how to treat interest on drawing charged in accounting equation?
Answers
Interest on Drawings is charged from the owner for the withdrawals made by him. Therefore, it is an expense for the owner and an income for the business.
So, it is shown as a deduction as well as addition to Owner's Equity in the Accounting Equation.
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Answer:
The required answer is:
Interest on drawings is added as well as subtracted from the capital in the accounting equation.
Explanation:
Drawing interest can be calculated using either the direct technique or the product method. Additionally, interest on withdrawals may be computed using the average period technique if partners withdraw a set amount at a set interval. There are various ways to calculate interest on drawings depending on the dates and quantity of drawings.
(i) Direct method:
Interest is charged on withdrawals during the time frame between the date of the withdrawal and the accounting year's end. The interest on drawings is calculated using the formula below:
Interest on drawings = Amount of drawings x Rate of interest x Period of interest
(ii) Product method:
Under the product approach, interest is computed on the sum of the products, which is the product of the number of withdrawals and the time during which they were made. Interest is computed on the total amount of products at the rate per month if the product is expressed in terms of months. Interest is computed on the entire amount of products at the rate per day if the product is calculated in terms of days. In all circumstances, this approach can be utilized instead of the direct approach.
Interest on drawings = Sum of products x Rate of interest p.a. × 1/12
(iii) Average period method:
If the partners make fixed-amount withdrawals at set intervals, the interest on those withdrawals may be computed using the average period. Fixed time intervals include withdrawals made every month, quarter, half-year, every two months, and every four months.
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