Drawing Account is Which Type of Account?

In the world of finance and business accounting, a “Drawing Account” plays a unique role in keeping the financial affairs of a business organized and transparent. Whether you’re a sole proprietor, a partner in a partnership, or a shareholder in a closely held corporation, understanding the concept of a drawing account is crucial for maintaining clear financial records and making informed financial decisions.

What Is Drawing Account?

When a sole proprietor or the business owner withdraws assets such as goods or cash from business for his personal use, accounting termed it as owner’s drawing. In order to keep track of these drawings from the owner in a given fiscal year, drawing account is generated. Drawing account is a contra owner’s equity account which reports withdrawals made by business owner for his personal use during a specific accounting year. Simply, it is the reduction in the owner’s total investment amount. Thus, it is a capital account.

Drawing Account

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Nature of Drawing Account

Drawing account is temporary in nature because it is created for a specific accounting period. It is an owner’s equity contra account as any withdrawal made by business owners ultimately will reduce owner’s equity account. Drawing account is primarily used for partnership or sole proprietorships businesses.

  • Balance Sheet: Owner’s drawings are subtracted from the owner’s equity section on the balance sheet, showing the reduced ownership interest in the business.
  • Income Statement: Unlike expenses that affect net income, drawings are not considered business expenses. They are not included in the determination of net income.

Effect on accounting equation

Double-entry system requires debit as well as credit in every journal entry. Cash or any asset withdrawal will require a credit to the asset account and in response drawing account is created. All drawings debit balance in a given accounting year will than closed by transferring it to the owner’s equity account.

Drawing Account

In a business, every transaction changes or have an impact on accounting equation.

Assets (decreases) = liability (no change) + equity (decreases)

Drawing Journal entry

Date

Particulars

Debit

Credit

XXX

Drawing a/c

XXXX

 
 

                 Cash a/c

 

XXXX

Drawing adjusting entry

Date

Particulars

Debit

Credit

XXX

Capital a/c

XXXX

 

 

                 Drawing a/c

 

XXXX

Example

Assume that Mr. John invested $30,000 cash and brings equipment worth $15,000 to start a sole proprietorship business with the registered name of ABC Company on 1st April 2023. Suppose Mr. John withdraws $1,000 and $500 from business for his personal use at the end of July and September 2023, respectively. This will lead toward reduction in company’s assets and creation of drawing account. The journal entries are:

Date

Particulars

Debit

Credit

1st April 2023

Cash

Equipment

$30,000

$15,000

 

 

                  Owner’s Capital

 

$45,000

July 30

Drawing a/c

$1,000

 

 

                 Cash a/c

 

$1,000

Sep 30

Drawing a/c

$500

 

 

                 Cash a/c

 

$500

Drawing account is temporary in nature and closed by transferring it to the owner’s equity account. Thus, total drawing amount ($1,000 + $500 = $1,500) will then transferred to the owner’s equity account at year end 2023 by reducing owner’s equity by $1,500.

Adjustment at the yearend:

Date

Particulars

Debit

Credit

30 Dec, 2023

Capital a/c

$1,500

 

 

                 Drawing a/c

 

$1,500

Is Drawings an Expense Account Or A Liability Account?

“Drawings” typically refers to the withdrawals or distributions that a business owner takes from their business for personal use. In accounting, “drawings” are not considered an expense account or a liability account, but rather an equity account.

When a business owner withdraws money from the business for personal use, it’s important to track these transactions separately from the business’s regular operations. This is usually done by creating a “Drawings” account in the equity section of the accounting records. This account is used to record the reduction of the owner’s equity (specifically, the owner’s capital account) as a result of the owner taking money out of the business.

So, in summary:

  • Expense Account: Expenses are costs incurred by the business in its operations, such as salaries, rent, utilities, etc. Drawings are not considered expenses because they are personal withdrawals by the owner and not related to the business’s operating expenses.
  • Liability Account: Liabilities are obligations or debts that a business owes to external parties, such as loans or accounts payable. Drawings are not considered liabilities because they represent money taken out of the business by the owner and do not create obligations to external parties.
  • Equity Account: Drawings are recorded as a decrease in the owner’s equity in the business. The equity section of the balance sheet includes accounts related to the owner’s investment (capital) and any withdrawals (drawings) made by the owner.

It’s important to note that the treatment of drawings can vary depending on the legal structure of the business (sole proprietorship, partnership, and corporation) and the specific accounting practices being followed. Consulting with an accountant or financial professional is recommended to ensure accurate and compliant accounting for your specific business situation.

Key Points

  1. Definition: A drawing account is a record used to track withdrawals made by the owner or owners of a business for personal use. It’s essentially a way to separate personal transactions from business transactions in the accounting records.
  2. Equity Account: The drawing account is classified as an equity account, specifically under the owner’s equity section of the balance sheet. It represents the reduction in the owner’s equity caused by the owner withdrawing funds from the business.
  3. Types of Entities: Drawing accounts are most commonly associated with sole proprietorships and partnerships, where the owners’ personal finances are closely intertwined with the business finances. In corporations, a similar concept might be referred to as “Dividends Payable” or “Distributions to Shareholders.”
  4. Recording Withdrawals: When the owner takes money out of the business for personal use, it’s recorded as a debit to the drawing account and a credit to the cash account (or another appropriate asset account). This decreases the owner’s equity.
  5. Separation of Accounts: Maintaining a separate drawing account helps in tracking the owner’s personal transactions separately from business transactions. This separation is crucial for accurate financial reporting and tax purposes.

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Hira Aziz

Hira Aziz - Author

She is a Business Content writer and Management contributor at 12Manage.com, where she contributes a business article weekly. She has over 2 years of experience in writing about accounting, finance, and business.

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