Drawing account definition
/What is a Drawing Account?
The drawing account is an accounting record used in a business organized as a sole proprietorship or a partnership, in which is recorded all distributions made to the owners of the business. They are, in effect, "drawing" funds from the business (hence the name). There is no tax impact associated with the withdrawn funds from the perspective of the business, since taxes on these withdrawals are paid by the individual partners.
How to Account for a Drawing Account
The accounting transaction typically found in a drawing account is a credit to the cash account and a debit to the drawing account. The drawing account is a contra equity account, and is therefore reported as a reduction from total equity in the business. Thus, a drawing account deduction reduces the asset side of the balance sheet and reduces the equity side at the same time. In short, a drawing account deduction reduces the asset base of a business by the amount of the deduction.
The drawing account is not an expense - rather, it represents a reduction of owners' equity in the business. The drawing account is intended to track distributions to owners in a single year, after which it is closed out (with a credit) and the balance is transferred to the owners' equity account (with a debit). The drawing account is then used again in the next year to track distributions in the following year. This means that the drawing account is a temporary account, rather than a permanent account.
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Are Drawing Accounts Used in Corporations?
In businesses organized as companies, the drawing account is not used, since owners are instead compensated either through wages paid or dividends issued. In a corporate environment, it is also possible to compensate owners by buying back their shares in a treasury stock transaction; however, this also reduces their relative ownership percentage of the business, if they are the only shareholders whose shares are being repurchased. If the shares of all shareholders are being repurchased in equal proportions, then there is no effect on relative ownership positions.
Drawing Account Best Practices
There are a few best practices that can be used to improve the accounting associated with a drawing account. These best practices are as follows:
Maintain partner-level detail. It is useful to create a schedule from the drawing account, showing the detail for and summary of distributions made to each partner in the business, so that the appropriate final distributions can be made at the end of the year to ensure that each partner receives his or her correct share of the earnings of the business, in accordance with the terms contained within the partnership agreement. This is particularly important if there is a risk of disputes over the amount of funds distributed amongst the partnership; this is most likely to be the case when there are many partners.
Report withdrawals. If the business is a partnership or has multiple stakeholders, be transparent about withdrawals. Regularly report on the drawing account’s status, so that anyone can spot accounting irregularities and question them.
Use a dedicated bank account. Consider having a separate bank account or sub-account for drawing transactions to simplify tracking.
Establish accounting policies. Clearly outline what types of expenses can be charged to a drawing account. Specify which expenses are personal versus business-related.
Example of a Drawing Account
ABC Partnership distributes $5,000 per month to each of its two partners, and records this transaction with a credit to the cash account of $10,000 and a debit to the drawing account of $10,000. By the end of the year, this has resulted in a total draw of $120,000 from the partnership. The accountant transfers this balance to the owners' equity account with a $120,000 credit to the drawing account and a $120,000 debit to the owners' equity account.
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