What is Interest on Drawings?
We need to calculate interest on drawings when partner withdraws certain goods/assets from the business for a temporary period and interest is applicable on balance. The interest is calculated based on the time for which withdrawal was made.
Background
Any withdrawal of cash or goods from the business by its owners for their personal use is termed as drawings. Drawings are returned to the business; otherwise, they are deducted from the owner’s equity accounts. This deduction is not always made in the original amount (depending on the agreement); instead, it is charged at a mark-up depending on the circumstances; just as interest is charged on loan granted to an outsider. Similarly, interest is charged on drawings extracted by the proprietor or business partners. We understand that drawings are a reduction in business profit; however, interest in drawing adds to the business income.
This income is treated the same way as the income on loan disbursed.
Calculation for the interest of drawings
There are two methods to calculate interest on drawings:
- Simple method
- Product method
Simple Method:
Interest on Drawing = amount of drawings × Rate/100 × No. of months/12
For example:
Mr. David has withdrawn $300 for six months at an interest rate of 5%.
Interest on Drawing = 300 × 5/100 × 6/12 = $7.5
Product Method: (when unequal amounts are withdrawn at unequal intervals of time)
Interest on drawing = total of products × rate/100 × Average period/12
Total products are calculated by multiplying each drawing with the period for which it was drawn.
Conclusion
Drawing is when the owner draws goods/cash from the business for personal use. If goods are to be returned to the business and interest is agreed upon, the partner pays the interest to the business.
This interest can be calculated via two methods. These methods include the simple interest method and product interest method.
