Question

Illustrate how interest on drawings will be calculated under various situations.

Answer 1

When a partner withdraws any amount, either in cash or in any other form, from the firm for his/her personal use, then it is termed as drawings. The interest charged by the firm on the amount of drawings is termed as interest on drawings. The method of calculating interest on drawings depends on the information available for time and frequency of the drawings made by the partner. The following different situations of drawings made illustrate the calculation of interest charged on drawings.

Situation I: When all the information regarding amount, date and rate of interest on drawings is given: When a partner withdrew Rs 10,000 on July 01 and interest on drawings is charged at 12% pa and the firm closed its books on December 31 every year then interest on drawings amount to Rs 600.

Interest on drawings $=\text{Total Amount}\text{Drawn}\times \frac{\text{Rate of Interest}}{100}\times \frac{\text{Period}}{12}$

Interest on Drawings $=10000\times \frac{12}{100}\times \frac{6}{12}=Rs600$

Situation II: When information regarding amount, rate of interest on drawings is given

Case I: Sometimes amount and rate of interest on drawings (per annum) is given but date is not mentioned

In this case when the details regarding the amount of drawings and rate of interest on drawings (p.a.) is given but the date of drawings is not given then interest will be charged on average basis and the period of drawings will be taken as 6 months.

e.g., If a partner withdrew Rs 10,000 and rate of interest on drawings is 12% pa then the interest on drawings amounts to Rs 600.

Interest on drawings = $10,000\times \frac{12}{100}\times \frac{6}{12}=Rs600$

Case II: Sometimes the amount and rate of is interest on drawings is given but the date and per annum rate of interest is not mentioned.

In this case, when the date and the rate of interest are given but per annum is not specified, then annual interest is charged.

e.g., If a partner withdrew Rs 10,000 and interest rate is 12 %, then the interest on drawings amounts to Rs 1,200.

Interest on drawings = Total amount withdraw $\times \frac{Rate}{100}$

Interest on drawings = $10000\times \frac{12}{100}=Rs1,200$

Situation III: When a fixed amount is withdrawn at regular interval

Case I: Sometimes a fixed amount is withdrawn at the beginning of each month and the rate of interest is given then the interest is calculated for 6.5 months.

e.g., If a partner withdraws Rs 1,000 in the beginning of every month and the rate of interest is 12% pa, then the interest on drawings amount to Rs 780.

Interest on drawings $=12,000\times \frac{12}{100}\times \frac{6.5}{12}=Rs780$

Total amount of drawings $=(1,000\times 12)=Rs12,000$

Case II: Sometimes a fixed amount is withdrawn at the end of each month and the rate of interest is given then the interest is calculated for 5.5 months.

e.g., If a partner withdraws Rs 1,000 at the end of each month and rate of interest is 12% pa then interest on drawings amount to Rs 660.

Interest on drawings = Total amount of drawings $\times \frac{Rate}{100}\times \frac{5.5}{12}$

Interest on drawings $=12,000\times \frac{12}{100}\times \frac{5.5}{12}=Rs660$

Case III: Sometimes a fixed amount is withdrawn at the mid of each month and the rate of interest is given then the interest is calculated for 6 months.

e.g., If a partner withdraws Rs 1,000 on 15th of every month and the rate of interest is 12% p.a. then the interest on drawings amount to Rs 720.

Interest on drawings = Total amount of drawings $\times \frac{Rate}{100}\times \frac{6}{12}$

Interest on drawings = $12,000\times \frac{12}{100}\times \frac{6}{12}=Rs720$

Case IV: If a fixed amount is withdrawn in the beginning of every quarter then the interest is calculated for 7.5 months.

e.g., If a partner withdraws Rs 5,000 in the beginning of every quarter and rate of interest is 12% p.a. then the interest on drawings amount to Rs 1,500.

Interest on drawings = Total amount of drawings $\times \frac{Rate}{100}\times \frac{7.5}{12}$

Interest on drawings = $20,000\times \frac{12}{100}\times \frac{7.5}{12}=Rs1,500$

Total amount of drawings $=5000\times 4=Rs20,000$

Case V: If a fixed amount is withdrawn at the end of every quarter, then the interest is calculated for 4.5 months.

e.g., If a partner withdraws Rs 5,000 at the end of every quarter and the rate of interest is 12% pa then the interest on drawings amount to Rs. 900

Interest on drawings = Total amount of drawings $\times \frac{Rate}{100}\times \frac{4.5}{12}$

Interest on drawings $=20,000\times \frac{12}{100}\times \frac{4.5}{12}=Rs900$

Total amount of drawings $=5000\times 4=Rs20,000$

Situation IV: When different amount is at different intervals

When different amount is withdrawn by a partner at different dates then the interest is calculated by product method. The period of drawings is calculated from the date of withdrawal to the last date of the accounting year.

e.g., A partner withdraws Rs 6,000 on March 01, Rs 4,000 on June 01, Rs 5,000 on Aug 1 and Rs 2,000 on Nov 30 and the rate of interest on drawings is 12% p.a. The firm closes its book on December 31.

$\begin{array}{cccc}\text{Date}& \text{Amt. (Rs)}& \text{Outstanding Period}& \text{Product}\\ \text{Mar 01}& 6,000& 10& 6,000\times 10=60,000\\ \text{Jun 01}& 4,000& 7& 4,000\times 7=28,000\\ \text{Aug 01}& 5,000& 5& 5,000\times 5=25,000\\ \text{Nov 30}& 2,000& 1& 2,000\times 1=2,000\\ & & & \underset{–}{\overline{1,15,000}}\end{array}$

Interest on drawings = Sum of product $\times \frac{Rate}{100}\times \frac{1}{12}$

Interest on drawings $=1,15,000\times \frac{12}{100}\times \frac{1}{12}=Rs1,150$