What is the Journal Entry for Interest on Drawings?

A journal entry for interest on drawings is a record of the interest that a business owner has paid on money borrowed from the business. This type of entry is typically made at the end of the accounting period and is used to adjust the balance in the owner's equity account. The journal entry for interest on drawings is typically a debit to the interest expense account and a credit to the drawings account. The amount of the debt will be the interest the business owner has paid on the borrowed money. The credit will be for the same amount and will be used to reduce the balance in the drawing account. The journal entry for interest on drawings is an integral part of the accounting process for businesses that borrow money from their owners. This entry ensures that the business owner's equity account is accurate and up to date. 

Did you know? An Italian mathematician named Luca Pacioli produced the first book on double-entry accounting in 1494, which introduced the concept of a journal entry.

What is Interest in Drawings?

The individual must repay the amount with interest within a specified period. The interest on the drawing is the amount of money the individual must pay back to the bank or financial institution. 

Interest on the drawing is the percentage of interest that is paid on money that is borrowed and not yet repaid. This can be money that is borrowed from a financial institution, such as a bank, or it can be money that is borrowed from another person. The interest that is paid on money that is borrowed from a financial institution is usually lower than the interest that is paid on money that is borrowed from another person. 

Also Read: Learn about Inventory Accounting - Meaning, Objectives, Types & Method

How to calculate interest on drawings? 

You can compute interest on drawings using either the direct technique or the product method. 

 1. Average period Method 

This approach is utilised when partners regularly withdraw the same amount. This method uses the following formula to calculate interest on drawings. 

Interest on Drawings = Drawings overall x Rate/100 x Average Period/12 

(Average Period = (Months left after first withdrawal Months left after last withdrawal) / 2) 

2. Product Approach 

This method is used when drawings are made in irregular intervals or in varying amounts. 

Interest on Drawings = Total Product X Interest Rate/100 X 1/12 

When equal amounts are withdrawn at regular or equal intervals of time, interest on drawing can be calculated on the total of the amount drawn, for the average of the period applicable to the first and last instalment. 

What is the Journal Entry 

A journal entry is a written record of a financial transaction. Journal entries are used to record transactions in the accounting system. A journal entry includes the transaction's date, the account's name, the amount of the transaction, and a description of the transaction. Journal entries are classified into two types: debits and credits. Debit entries are those journal entries that increase the balance of an account. Credit entries are those journal entries that decrease the balance of an account. 

The Journal Entry is the first step in the accounting cycle. Also, it is used to record transactions in the accounting system. Further, it includes the transaction's date, the account's name, the amount of the transaction, and a description of the transaction. 

Also Read: What are Expenses in Accounting? Meaning & Types of Expenses in Accounting

Journal entry for Interest on Drawings. 

In accounting, interest on drawings refers to the interest charged on money borrowed from a business by its owners. This is a short-term loan, and the interest is typically charged at a rate higher than the rate the company would pay if it borrowed money from a bank. The business owners may be charged interest on their drawings if they do not repay the money within a certain period or if the business does not have enough money to repay the loan. 

• Journal entry involving Capital Account 

Recording of Interest receivable on drawings from partners: 

• Journal entry involving Drawings Account 

We need to record the transaction with a drawing account. Later, the drawing account settles with the capital account on a periodical basis. Recording Interest with drawings account: 

Components of Journal entry for Interest on Drawings 

A few components make up a journal entry for interest on drawings. 

• The first is the transaction's date, which is the date that the interest was earned on the drawings.  
• The second is the account where the interest was earned. This is usually the account that the drawings were made from.  
• The third is the amount of interest that was earned. This is the amount of interest that was made in the drawings.  
• The fourth is the account that the interest was paid into. This is usually the account that the drawings were made from.  
• The fifth is the account that the interest was paid out of. This is usually the account that the drawings were made from. 
• The last thing that should be included in the journal entry is a brief description of the transaction. This will help to explain what the journal entry is for and will be helpful in the future if there are any questions about the transaction. 

Examples For Journal entries for Interest on Drawings 

Example 1: 

Interest is charged on drawings ₹500. 

• The Drawings Account gets debited with ₹500 
• Interest on Drawings gets credited with ₹500

Example 2:  

Case 1: Withdrawn cash from the business for personal use ₹5,000.

• The drawing account gets debited with ₹5000 
• Cash Account gets credit with ₹5000 

Case 2: Interest charged on Drawings @6%. 

• Drawing accounts get debit with 6% interest which is ₹300 
• Interest on drawing account get credit with the same amount of ₹300 

Important Points 

1. The interest on the drawings account is used to track the interest the business owes to its owners on the money they have drawn from the business.  
2. The journal entry for interest on drawings is typically made at the end of the accounting period.  
3. The amount of interest owed to drawings can be significant, especially for small businesses.  
4. Businesses need to keep track of the interest on drawings to budget for it and avoid surprises. 

Also Read: What is Management Accounting? Learn Definition, Importance, Objectives

Conclusion:

Interest on Drawing is an account used to track the interest income that a business earns from money it has invested. This account is essential because it helps companies keep track of their earnings and ensure they are getting the most out of their investments. In the journal entry, we discuss our interest in drawing. This is the amount of interest earned on borrowed money and then used for investments or other purposes. The interest in drawings can be a significant source of income for many people, and it is essential to understand how it works to make the most of it. 

Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.