A drawing account is a financial account used by proprietors or partners in a business to record the withdrawals they make for personal use. These withdrawals may include cash or other assets taken from the business.
How the Drawing Account Fits into Accounting
The Basic Concept
The drawing account is distinct from the business’s main operating accounts. Its purpose is to clearly segregate owner withdrawals from the general expenses and income of the business. At the end of the fiscal year, this account is closed, and the balance is transferred to the owner’s equity account or the profit and loss account.
Process and Mechanism
- Recording Withdrawals: When a proprietor or partner withdraws money or assets from the business, an entry is made in the drawing account to reflect this transaction.
- Year-End Closure: At the end of the accounting period, the drawing account is closed by transferring its balance to the owner’s equity account, thereby resetting the drawing account balance to zero for the new accounting period.
Example of Drawing Account Transactions
Consider a scenario where a partner in a firm withdraws $5,000 during the year for personal expenses. The entries would be:
At year-end, if the total withdrawals recorded in the drawing account amount to $15,000, this balance is transferred as follows:
Historical Context
The concept of a drawing account has been foundational in partnership and proprietorship accounting for centuries. It provides a clear mechanism to separate personal withdrawals from business finances, ensuring transparency and accuracy in financial reporting.
Applicability in Modern Accounting
Proprietorships and Partnerships
The drawing account is predominantly used in businesses structured as sole proprietorships or partnerships. These business types require a method to differentiate between business operations and personal finances of the owner(s).
Relevance for Corporations
Corporations typically do not use drawing accounts due to their distinct legal and accounting requirements. Instead, dividends or salaries are used to distribute earnings to the shareholders or owners.
Comparisons with Related Terms
Owner’s Equity
Owner’s equity represents the owner’s interest in the business. It encompasses the initial capital contributed by the owner, plus any retained profits, minus any withdrawals recorded in the drawing account.
Retained Earnings
Retained earnings refer to the accumulated profits that are not distributed to the owners and are retained within the business for growth, debt repayment, or other purposes.
FAQs
What types of transactions are recorded in the drawing account?
How is the drawing account different from a capital account?
Is the drawing account a permanent account?
Summary
The drawing account is an essential tool for tracking personal withdrawals by business owners in proprietorships and partnerships. It ensures clear separation and proper accounting of personal and business finances. Understanding its use and implications is crucial for effective financial management and accurate reporting.
References
- Principles of Accounting by Belverd E. Needles Jr. and Marian Powers.
- Fundamentals of Financial Accounting by Fred Phillips, Robert Libby, Patricia A. Libby.
- Internal Revenue Service (IRS) guidelines on business accounting practices.
- Generally Accepted Accounting Principles (GAAP) resources.
By comprehending the drawing account’s role and its application, business owners can maintain clear and organized financial records, allowing for accurate end-of-year financial reporting and analysis.
