Drawing Account

Definition

A Drawing Account is a type of account used in a sole proprietorship business model where the owners withdraw funds for personal use. This account keeps track of monies removed from the business by the owner, reducing the owner’s equity in the business. It is not an expense of the business, but rather a distribution of the owner’s equity.

Phonetic

The phonetics of the keyword “Drawing Account” is: ˈdrɔɪŋ əˈkaʊnt

Key Takeaways

1. Drawing Account Definition: A drawing account is a separate record maintained by sole proprietorships and partnerships to track any business income taken out for personal use. It literally represents business funds drawn by the owners for their personal needs.
2. Nature and Treatment: The drawing account is a contra-equity account and not an expense account, therefore it doesn’t directly affect the business’s profit and loss. However, it reduces the owner’s equity in the business and is closed to the capital account at the end of each accounting period.
3. Income Tax Considerations: Since the money drawn from the business is not considered a business expense, it is not tax-deductible. The owner is responsible for reporting draw amounts appropriately for income tax purposes.

Importance

The Drawing Account is a significant concept in business finance as it concerns the proprietor’s personal financial transactions within the business. When a business owner withdraws cash or other assets from the company for personal use, these are recorded in the Drawing Account. It reflects the amount of withdrawals made over a specific period, often a year. This account is important because it helps segregate business income from personal withdrawals, ensuring accurate accounting and clear financial analysis. It also aids in the calculation of the owner’s equity or capital to evaluate the financial health of the business. Thus, maintaining a separate Drawing Account enforces financial discipline and improves financial transparency.

Explanation

The primary purpose of a drawing account is to track the amounts that a business owner draws from the company’s profits for their personal use. This account is specifically necessary for businesses that operate under the legal structure of a sole proprietorship or partnership, where the business and the owner or partners are legally considered the same entity. Drawing accounts facilitate the segregation of business income and owner’s personal draw. This helps maintain financial clarity and aids in the proper management of cash flows. In essence, it acts as an intermediary to ensure business profits aimed at personal consumption are monitored and managed systematically. The use of a drawing account simplifies the accounting process by providing a more accurate view of the company’s actual retained earnings and the owner’s or partners’ equity. It is especially important when it comes to preparing the business’s financial statements and determining its worth. Not only does it track the owner’s withdrawals, but it also assists in calculating the reduction in owner’s equity that should be reported in the balance sheet. Essentially, a drawing account ensures a transparent and efficient financial management process within a business setting, aiding in improved decision-making.

Examples

A drawing account is an accounting record maintained to track money withdrawn from a business by its owners. It is used primarily for businesses that are partnerships or sole proprietorships. Here are three real world examples of how a drawing account might be used:1. Small Business Owner: Mr. Sullivan owns a small bookstore and to support his living expenses, he withdraws a certain amount from his business every month. These withdrawals are recorded in a drawing account. It serves as a record of the owner’s withdrawal which is not a business expense but reduces the owner’s equity in the business.2. Independent Contractor: Sarah works as a freelance graphic designer. She operates her business as a sole proprietorship from her home. Each month, she withdraws money for her personal use such as paying rent, groceries, etc. These withdrawals from the business are tracked in her drawing account.3. General Partnerships: In a restaurant business run by two partners, Jen and Ben, both of them withdraw a certain amount of money from the business each month for their personal use. These withdrawals are documented individually in two separate drawing accounts. This allows them to properly track the amount of money each partner has taken from the business profit.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Owner’s Equity
• Capital Account
• Withdrawal
• Net Income
• Balance Sheet

Sources for More Information

• Investopedia
• Accounting Coach
• The Balance Small Business
• Corporation Wiki