Drawing Account

What is a Drawing Account?

A drawing account, in the context of business finance, is a ledger that carefully tracks money and other assets withdrawn from a business.

Typically, this accounting record applies to businesses structured as sole proprietorships or partnerships, where owners have more flexibility in accessing business funds for personal use.

A drawing account is an essential aspect of accounting for businesses, primarily sole proprietorships and partnerships. It records the money and assets withdrawn by business owners for their personal use.

This article delves into the details of drawing accounts, their significance in financial records, and how they function in business finance.

Usage of Drawing Accounts

Drawing accounts plays a crucial role in specific business structures, especially in sole proprietorships and partnerships.

Let’s take a look at how these accounts play a role in different forms of business:

1. Sole Proprietorships: In a sole proprietorship, the owner is the business entity. The owner can use the business's assets for personal expenses as there is no individual entity. On the other side, if the business fails to pay, the owner's personal funds can be taken to pay off debts.  Owners in this setup use a drawing account for marking what they use as personal withdrawals from the regular business expenses.
2. Partnerships: Partnerships are business entities formed by two or more individuals who share ownership and financial responsibilities. Drawing accounts in partnerships helps track the withdrawals made by each partner for personal use, ensuring transparency and fairness in distributions.

Is Drawings an Expense?

Drawings accounts are not limited to tracking cash withdrawals, they include all assets that owners might withdraw from the business for personal use, including cash and other assets like equipment.

Personal withdrawals cannot be used as a tax-deductible business expense. Business owners must be aware of the regulations and tax implications surrounding an owner's draws. In many cases, an owner's draws are considered taxable income.

In addition to cash, this account carefully documents the withdrawal of various assets, such as equipment or inventory, for personal use. This comprehensive coverage ensures that all owner's draws are accounted for and do not go unnoticed.

One crucial aspect of this account is its role as a contra account to the owner's equity. In accounting, contra accounts are used to track transactions contrary to the main account.

Since owner withdrawals represent a reduction of the owner's equity in a business, the drawing account, with its debit balance, offsets the expected credit balance of an owner's equity account.

Contra accounts serve a vital role in double-entry bookkeeping. While the primary account records the standard transaction, the contra account records transactions that move in the opposite direction.

In the case of drawing accounts, the debit balance represents owner withdrawals and is offset by credits in cash accounts.

Purpose of a Drawings Account

The presence of a drawings account ensures that all drawings are clearly documented in financial records. This not only maintains accounting accuracy but also provides transparency, making it easier for business owners and accountants to understand the organization's financial health.

Drawings accounts work on an annual cycle. At the end of each fiscal year, the account is closed, and its balance is transferred to the owner's equity account. Then, in the new year, a fresh account is established for tracking distributions.

Some of the purposes include:

1. Tax Impact: Since taxes on withdrawals are paid by individual partners in a partnership, there is no tax impact on the business associated with the withdrawn funds.
2. Facilitating Fair Distribution: Drawings accounts also play a vital role in ensuring fair distribution among business partners in a partnership. They record the details and summary of distributions made to each partner based on the partnership agreement. This careful tracking ensures that each partner receives their appropriate share of the company's earnings, as agreed upon in the partnership terms.
3. Drawing Account vs. Business Expenses: A drawing account records owner withdrawals for the purpose of accounting clarity. Therefore, it doesn't appear on the income statement of the business and is not a business expense account. Business expenditures are expenses the enterprise acquires to function and generate income, such as leases, utilities, and wages. 

Recording Transactions in the Drawings Account

The journal entry involves a debit to the drawings account and a credit to the cash account (or the asset account from which the withdrawal is made).

Below is an example of the journal entry for the drawing account:

When closing the account, a sole proprietorship's entry typically includes a debit to the owner's capital account and a credit to the drawings account.

Understanding the drawings accounts is essential for small business owners, especially in sole proprietorships and partnerships.

While the owner's draws allow business owners to access their business's assets for personal use, they are not business expenses and must be recorded correctly.

Drawings accounts serve as a systematic way to manage and record these withdrawals, ensuring fairness in distribution among partners and maintaining the financial integrity of the business.

Business owners must be aware of the regulations and tax implications surrounding owner's draws, and seek guidance from professionals to ensure compliance and accurate financial reporting.

Researched and Authored by Pratik Bhatia | LinkedIn

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