Journal entry for Interest on Drawings is to record the interest income.
What’s the need to record?
Drawings might attract interest.
Are you wondering why there is an interest charge on drawings?
Come, let’s explore this.
Drawings are the amount that partners withdraw for personal use from the firm.
Businesses must find an alternative source of funds to replace the amount of the withdrawals.
Borrowing finances from other sources will not be cost-free.
Therefore, the business obtains funds from external sources to cover the amount of the draw.
That’s the logic for charging Interest on the drawings.
Wanna check some examples here?
Here we go…
- Cash Drawings,
- Usage of business Assets by the owner,
- Rental Payment of Owner’s Residence, or
- Payment of Personal Life Insurance (no commitment from business).
Table of contents
Journal entry for Interest on Drawings:
There is some flexibility in recording Interest on the Drawings Journal entries
Drawings Interest can be recorded in either the Capital account or the Drawing Account. Let’s examine both approaches.
1) Journal entry involving Capital Account
Recording of Interest receivable on drawings from partners:
2) Journal entry involving Drawings Account
We need to record the transaction using the drawing account. Later, the drawing account settles with a capital account on a periodical basis. Let’s look at these entries.
Recording Interest with drawings account:
Settlement of drawings accounts with the Capital account:
3) Blended Accounting treatment
The approaches are not over yet.
We got more.
Generally, payment for the Interest on drawings will not be in cash immediately. But in some rare scenarios, partners agree to repay the drawings and interest amount before the end of the year.
An alternative treatment will be posting the journal entry with the Interest receivable. The entry will be
Recording of Interest Receivable on Drawings:
The subsequent entry to record the receipt of the interest from partners.
Note: The above-blended approach does not happen frequently.
Runners Insight:
The rate of interest and repayment terms of both the Drawings and Interest will depend on the agreements among the partners. It’s worth reading the Partnership Acts to better understand all the applicable rules and regulations.
FAQs relating to Journal Entry for Interest on Drawings:
How do you record Interest on drawings?
Interest on drawings is income for the partnership firm. So, we will credit the income and gains according to the golden rules of accounting.
An income account can be increased by crediting it per modern accounting rules. The corresponding debit will be the Capital account to decrease to the extent of Interest payable by the partner or Bank account if the payment occurs immediately.
Is Interest on drawings debited or credited?
Interest on drawings will be on the credit side in the Partnership’s books.
Is interest on capital debited?
Interest on capital is also a related concept. Such interest is an expenditure to the business and will be debited in the journal entry. Refer to Capital Interest JE.
Will the Withdrawal of Cash for Office Use fall under Drawings?
Nope. Withdrawing cash for office use is for business operations, so the transaction will not fall under the personal drawings category.
Drawings come only if the funds or assets are used for personal purposes.
Why is Interest on drawings income?
The Interest charge on drawings compensates the Interest payable on External borrowings. The extent of the capital withdrawn from the business must be sourced from Lenders like Banks, Financial Institutions, etc. Such Borrowings attract Interest. So, there will be an interest charge on the drawings, which is income receivable from the partner to the entity.
Summary:
Interest on drawings is an income to the business and will be on the credit side of the journal entry. The Corresponding debit will be to the Capital account.
A capital account is a liability to the business. Interest on drawings is receivable from the partner. So, we will set off the capital liability with the Interest receivable asset. Therefore, debiting the capital account in the journal entry is appropriate.
We hope this article provided a better understanding of Interest on drawing entries.
