In accounting, drawings mean the withdrawal of cash, merchandise or another item from business by the owner for his personal use. Sometimes, drawings are treated just like a loan to the owner and interest at normal rate is charged thereon.
The amount of interest charged on drawings is an indirect income of the business and 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 Profit and Loss Account.
- On the other hand, it is a personal expense of the owner, therefore; it will be added in the Drawings Account in Balance Sheet and ultimately will be deducted from the Capital.
The interest on drawings is an income for the business and is, therefore, credited in the books of the business. The proper journal entry to record interest on drawings is given below:
On January 1, 2016, Mr. Black withdraws $2,000 cash from business for his personal use. The amount is not returned to business till the end of the accounting period; December 31, 2016. The interest on drawings is to be charged @ 10% p.a.
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 our example, we have computed interest on drawings for the full year because the money has been drawn for a full year. If the date on which the amount is withdrawn is not given in the question, the interest on drawings will be computed on the whole amount for six months assuming that the money is drawn throughout the year.