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The direct approach or the product method can be used to calculate interest on drawings. Interest on drawings can also be calculated using the average period technique if the partners withdraw a specified amount at a fixed time interval. Different methods for calculating interest on drawings can be used depending on the dates of the drawings and the amount of drawings.
There are some methods to calculate the interest on Drawing.
Direct Method
Interest is calculated on drawings for the period between the date of the drawings and the accounting year’s closing date. Interest on drawings equals the amount of drawings multiplied by the rate of interest multiplied by the period of interest.
Interest on Drawings=Amount of Drawing×Rate of interest ×Period of Interest
The term “interest period” refers to the time between the date of the drawings and the end of the accounting year. When different sums are removed at different times, this procedure is appropriate.
Product Method
Interest is calculated using the product method on the total of the products, which is the product of the amount of drawings and the time for which the amount was withdrawn. If the product is determined in months, interest is calculated at a monthly rate on the total of products. If the product is determined in days, interest is calculated at a daily rate on the total number of products. As an alternative to the direct method, this strategy can be employed in any situation.
The following is the procedure for calculating interest on drawings using the product method:
- To determine the individual product, multiply each amount withdrawn by the relevant period (in months).
- Calculate the total value of all the individual products.
- Using the formula below, calculate interest at the recommended rate for one month.
If the interest period is measured in days, each amount withdrawn must be multiplied by the relevant period (in days) to get the individual product, and the interest on drawings must be calculated using the formula below.
Average Period Method
If the partners withdraw a given amount at a fixed time interval, the average duration may be used to calculate interest on the drawings. Monthly, quarterly, half-yearly, once every two months, and once every four months are all examples of fixed time interval withdrawals. To compute interest on drawings, use the following formula:
Interest on Drawing=Total amount of drawings made during the year x Rate of Interest per annum
Conclusion
Different methods for calculating interest on drawings can be used depending on the dates of the drawings and the amount of drawings. Interest is calculated on drawings for the period between the date of the drawings and the accounting year’s closing date. Interest is calculated using the product method on the total of the products, which is the product of the amount of drawings and the time for which the amount was withdrawn. If the product is determined in months, interest is calculated at a monthly rate on the total of products. If the product is determined in days, interest is calculated at a daily rate on the total number of products. As an alternative to the direct method, this strategy can be employed in any situation.
