Interest on Drawings

What is drawings in Partnership Accounts

Drawings means any amount withdrawn , either in cash or kind, by partners for personal use from the firm. Usually we think that drawings is done only in cash. But this is not correct. Drawings can be done in the form of any asset like cash, machine, vehicle, computer, stock, etc.

In other words whenever any partner takes any of the firms assets for his personal use then it is known as drawings

Journal entry for Drawings

• Drawings A/c Dr..
  • To Cash A/c
  • To Machine A/c
  • To Stock A/c
  • To Vehicle A/c
  • (Any asset which is withdrawn by the partner is credited)

• Partner Capital A/c Dr..
  • To Drawings A/c

Alternately, we can combine the above two entries and make a single entry

• Partner Capital A/c Dr..
  • To Cash A/c
  • To Machine A/c
  • To Stock A/c
  • To Vehicle A/c
  • (Any asset which is withdrawn by the partner is credited)

Types of Drawings

• Drawings are of two types
  • Drawings against Capital
  • Drawings against Profits

Drawings against Capital

When a partner withdraws the amount he has invested into the business then it is called as drawings against capital. Since this was the partners own money which he gave to the business so no interest on drawings is charged on this amount. However the impact of such drawings comes in the form of reduced interest on capital

Drawings against profits

Whatever profits are earned by the firm are distributed among the partners. It is their reward for doing business which they can use for meeting their personal expenses.

However the profits are known only at the end of accounting year after the final accounts are prepared. So the partners become entitled to withdraw their profits only at the end of accounting year. But usually partners does not wait for the end of year and starts withdrawing money during the year itself. This means that they are withdrawing profits in advance before they becomes entitled to it. Due to this reason firm can charge interest from partners on such drawings.

How to Calculate Interest on Drawings against profits

• There are two methods to calculate interest on Drawings against profits
  • Product Method - Can be used in each and every case
  • Average Period method - Can be used only when each drawings during the year is of same amount and the time interval between each successive drawings is also same. Example - If a partner withdraw Rs 5000 at the beginning of every month throughout the year. Or it can be at the end of every month, beginning of every quarter, etc.

Interest rate is usually given per annum. However when rate of interest is given without "per annum" words then interest is calculated without considering the time factor

Calculation of Interest under product method

Example -

Question - Suppose a partner has made drawings during the year as follows. Interest rate on drawings is 15% per annum

Answer - Notice that the amount of drawings is not equal and also the time interval between successive drawings is also unequal. So we will use the product method

Interest Calculated as 84000*15/100*1/12 = Rs 1050

Calculation of Interest under Average Period Method

This method is also known as short cut method.

• Can be applied only when a) amount of each drawings is same for a partner b) time interval between successive drawings is same

• Step 1 - Find the average Period applicable
  • Average Period = (Months left after 1st drawing + Months left after last drawing) / 2
• Step 2 - Find Interest
  • Interest on Drawings = Total Drawings X Interest Rate / 100 X Average Period / 12
  • where, Total Drawings = Sum of each drawing during the year. Suppose a partner withdraws Rs 5000 at the beginning of every month. Total Drawings = 5000 X 12 months = Rs 60000

In the below table the calculation of average period for each case of fixed amount of drawings is shown. Students can either understand the calculation or memorize the average period in each case.

Meaning of Quarter - The whole year is divided into four parts of 3 months each. Example 1st quarter - Apr to Jun, 2nd Quarter - July to Sep , 3rd Quarter - Oct to Dec, 4th Quarter - Jan to Mar

Meaning of half year - The whole year is divided into 2 parts of 6 months each. Example - 1st half - Apr to Sep, 2nd half - Oct to Mar

Drawings during 1st 6 months only - Sometimes question says that fixed amount withdrawn at fixed intervals for only 1st 6 months of the year. In such cases the calculation of average period will change accordingly. Mainly the period from last drawings will change in the formula.

• Example - A Partner withdraw Rs 2000 at the beginning of very month for 1st 6 months.
• So Average period will be
  • a) Months after 1st drawings - 12 mths (From 01-Apr to 31-Mar)
  • b) Months after last drawings - 6 mths (From 30-Sep to 31-Mar)
  • Average period = (12+6)/2 = 9 months.

• Drawings during last 6 months only - Sometimes question says that fixed amount withdrawn at fixed intervals for only last 6 months of the year. In such cases the calculation of average period will change accordingly. Mainly the period from first drawings will change in the formula.
  • Example - A Partner withdraw Rs 2000 at the beginning of very month for last 6 months.
  • So Average period will be
    • a) Months after 1st drawings - 6 mths (From 01-Oct to 31-Mar)
    • b) Months after last drawings - 1 mths (From 01-Mar to 31-Mar)
    • Average period = (6+1)/2 = 3.5 months.

Similarly students should recalculate average period in cases of drawings during 1st 6 months or last 6 months in other cases of drawings at end of month, beginning of quarter, end of quarter, etc.

Note : If date of drawings is not given then it is assumed to be done at the middle of every month. Hence in such case interest is calculated for 6 months average period

Example Average Period Method -

Suppose Mr X draws Rs 10000 periodically at equal intervals. Interest on drawings charges @ 15% p.a. Calculate Interest on Drawings if drawings are made regularly :

• In the beginning of the month
• In the middle of the month
• At the end of the month
• At the beginning of each quarter
• At the end of each quarter
• In the middle of each quarter

Answer - Here total drawings during the year are Rs 120000 (10000-12) in case of monthly/ Rs 40000 (10000*4) in case of quarterly drawings

Journal Entries for Interest on Drawings

• Partner Capital/Current A/c Dr..
  • To Interest on Drawings A/c
• Interest on Drawings A/c Dr..
  • To Profit and Loss Appropriation A/c

Alternately we can combine the above two entries to pass a single entry

• Partner Capital/Current A/c Dr..
  • To Profit and Loss Appropriation A/c

Note : Capital A/c to be used in case of fluctuating capital method and Current A/c to be used in case of fixed capital method

Product Method vs Average period method Difference