Drawing Account: What It Is and How It Works

What is Drawing Account?

A drawing account is a temporary accounting record used by sole proprietorships and partnerships to track owners' personal withdrawals of cash, assets, or goods from the business, which reduces owners' equity without affecting net income or expenses. This account helps separate personal use from business operations for clearer financial management and tax reporting.

It operates as a contra account to the capital account, ensuring owners' equity is accurately represented without impacting the profit-and-loss statement.

Key Characteristics

Drawing accounts have distinct features critical for small business bookkeeping:

• Temporary contra-equity account: Maintains a debit balance opposite to the owners' capital account and is closed at period-end by transferring its balance to the capital account.
• No impact on income statement: Withdrawals recorded here do not reduce net income since they are not business expenses but reduce equity and assets on the balance sheet.
• Specific to certain business types: Commonly used by sole proprietorships and partnerships, unlike corporations that use salaries or dividends for owner withdrawals.
• Personal vs. business use tracking: Helps maintain compliance with tax rules related to the ability to pay taxation by separating personal withdrawals from business transactions.

How It Works

When an owner withdraws cash or assets, the drawing account is debited while the corresponding asset account is credited, reducing both assets and equity. At the end of the accounting period, the drawing account balance is closed out by debiting the owners' capital account and crediting the drawing account, which reduces permanent equity.

Maintaining a dedicated sub-account for drawings and defining clear policies on allowable personal expenses can prevent confusion between business and personal finances, supporting adherence to GAAP standards.

Examples and Use Cases

Drawing accounts play a vital role in managing owner withdrawals in various business scenarios:

• Sole proprietorship: An owner withdrawing cash monthly for personal use records each withdrawal in the drawing account, later closing it to update equity.
• Partnerships: Partners may draw funds proportionally, reducing partnership equity without affecting the business’s taxable income.
• Airlines: Companies like Delta manage complex owner equity structures, though they typically use salaries and dividends rather than drawing accounts.
• Financial planning: Entrepreneurs using services from best online brokers often track personal withdrawals meticulously to ensure accurate financial reporting.

Important Considerations

While drawing accounts simplify tracking owner withdrawals, excessive or unmonitored drawings can erode your business’s financial health. It’s crucial to set limits and maintain clear documentation to preserve equity and comply with tax regulations.

Implementing robust bookkeeping practices and understanding the interplay between drawing and capital accounts can enhance your financial clarity and long-term business viability.