Every company needs to have an accounting department to maintain and keep a record of its financial operations. The financial department must note every business transaction in an account book or a journal. This is one of the most common methods to identify transactions related to the expenses or revenue.
But, when it comes to bookkeeping, we need to know every detail of a transaction about all the relevant accounts. And this is why the drawing account is one type of account that we all need to know. A drawing account records the surplus amount which is to be transferred or withdrawn from the primary current account.
In this blog, we have explained the drawing accounting definition, the example of a drawing account journal entry, and more.
Did you know? A drawing account is also known as a contra account.
Drawing Account Definition
A drawing account can be defined as an accounting record that keeps track of owners withdrawing funds from the business. This type of account is more prominent in businesses like sole proprietorships and partnerships.
What Is a Drawing Account?
A drawing account is an account used in the double-entry bookkeeping system to account for funds withdrawn from a firm's operating account. In other words, it is used to record cash withdrawals made by the owner(s) for personal use during the usual business. The owners may need these withdrawals for several reasons like salary, inventory and tax payments.
Also Read: Basis of Accounting - What Is the Difference Between Cash and Accrual Basis of Accounting
Features of a Drawing Account
The following are the features of a drawing account:
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No Impact of Taxes
The businesses do not bear the impact of taxes on the withdrawal of funds as the individual partners pay taxes on their withdrawals.
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Tracks Funds Withdrawn
A drawing account keeps track of the entire amount of funds withdrawn from the business by owners for personal purposes. It aims to monitor the owner's withdrawals while maintaining the company's total capital balance.
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Temporary Account
A drawing account is a temporary account type. Because, at the end of the financial year, the account is balanced with a credit amount and later transferred to the balance sheet under the owner's equity head as a debit balance. The account is only utilised again in the next financial year to monitor the withdrawals of funds by owners of the business.
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Not a Nominal Account
Any withdrawals made by the owners of a business are not considered an expense incurred by the firm. Therefore, it is not a nominal item to record in the profit and loss (P&L) account. In other words, drawings mean a reduction of the owner's capital due to the withdrawal of funds for personal use. Hence, the drawing account's amount becomes a part of the balance sheet.
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Tracks Funds Withdrawals
A drawing account records and tracks the owner's withdrawals of funds from the business for various personal uses.
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Associated With Smaller Scale Businesses
A drawing account is generally created for smaller businesses like sole proprietorships and partnerships. As for huge corporations, creating a drawing account is unusual.
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Withdrawals of Any Asset Are Drawings
A drawing account tracks not just funds in terms of money but any assets that business owners withdraw. This is done to record their total assets withdrawn during the entire current financial year.
Presentation of Drawing Account Journal Entry
Any transaction that reduces cash or other assets from the business, especially for owners' personal use, has the effect of crediting cash accounts. This is because it is debiting drawing accounts as the capital is equally falling with a decrease in assets of the company. That is debit assets that go out of business and debit liabilities in case there is any decrease.
In other words, we can refer to a drawing account as the contra equity account, because of the reduction in the total equity of the business. There is a parallel reduction on both sides of the assets and liabilities of the balance sheet due to this transaction made by the owners.
The Custom of Drawing Accounts: Who Uses These?
A drawing account is generally prepared for businesses like partnerships and sole proprietorship firms. That means the owners are not considered separate from their businesses, as in the case of the companies incorporated under the Companies Act, 2013. Therefore, if any funds or other assets are withdrawn from the business for any personal use, there will be a direct reflection on the accounts of such firms as 'drawings' and hence, the necessity of preparing a drawing account.
On the other hand, where the company's businesses are treated as separate from their members, such a company need not prepare any drawing accounts for any withdrawals or use of funds and assets. Such distinct companies are the incorporated companies with a recognition of a separate legal entity under the Companies Act, 2013 or other multinational corporations. Hence, no these companies don’t need to prepare a drawing account.
Example of a Drawing Account in Journal Entry
Now, let's explain to you the example of a drawing account transaction. Let us take a partnership firm named Gopala Partnership which has two partners. The two partners are Ms Ranchi and Ms Desai.
Every month, this partnership firm, sends ₹10,000 to each of its partners. This transaction in the books of Gopala would have to credit the cash account with ₹20,000 and the drawing account would be debited by ₹20,000.
At the end of the financial year, the Gopala Partnership firm will have a total amount of ₹240,000 withdrawn from the business. This same amount of ₹240,000 will be transferred to the account of the owner's equity as a credit balance and debited from the account of the owner's equity.
In this way every unincorporated company tracks their total withdrawals from the business by preparing a drawing account temporarily for the relevant financial year.
Also Read: Understand Accounting Ratios – Overview, Meaning, Types and Formulas
Conclusion:
To conclude, the drawing account is important in accounting that every individual running an unincorporated firm should understand. Drawing accounts are a distinct component of the double-entry accounting system and are used to record transactions that are unrelated to daily business activities. Thus, drawing accounts are temporary accounts in which transactions are recorded until they are transferred to the permanent or real account known as the balance sheet or the position statement.
Thus, it is always advisable to maintain separate accounts to differentiate between the business and the individuals running it. This helps in keeping the professional and personal transactions separate. We hope you found this article helpful and informative.
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