What are Drawings in Accounting?

Definition of Drawings in Accounting

In the accounting world, drawings refer to the withdrawal of funds or assets from a business by its owner (or owners) for personal use.

 

These withdrawals are typically made by sole traders or partners in a partnership.

 

Business drawings can take various forms, including cash, goods, or services, and represent a reduction in the owner’s equity in the business.

What are Drawings in Accounting?

Why Are Drawings Made?

Owners usually make drawings for personal reasons, such as to cover personal expenses or to simply take profits out of their business.

 

These transactions are different from the business’s regular expenses, which are incurred in the day to day running of the business.

Drawings in Different Business Structures

The use of drawings holds varying significance in different business structures:

 

Sole Trader

 

In a sole trader arrangement, the business and the owner are considered a single entity.

 

Therefore, drawings directly affect the owner’s equity, and are essential for the owner’s livelihood.

 

Partnerships

 

In partnerships, drawings are often used to distribute profits among partners, reflecting their share in the business.

 

Properly managing drawings ensures fairness and equity among partners.

 

Corporations

 

Corporations, unlike sole proprietorships and partnerships, typically do not have drawings in the same sense.

 

Instead, shareholders receive returns on their investments through dividends, and executives may also receive compensation packages separate from dividends.

How Drawings Affect the Accounting Equation

To understand the impact of drawings on a business’s financial position, it is important to consider the accounting equation:

 

Assets = Liabilities + Owner’s Equity

 

  • Assets: These are the resources owned by the business, including cash, inventory and equipment.
  • Liabilities: These represent the company’s obligations to external parties, such as loans, accounts payable and other debts.
  • Owner’s Equity: This is the residual interest in the assets of the entity after deducting liabilities. It belongs to the owner(s) and represents the owner’s financial interest in the business.

 

When an owner makes a drawing, it affects the accounting equation in the following way:

 

  • Decrease in Assets: The withdrawal of cash or other assets reduces the total assets of the business. For example, if the owner withdraws £10,000 in cash, the cash account would decrease by £10,000.
  • No Change in Liabilities: Drawings do not impact liabilities. Liabilities are external obligations and are unrelated to the owner’s personal transactions.
  • Decrease in Owner’s Equity: Drawings decrease the owner’s equity in the business. This reduction reflects the owner’s personal use of business assets. Using the example above, if the owner has £100,000 in owner’s equity before the withdrawal, it will decrease to £90,000 after the £10,000 cash withdrawal.

What is the Double Entry for Drawings?

To accurately record drawings, businesses often use a separate drawing account, which is a sub-account of owner’s equity. Here’s how it works:

 

  1. Create a Drawing Account: Establish a drawing account under owner’s equity in the chart of accounts.
  2. Record Withdrawals: Whenever the owner makes a withdrawal, record it in the drawing account. For example, if the owner takes £1,000 in cash for personal use, the drawing account would be debited by £1,000.
  3. Reduce Owner’s Equity: This debit to the drawing account reduces the owner’s equity in the business, as shown on the balance sheet.
  4. Keep It Separate: Separating drawings from other business transactions helps maintain clarity and transparency in financial statements, and also makes it easier to monitor and track.

For example, let’s assume that Terry is a sole trader. If Terry withdraws £1,000 in cash for personal use, the accounting double entry would look like this:

Drawing Account

Debit

£1,000

Cash

Credit

£1,000

After this transaction, the owner’s equity in Terry’s business would decrease by £1,000.

Impact on Financial Statements

Let’s consider how drawings impact the various financial statements:

 

Income Statement

 

Business drawings do not impact the income statement directly since they are not considered expenses.

 

However, excessive drawings can indirectly affect the business’s profitability by reducing available funds for reinvestment.

 

Balance Sheet

 

Drawings reduce owner’s equity, which is reflected on the balance sheet.

 

A lower owner’s equity means a lower total equity for the business.

 

Statement of Cash Flows

 

Cash withdrawals are reflected in the cash flow statement under financing activities as a reduction in cash.