Drawings in accounting refer to the withdrawal from a business by its owner in the form of cash or any other asset aimed to spend for personal use rather than business use. For instance, if the owner pays house rent, or buys a car, or pays a child’s tuition fee, or goes on a vacation using business capital, then it is recorded as a reduction to the owner’s equity account or drawings.
A drawing account is maintained to keep a record of such withdrawals. This account is used primarily by sole proprietorship and partnership firms. Maintaining drawings account is important because if the owner’s withdrawals are overlooked, then it can lead to discrepancies in the business’s financial statements. The drawings account acts as a counter account for the owner’s equity account; hence it is balanced and closed at the end of each financial year.
Further, it helps an owner to assess how many business resources they have extracted for their personal use.
Examples of Drawings in Accounting
For example, David owns the company, and he withdraws $2,000 every month for his personal use. This money is part of the business’s revenue generated from business operations. David uses the money for purchasing any items that are not related or used for the business, such as clothing, etc. Since the cash is part of the business’s assets, the transaction must be visible in its accounts. Hence, a drawing account is used to track all personal drawing by David. If David uses the same money to buy equipment for the business, then it won’t be considered as a drawing.
For Example, John and Mason are partners of a manufacturing firm ABC. John takes out $100 from the business’s bank account on a monthly basis. Mason does not withdraw any money. In this case, two drawing accounts would be formed named “Drawing-John” and “Drawing-Mason” to record their drawings separately. Hundred dollars per month will be reported to John’s drawing account. At the end of the year, the drawing account will be closed, and its balance will be transferred to John’s equity account; as a result, John’s equity will be reduced by $1,200 ($100 * 12 months). On the other hand, the account of Mason has a nil balance. Hence, there is no amount to be transferred.
How to treat Drawings in Accounting
The drawings are incurred from the business revenues; therefore, according to the Generally Accepted Accounting Principles (GAAP), they must be reported in the financial statements. This transaction will impact statements by showing a decrease in assets, specifically the cash account, and a mirror decrease in capital.
Following is a depiction:
|+ Profit for Period||$5,000|
Are Drawings an Asset or Expense?
Drawings are withdrawn from the business, mostly in cash form, for the owner’s personal expenses. When cash is retracted, it must be returned to the company by any means. Either the owner adds the amount of the annual drawing to the business bank account, or the equivalent value is reduced from the owner’s equity. In both circumstances, owners are held responsible for the transaction.
So, drawings are personal expenses and not business expenses. Hence, they are simple reductions in equity. So, drawing cannot be termed as assets or expenses.
Drawings as Journal Entries
When cash is withdrawn by owners, the cash account in the assets section is credited by the amount taken. Adjacently, the drawing account is debited by the same amount.
|Cash (The owner withdraws cash for personal use)||100|
At the end of the accounting period, the balance of the drawings account is closed in the respective capital account. The normal increase of capital accounts is credited, so a debit would mean that the account is being decreased. The drawing account must have zero balance at the start of the new accounting period.
|Drawings (Drawings are deducted from the owner’s account)||100|
Given is the closing entry, and balance is transferred from the drawings account to owner equity.
What type of account is a drawings account?
The drawing account is principally a contra-account to the capital account section. All drawings are eventually closed in the equity account (capital accounts). It is treated as an expense throughout the accounting period for convenience, but it is ultimately a track of the owner’s actions. It must coincide with the owner’s equity account.
Drawings Account Behavior in Company Ledgers
The ledger is maintained according to accounts separately, unlike journal entries. The ledger is updated monthly and closed upon the end of the accounting period. For the drawing account, each transaction is recorded individually, even if it occurred on the same day. The following table shows the ledger account of drawing. The transactions are identified by the date they were processed and recorded in the journal book. The balance is accumulated in the ledger accordingly.
The corresponding entries are made to the cash ledger.
At the end of the financial year, all capital accounts must be closed. The total balance of the drawing account is made zero by crediting it to the owner’s capital account.
|Dec 31 (end of the year)||200||200|
Similarly, the corresponding entries are made to the owner’s equity account.
|Dec 31 (end of the year)||200||200|
The net impact of closing entry is credit of drawing account and transfer of balance to the owner’s equity via debit.
Drawings in Profit and Loss Account / Income statement
The profit and loss account or the income statement reports the business’s income by reducing expenses from revenue generated. The impact of drawing is not shown on the profit and loss statement. Drawings are only the movement of cash from assets to the equity that is illustrated in the balance sheet. So, there is no impact on the profit and loss/income statement.
Drawings in the Balance Sheet
Drawings cause an indirect parallel impact on the company’s assets particularly, the cash account. This change is reported in the balance sheet of the company, where cash is credited and the owner’s equity is debited. Since the cash amount doesn’t fully tell us the details, the information relating to the drawings is included in the notes to the financial statements.
Reading on tothefinance.
Drawings are personal expenses of the owner. An owner might take out certain cash/goods from the business and make personal use. For instance, he/she might take cash from the business bank account and go shopping with his girlfriend. The shopping for a girlfriend has nothing to do with the business. Hence, this particular expense with the cash of business shall be classified as drawing.
Journal entry for the drawing is simple and straightforward; it’s debited from the owner’s equity and credit for the cash paid as drawing.
Drawings are neither assets nor liability; that’s the reduction of the company’s equity and deducted from the owner’s equity.