Interest on Drawing in case of Partnership
Interest on Drawings is an interest charged on the amount withdrawn by the partners for personal use. Such interest is an income for the firm and an expense for the partners, and hence is credited to the Profit and Loss Appropriation Account of the firm and is deducted from the partner’s Capital/Current Account. Interest on drawings is to be charged when specifically provided in the Partnership Deed along with the rate of interest. Interest on drawings should be charged from the date of withdrawal of the amount till the date of the preparation of Balance sheet. However, in case no date of withdrawal is mentioned, interest on drawings should be charged for the half-year (six months) on the whole amount based on the assumption that drawings are made evenly throughout the year.
Difference between Drawing against Profit and Drawing against Capital:
Drawing against Profit
Drawing against Capital
|Meaning||Drawing against profit means the amount withdrawn by the partners for personal use is a part of the profit earned by the firm in its ordinary course of business operation.||Drawing against capital means the amount withdrawn by the partners for personal use in excess of the profit amount. Such drawings are considered to be part of the capital.|
|Effect on Capital||No effect on capital.||The capital of the partners is deducted/ reduced by the amount of drawing.|
|Effect on Interest on Capital||It is not considered to calculate Interest on Capital.||It is considered to calculate Interest on Capital.|
|Charging Interest on Drawings||Under such a situation Interest on drawings is charged on the amount of drawings.||Interest on drawings is not charged separately as the amount of drawing is deducted directly from the capital and reduces the amount of Interest on Capital.|
The Capital accounts of the partners are maintained using either of the following methods:
- Fixed Capital Account.
- Fluctuating Capital Account.
The Accounting Treatment of Interest on drawings depends upon the method of maintaining the capital account used by the firm.
1. Fixed Capital Account:
Under this method, the capital invested at the beginning remains constant unless additional capital is introduced. So, a separate account called a Current Account or Drawing Account is prepared to treat the Interest on drawings. Interest on drawings being an expense for the partner is debited to the Partner’s Current Account.
Interest on drawings under Fixed Capital Account method is treated as:
Posting in Various Accounts:
** denotes that Current A/c can either have credit or debit balance unlike Capital A/c that only have credit balance.
Shiv and Ram are partners sharing profit in a ratio of 1:1. They follow a Fixed Capital Account method, and their fixed capital is ₹5,00,000 and ₹3,00,000, respectively. Their Drawings during the year are ₹50,000 and ₹20,000, respectively. Interest on Drawing is charged @10% p.a. as per the Deed. Balance of Current A/c of Shiv and Ram are ₹80,000 (Cr.) and 60,000 (Cr.), respectively. Pass the necessary Journal entries and show the treatment of Interest on Drawing in Profit and Loss Appropriation Account and Partner’s Capital/ Current Account.
2. Fluctuating Capital Account:
Under this method, the capital of the partners changes throughout the year, and hence no separate account is needed. All the items are recorded in a single Capital Account. So, Interest on drawings being an expense for the partner is debited to the Partner’s Capital Account.
Interest on drawings under Fluctuating Capital Account method is treated as:
Posting in Various Accounts:
Shyam and Ram are partners sharing profit in a ratio of 1:1. They follow a Fluctuating Capital Account method and their capital on 1st April 2020, is ₹10,00,000 and ₹8,00,000, respectively. Their Drawings during the year are ₹80,000 and ₹50,000, respectively. Interest on Drawing is charged @10% p.a. as per the Deed. Pass the necessary Journal entries and show the treatment of Interest on Drawing in Profit and Loss Appropriation Account and partner’s Capital Account.
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