Assuming that the drawings were made evenly throughout the year, the interest on drawings has been calculated for an average period of 6 months:

 

Interest on drawings Description: 24940.png


Case (b): Average period
= (Longest outstanding period + Shortest outstanding period)/2 = (12 + 1)/2 = 6½ months

 

Interest on drawings = Description: 24931.png


Case (c): Average period
=(Longest outstanding period - Shortest outstanding period)/2 = (12 - 1)/2 = 5½ months

 

Interest on drawings = Description: 24924.png


Case (d): Average period
= (Longest outstanding period - Shortest outstanding period)/2 = (11.5 + 0.5)/2 = 6 months

 

Interest on drawings = Description: 24916.png


Case (e):

 


 

Interest on drawings = Description: 24891.png

Case (f): Average period = (Longest outstanding period + Shortest outstanding period)/2 = (12 + 3)/2 = 7 ½ months

 

Interest on drawings = Description: 24883.png

Case (g): Average period = (Longest outstanding period + Shortest outstanding period)/2 = (9 + 0)/2 = 4 ½ months

 

Interest on drawings = Description: 24876.png


Case (h): Average period
= (Longest outstanding period + Shortest outstanding period)/2 = (10.5 + 1.5)/2 = 6 months

 

Interest on Drawings = Description: 24869.png


Illustration 3

 

X, Y and Z are three partners in a partnership firm since 31st March 2013. They share profits and losses equally. According to the partnership agreement, interest on drawings is to be charged at the rate of 10 per cent p.a. Drawings made by the partners during the year 2013–2014 are as follows:



The profits for the year amount to ₹ 15,000. You are required to compute the interest on drawings recoverable from the partners.


Solution:

 

Computation of interest on drawings



Amount of interest (on the total product for 1 month):

 





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