Investors invest in a company or business to receive returns in exchange. For companies, these returns come from dividends paid to shareholders. However, other business entities may not use these. For example, sole proprietorships, partnerships, etc., do not pay dividends. Instead, they allow owners to withdraw their profits through a drawing account.
What is a Drawing Account?
A drawing account is a financial account that records any drawings made by the owners of a business. These drawings usually include cash. In some cases, it may also contain other assets. A drawing account helps accountants track any profit distributions to the owners. However, it does not appear on the balance sheet on its own.
A drawing account is a contra-equity account. Essentially, it reduces the equity balance in the balance sheet without appearing on the statement. Like dividends, drawings do not constitute an expense in the income statement. Instead, it represents a reduction in capital for the business. At the end of each year, accountants close this account with the balance reducing the owner's equity.
What is the accounting for a Drawing Account?
A drawing account holds any withdrawals from a business by its owners. In most cases, it includes a debit for the amount withdrawn by the owners. It also impacts the relevant asset account, which usually includes cash. During the year, accountants record all withdrawals from the business in this account.
As stated above, a drawing account is a contra-equity account. It does not appear on the balance sheet on its own. However, it reduces the owners' equity reported in the statement. At the end of each period, accountants close the drawing account and transfer its balance to the equity account. It also constitutes a reduction in the owners' residual interest in the business entity.
What is the journal entry for Drawing Account?
The journal entry for a drawing account is straightforward. Usually, it includes the transaction where an owner withdraws resources from the business. In that case, the journal entry will be as below.
At the end of the period, accountants transfer any balances in the drawings account to the equity account. In this case, the balance in the equity account will decrease. The journal entry for the transaction will be as follows.
Red & Co. is a sole proprietorship. The owner withdrew $10,000 in cash for their personal use. The journal entry for this transaction is as follows.
The owner also withdrew a vehicle from the business. At the time, its carrying value was $5,000. The journal entry for the transaction is as follows.
At the end of the period, the accountants of Red & Co. transferred the drawings to the equity account. The journal entry for the transaction was as follows.
Businesses maintain a drawing account to record withdrawals of resources by their owners. Usually, it records owners withdrawing cash from the business for personal use. The drawings account does not appear on the balance sheet as it is a contra-equity account. At the end of each period, accountants transfer the balance in this account to the equity account.