Drawings refer to the withdrawal of cash or other assets from a business by its owner for personal use. In sole proprietorships and partnerships, drawings are common as owners take out funds for personal expenses, living costs, or other non-business-related purposes. Unlike salaries, drawings are not considered business expenses and do not affect the profit and loss account. Instead, they reduce the owner’s equity or capital in the business.
1. Understanding Drawings
Drawings occur when the owner removes resources from the business for personal use. This can be in the form of:
A. Types of Drawings
- Cash Withdrawals: The most common form, where the owner takes out cash from the business.
- Goods Withdrawn for Personal Use: When the owner takes inventory or goods for personal consumption.
- Use of Business Assets: Personal use of business assets like vehicles, equipment, or property.
B. Drawings in Different Business Structures
- Sole Proprietorships and Partnerships: Owners withdraw funds directly, and these are recorded as drawings.
- Corporations: Drawings are not applicable. Owners receive money through dividends or salaries, which are handled differently in accounting.
2. Accounting Treatment of Drawings
Drawings reduce the owner’s equity in the business. They are recorded in a Drawings Account, which is a contra account to the owner’s capital account.
A. Journal Entry for Drawings
When an owner withdraws cash or goods, the following journal entry is made:
| Account | Debit | Credit |
|---|---|---|
| Drawings A/c | XXX | |
| Cash/Bank A/c (for cash withdrawals) OR Inventory/Assets A/c (for goods/assets withdrawn) |
XXX |
Note: At the end of the accounting period, the balance in the Drawings Account is transferred to the Capital Account, reducing the owner’s equity.
3. Examples of Drawings
A. Example 1: Cash Drawings
John, a sole proprietor, withdraws $2,000 from his business account for personal use.
Journal Entry:
| Drawings A/c | $2,000 | |
| Cash/Bank A/c | $2,000 |
B. Example 2: Goods Withdrawn for Personal Use
Sarah, a business owner, takes goods worth $500 from her store inventory for personal use.
Journal Entry:
| Drawings A/c | $500 | |
| Inventory A/c | $500 |
C. Example 3: Personal Use of Business Assets
Michael uses the company car for a personal trip. The estimated value of the usage is $300.
Journal Entry:
| Drawings A/c | $300 | |
| Vehicle Expenses/Depreciation A/c | $300 |
4. Impact of Drawings on Financial Statements
A. Balance Sheet
- Drawings reduce the capital or owner’s equity in the balance sheet. They are not shown as expenses but are deducted from the owner’s capital account at the end of the accounting period.
B. Profit and Loss Account
- Drawings do not appear in the profit and loss account as they are not considered business expenses. They affect only the owner’s equity.
5. Drawings vs. Salaries
It’s important to distinguish between drawings and salaries:
| Drawings | Salaries |
|---|---|
| Withdrawals of funds or assets by the owner for personal use. | Payments made to employees (including owners in corporations) for services rendered. |
| Not considered a business expense; reduces owner’s equity. | Considered a business expense; reduces profit. |
| Common in sole proprietorships and partnerships. | Common in corporations and larger businesses. |
6. Importance of Properly Recording Drawings
A. Accurate Financial Reporting
- Ensures that the financial statements reflect the true position of the business’s capital and assets.
B. Separation of Business and Personal Finances
- Helps maintain a clear distinction between business and personal expenses, which is essential for legal and tax purposes.
C. Compliance with Tax Regulations
- Proper recording of drawings ensures compliance with tax regulations, especially when determining taxable income.
D. Monitoring Owner Withdrawals
- Tracking drawings helps owners manage how much they are withdrawing from the business, ensuring sufficient funds remain for business operations.
7. Common Mistakes to Avoid When Recording Drawings
A. Treating Drawings as Expenses
- Solution: Record drawings in the Drawings Account, not as business expenses in the profit and loss account.
B. Failing to Record Non-Cash Drawings
- Solution: Ensure that goods or assets withdrawn for personal use are recorded as drawings, not left unaccounted for in inventory or asset accounts.
C. Not Adjusting for Drawings at Year-End
- Solution: Transfer the drawings balance to the capital account at the end of each accounting period to reflect the reduction in the owner’s equity.
The Role of Drawings in Business Accounting
Drawings play a significant role in the accounting of sole proprietorships and partnerships, reflecting the personal withdrawals made by owners from the business. Properly recording drawings ensures that financial statements present an accurate picture of the business’s financial position and that personal and business finances are clearly separated. By maintaining accurate records of drawings, businesses can ensure compliance with tax regulations, support effective financial management, and safeguard the sustainability of their operations.