Accountancy · Ch 1 — Accounting for Partnership: Basic Concepts
Interest on Drawings
Interest on Drawings
Interest on Drawings
When a partner withdraws money from the firm for personal use, the partnership deed may provide for charging interest on such drawings. This interest is an income for the firm and a charge against the partner who withdrew the money. The purpose of charging interest on drawings is to discourage partners from making excessive withdrawals, which can strain the firm's cash flow.
Key rule: No interest is charged on drawings unless the partnership deed expressly provides for it. If the deed is silent on this matter, no interest is charged.
The interest is calculated at the agreed rate for the period the withdrawn amount remained outstanding from the partner during the accounting year. The method of calculation depends on the pattern of withdrawals.
When Fixed Amounts Are Withdrawn Every Month
When a partner withdraws a fixed amount at regular intervals (say, every month), the interest is calculated using the average period method. The average period depends on when during the month the withdrawal was made.
(a) Withdrawal at the beginning of each month
If the amount is withdrawn on the first day of every month, the first withdrawal remains outstanding for 12 months and the last withdrawal for 1 month.
Average Period = (12 + 1) / 2 = 6.5 months (or 13/2 months)
Interest = Total Annual Drawings × Rate × 13/2 × 1/12
Example: Aashish withdrew ₹10,000 per month at the beginning of each month. Rate of interest = 8% p.a.
Total drawings = ₹10,000 × 12 = ₹1,20,000
Interest = ₹1,20,000 × 8/100 × 13/2 × 1/12 = ₹5,200
(b) Withdrawal at the end of each month
If withdrawn on the last day of every month, the first withdrawal remains outstanding for 11 months and the last withdrawal for 0 months.
Average Period = (11 + 0) / 2 = 5.5 months (or 11/2 months)
Interest = Total Annual Drawings × Rate × 11/2 × 1/12
Example: Aashish withdrew ₹10,000 per month at the end of each month.
Interest = ₹1,20,000 × 8/100 × 11/2 × 1/12 = ₹4,400
(c) Withdrawal in the middle of each month
When money is withdrawn in the middle of the month, nothing is added or deducted from the total period.
Average Period = (11.5 + 0.5) / 2 = 6 months
Interest = Total Annual Drawings × Rate × 6/12
Example: Aashish withdrew ₹10,000 per month in the middle of each month.
Interest = ₹1,20,000 × 8/100 × 6/12 = ₹4,800
When Fixed Amount Is Withdrawn Quarterly
When a fixed amount is withdrawn at the beginning or end of each quarter, the average period is calculated differently.
(a) Withdrawal at the beginning of each quarter
Average Period = (12 + 3) / 2 = 7.5 months
Example: Satish withdrew ₹30,000 quarterly at the beginning of each quarter. Rate = 8% p.a.
Total drawings = ₹30,000 × 4 = ₹1,20,000
Interest = ₹1,20,000 × 8/100 × 7.5/12 = ₹6,000
The detailed calculation can also be shown as:
| Date | Amount (₹) | Time Period | Interest (₹) |
|---|---|---|---|
| April 1, 2019 | 30,000 | 12 months | 30,000 × 8/100 × 1 = 2,400 |
| July 1, 2019 | 30,000 | 9 months | 30,000 × 9/12 × 8/100 = 1,800 |
| Oct. 1, 2019 | 30,000 | 6 months | 30,000 × 6/12 × 8/100 = 1,200 |
| Jan. 1, 2020 | 30,000 | 3 months | 30,000 × 3/12 × 8/100 = 600 |
| Total | 1,20,000 | 6,000 |
(b) Withdrawal at the end of each quarter
Average Period = (9 + 0) / 2 = 4.5 months
Interest = ₹1,20,000 × 8/100 × 4.5/12 = ₹3,600
The detailed calculation:
| Date | Amount (₹) | Time Period | Interest (₹) |
|---|---|---|---|
| June 30, 2019 | 30,000 | 9 months | 30,000 × 9/12 × 8/100 = 1,800 |
| Sept. 30, 2019 | 30,000 | 6 months | 30,000 × 6/12 × 8/100 = 1,200 |
| Dec. 31, 2019 | 30,000 | 3 months | 30,000 × 3/12 × 8/100 = 600 |
| March 31, 2020 | 30,000 | 0 months | 0 |
| Total | 1,20,000 | 3,600 |
When Varying Amounts Are Withdrawn at Different Intervals
When partners withdraw different amounts at different times, the product method is used. Under this method:
- For each withdrawal, multiply the amount withdrawn by the period (in months) for which it remained withdrawn during the financial year.
- The period is calculated from the date of withdrawal to the last day of the accounting year.
- Add all the products to get the total of products.
- Calculate interest as:
Interest = Total of Products × Rate × 1/12
Example: Shahnaz withdrew the following amounts during the year ending March 31, 2020. Rate = 7% p.a.
| Date | Amount (₹) | Time Period (months) | Product (₹) |
|---|---|---|---|
| April 1, 2019 | 16,000 | 12 | 1,92,000 |
| June 30, 2019 | 15,000 | 9 | 1,35,000 |
| Oct. 31, 2019 | 10,000 | 5 | 50,000 |
| Dec. 31, 2019 | 14,000 | 3 | 42,000 |
| March 1, 2020 | 11,000 | 1 | 11,000 |
| Total | 4,30,000 |
Interest = 4,30,000 × 7/100 × 1/12 = ₹2,508 (approx.)
When Dates of Withdrawal Are Not Specified
If the total amount withdrawn is given but the dates of withdrawal are not mentioned, it is assumed that the amount was withdrawn evenly throughout the year. In such a case, the average period is taken as 6 months (assuming withdrawals are made evenly in the middle of each month).
Example: Shakila withdrew ₹60,000 during the year. Rate = 8% p.a.
Interest = ₹60,000 × 8/100 × 6/12 = ₹2,400