Can you explain interest on drawings?
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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Drawings refer to the money withdrawn by owners/partners for personal use from the business.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 It can be cash withdrawn from business or furniture or car etc. Drawings are money or assets that are withdrawn from a company by its owners for personal use and must be recorded as a reduction of assets.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on drawings is the amount of interest paid by the partners, calculated concerning the period for which the money was withdrawn.
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-
Interest on Drawings = Total of Products × Rate/100 × 1/12
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
Journal entry for interest on drawings:
Interest transferred to Profit & Loss A/c: