class xii chapter 1 (d) Interest on Drawings

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Interest on Drawings

The partnership agreement may also provide for charging of interest on money withdrawn out of the firm by the partners for their personal use. As stated earlier, no interest is charged on the drawings if there is no express agreement among the partners about it.

However, if the partnership deed so provides for it, the interest is charged at an agreed rate, for the period for which drawings have been made. Remained outstanding from the partners during an accounting year. Charging interest on drawings discourages excessive amounts of drawings by the partners.

The calculation of interest on drawings under different situations is shown as here under.

When Fixed Amounts was Withdrawn Every Month

Many a time, a fixed amount of money is withdrawn by the partners, at equal time interval, say each month or each quarter. While calculating the time period, attention must be paid to whether the fixed amount was withdrawn at the beginning (first day) of the month, middle of the month or at the end (last day) of the month.

• Beginning of the month: If withdrawn on the first day of every month, interest on total amount will be calculated for 6½ months.
  Average Period = (12 + 1) / 2 = 6.5 months
• End of the month: If withdrawn at the end at every month, it will be calculated for 5½ months.
  Average Period = (11 + 0) / 2 = 5.5 months
• Middle of the month: If withdrawn during the middle of the month, it will be calculated for 6 months. When money is withdrawn in the middle of the month, nothing is added or deduced from the total period.
  Average Period = (11.5 + 0.5) / 2 = 6 months

Numerical Question 1

Problem: Aashish and John Ibrahm are partners. Aashish withdrew Rs. 10,000 per month during the year ending March 31, 2017 (Rate of interest: 8% p.a.). John withdrew Rs. 3,000 per month during the year ending March 31, 2020 (Rate of interest: 9% p.a.). Calculate interest for both assuming:

(a) Aashish withdraws at the beginning, middle, and end of the month.

(b) John withdraws at the beginning and end of the month.

Step-by-Step Solution:

Step 1: Calculate total drawings for Aashish.

Total Drawings = Rs. 10,000 × 12 months = Rs. 1,20,000

• Beginning (6.5 months): Rs. 1,20,000 × (8 / 100) × (13 / 24) = Rs. 5,200
• End (5.5 months): Rs. 1,20,000 × (8 / 100) × (11 / 24) = Rs. 4,400
• Middle (6 months): Rs. 1,20,000 × (8 / 100) × (6 / 12) = Rs. 4,800

Step 2: Calculate total drawings for John.

Total Drawings = Rs. 3,000 × 12 months = Rs. 36,000

• Beginning (6.5 months): Rs. 36,000 × (9 / 100) × (13 / 24) = Rs. 1,755
• End (5.5 months): Rs. 36,000 × (9 / 100) × (11 / 24) = Rs. 1,485

Numerical Question 2

Problem: Ram and Syam are partners sharing profits/losses equally. Ram withdrew Rs. 1,000 p.m. regularly on the first day of every month during the year 2015-16 for personal expenses. If interest on drawings is charged @ 5% p.a., calculate interest on the drawings of Ram.

Step-by-Step Solution:

Step 1: Identify the timing and calculate total drawings.

Withdrawals occur on the "first day of every month" (Beginning).

Total Drawings = Rs. 1,000 × 12 months = Rs. 12,000

Step 2: Determine the average period.

For drawings at the beginning of each month, the average period is 6.5 months.

Step 3: Apply the formula.

Interest = Total Drawings × (Rate / 100) × (Average Period / 12)

Interest = Rs. 12,000 × (5 / 100) × (6.5 / 12) = Rs. 325

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When Fixed Amount is withdrawn Quarterly

When fixed amount of money is withdrawn quarterly by partners, in such a situation, for the purpose of calculation of interest, the total period of time is ascertained depending on whether the money was withdrawn at the beginning or at the end of each quarter.

• Beginning of each quarter: If the amount is withdrawn at the beginning of each quarter, the interest is calculated on the total money withdrawn during the year, for a period of seven and half months i.e., (12+3)/2.
• End of each quarter: If withdrawn at the end of each quarter it will be calculated for a period of 4½ months, i.e., (9+0)/2.

Numerical Question 1

Problem: Satish and Tilak are partners in a firm, sharing profits and losses equally. During financial year 2016-2017, Satish withdrew Rs. 30,000 quarterly. If interest is to be charged on drawings @ 8% per annum, calculate average period and interest on drawings assuming:

(a) The amount is withdrawn at the beginning of each quarter.

(b) The amount is withdrawn at the end of each quarter.

Step-by-Step Solution:

Step 1: Calculate total drawings for the year.

Total Drawings = Rs. 30,000 × 4 quarters = Rs. 1,20,000

Step 2: Calculate for the beginning of each quarter.

Average period = 7.5 months (15/2).

Interest = Rs. 1,20,000 × (8 / 100) × (15 / 2) × (1 / 12) = Rs. 6,000

Step 3: Calculate for the end of each quarter.

Average period = 4.5 months (9/2).

Interest = Rs. 1,20,000 × (8 / 100) × (9 / 2) × (1 / 12) = Rs. 3,600

Numerical Question 2

Problem: Verma and Kaul are partners in a firm. The partnership agreement provides that interest on drawings should be charged @ 6% p.a. Kaul withdrew Rs. 3,000 per quarter, starting from April 01, 2019. Calculate interest on Kaul's drawings.

Step-by-Step Solution:

Step 1: Determine the timing of withdrawal.

"Starting from April 01" indicates the withdrawal happens on the first day of the quarter (Beginning).

Step 2: Calculate total drawings.

Total Drawings = Rs. 3,000 × 4 quarters = Rs. 12,000

Step 3: Apply the formula for the beginning of the quarter.

Average period = 7.5 months.

Interest = Rs. 12,000 × (6 / 100) × (7.5 / 12) = Rs. 450

The Magic Formula: Demystifying the "Average Period" Shortcut

Imagine a partner withdraws a fixed amount of money on the 1st of every single month. To calculate the interest on those drawings normally, an accountant would have to do 12 separate calculations! That is exhausting and leaves a lot of room for mathematical errors.

To save time, accountants use a brilliant shortcut called the Average Period Method. Instead of calculating interest for every single withdrawal, we group all the drawings together into one big total, and multiply it by a single "Average" time period.

But how do we find that magic average number? We use one simple, universal formula:

Average Period =
(Months left after FIRST drawing + Months left after LAST drawing) / 2

Understanding the Formula in Plain Words

To use this formula, assume your financial year runs from April 1st to March 31st (a full 12 months). You only need to ask yourself two questions:

• Question 1: On the exact day the partner made their very first withdrawal of the year, how many months were left until March 31st?
• Question 2: On the exact day the partner made their very last withdrawal of the year, how many months were left until March 31st?

Once you have those two numbers, simply add them together and divide by 2. Let's look at how this works in real life.

Practical Examples

Example 1: Withdrawals in the MIDDLE of every month

A partner withdraws Rs. 5,000 on the 15th of every month.

• First Drawing (April 15): Half of April is already gone. So, from April 15 to March 31, there are exactly 11.5 months left.
• Last Drawing (March 15): Only half of March is left. From March 15 to March 31, there is exactly 0.5 months left.

Applying the Formula:
(11.5 + 0.5) / 2   →   12 / 2 = 6 Months

The key number is 6. You will calculate interest on the total drawings for exactly 6 months.

Example 2: Withdrawals at the BEGINNING of every Quarter

A partner withdraws Rs. 10,000 on the first day of every quarter (April 1, July 1, Oct 1, Jan 1).

• First Drawing (April 1): This is the very first day of the year. The money stays in the firm for the entire year, meaning there are 12 months left.
• Last Drawing (January 1): This is the start of the final quarter. The money stays in the firm for January, February, and March. There are 3 months left.

Applying the Formula:
(12 + 3) / 2   →   15 / 2 = 7.5 Months

The key number is 7.5. You will calculate interest on the total drawings for 7.5 months.

Example 3: Withdrawals at the END of every Half-Year

A partner withdraws Rs. 20,000 at the end of every six months (September 30 and March 31).

• First Drawing (September 30): The first half of the year is completely over. From October 1 to March 31, there are 6 months left.
• Last Drawing (March 31): This is the very last day of the financial year. The books are closing immediately. There are 0 months left.

Applying the Formula:
(6 + 0) / 2   →   6 / 2 = 3 Months

The key number is 3. You will calculate interest on the total drawings for 3 months.

Pro-Tip for Students: As long as the amount withdrawn is the same every time, and the gap between withdrawals is exactly the same, this formula will never fail you!

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When Varying Amounts are Withdrawn at Different Intervals

When the partners withdraw different amounts of money at different time intervals, the interest is calculated using the product method. Under the product method, for each withdrawal, the money withdrawn is multiplied by the period (usually expressed in months) for which it remained withdrawn during the financial year. The period is calculated from the date of the withdrawal to the last day of the accounting year. The products so calculated are totalled on the total of the products interest at the specified rate is calculated as under:

Interest = Total of Products × Rate / 100 × 1 / 12

Numerical Question 1

Problem: John Ibrahm withdrew the following amounts during the year ending March 31, 2020: Rs. 12,000 on June 01, 2019; Rs. 8,000 on Aug 31, 2019; Rs. 3,000 on Sept 30, 2019; Rs. 7,000 on Nov 30, 2019; and Rs. 6,000 on Jan 31, 2020. Calculate interest on drawings if rate of interest is 9% p.a.

Step-by-Step Solution:

Step 1: Statements showing Calculation of Interest on Drawings.

Date	Amount Withdrawn (Rs.)	Period (in months up to March 31)	Product (Rs.)
Jun. 1, 2019	12,000	10	1,20,000
Aug. 31, 2019	8,000	7	56,000
Sept. 30, 2019	3,000	6	18,000
Nov. 30, 2019	7,000	4	28,000
Jan. 31, 2020	6,000	2	12,000
Total of Products			2,34,000

Step 2: Apply the product method formula.

Interest = Rs. 2,34,000 × (9 / 100) × (1 / 12) = Rs. 1,755

Numerical Question 2

Problem: Harry and Ali withdrew the following amounts from the firm, for their personal use during 2019-2020. The books are closed on December 31 every year. Calculate interest on drawings if the rate of interest to be charged is 10 per cent.

Harry: April 01 (5,000); July 01 (8,000); Dec 01 (5,000); March 01 (4,000).

Ali: April 01 (7,000); July 01 (4,000); Dec 01 (5,000); March 01 (9,000).

Step-by-Step Solution:

Step 1: Calculate the Statement Showing Calculation of Interest on Drawings for Harry.

Products = (5,000 × 12) + (8,000 × 9) + (5,000 × 4) + (4,000 × 1)

Products = 60,000 + 72,000 + 20,000 + 4,000 = Rs. 1,56,000.

Amount of Interest (Harry) = Rs. 1,56,000 × (10 / 100) × (1 / 12) = Rs. 1,300

Step 2: Calculate the Statement Showing Calculation of Interest on Drawings for Ali.

Products = (7,000 × 12) + (4,000 × 9) + (5,000 × 4) + (9,000 × 1)

Products = 84,000 + 36,000 + 20,000 + 9,000 = Rs. 1,50,000.

Amount of Interest (Ali) = Rs. 1,50,000 × (10 / 100) × (1 / 12) = Rs. 1,250

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When Dates of Withdrawal are not specified

When the total amount withdrawn is given but the dates of withdrawals are not specified, it is assumed that the amount was withdrawn evenly throughout the year. For calculation of interest, the period would be taken as six months, which is the average period assuming, that amount is withdrawn evenly in the middle of the month, throughout the year.

Numerical Question 1

Problem: Shakila withdrew Rs. 60,000 from partnership firm during the year ending March 31, 2020 and the interest on drawings is to be charged at the rate of 8 per cent per annum. Calculate the amount of interest on drawings.

Step-by-Step Solution:

Step 1: Identify that dates are not specified.

Total Drawings = Rs. 60,000.

Step 2: Take the average period of 6 months.

Step 3: Calculate the interest.

Interest = Rs. 60,000 × (8 / 100) × (6 / 12) = Rs. 2,400

Numerical Question 2

Problem: Amit and Bhola are partners in a firm. They share profits in the ratio of 3:2. As per their partnership agreement, interest on drawings is to be charged @ 10% p.a. Their drawings during 2019 were Rs. 24,000 and Rs. 16,000, respectively. Calculate interest on drawings based on the assumption that the amounts were withdrawn evenly, throughout the year.

Step-by-Step Solution:

Step 1: Note the total drawings for each partner.

Amit = Rs. 24,000; Bhola = Rs. 16,000.

Step 2: Apply the average period of 6 months for both.

Step 3: Calculate Amit's Interest.

Interest = Rs. 24,000 × (10 / 100) × (6 / 12) = Rs. 1,200

Step 4: Calculate Bhola's Interest.

Interest = Rs. 16,000 × (10 / 100) × (6 / 12) = Rs. 800

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