Adjusting Entries for Interest on Drawings
In accounting, drawings are withdrawals of cash, merchandise, or other items from the business by the owner for their personal use. In certain cases, drawings are treated as loans to the owner, with interest charged at the normal rate.
The amount of interest charged on drawings is an indirect income of the business. On the other hand, it is a personal expense of the owner. Interest on drawings has the following two effects on final accounts:
- It is an income of the business. Therefore, it will be recorded on the credit side of the profit and loss account.
- It is also a personal expense of the owner. Therefore, it will be added to the drawings account in the balance sheet and ultimately will be deducted from the capital.
Interest on drawings is a form of business income. Therefore, it is credited in the books of the business. The proper journal entry to record interest on drawings is given below:
On 1 January 2016, Mr. Black withdrew $2,000 in cash from his business for his personal use. The amount was not returned to the business until the end of the accounting period on 31 December 2016. The interest on drawings is to be charged @ 10% p.a.
Required: What adjusting entry should be made to record the interest on drawings at the end of the accounting period?
Interest on drawings = 2,000 × 0.1 = 200
Note for Students
In the example above, we calculated interest on drawings for the full year because the money was drawn for a full year.
If the withdrawal date was not given in the question, the interest on drawings would be calculated based on the whole amount for six months, assuming that the money is drawn throughout the year.