Drawings refer to transactions where the owner or owners are withdrawing funds from the business in the form or cash or some other asset, for example stock or equipment. Drawings and accounting entries associated with these transactions are important owners capital is correctly accounted for an ensuring the proper tax treatments are applied.
If we return to our trusty ABC Ltd, an example here could include both the owners taking cash out of the business or perhaps taking one of the older diggers the business no longer has use for. Both have value and can be treated as drawings.
It is important to mention here the four ways that an owner can withdraw funds from a business. In no particular order they can withdraw through being paid dividends, by being provided with a loan, by reimbursement of expenses or by making drawings.
Drawings relate to an owner taking funds from a business that they have already put in, ie they are drawing down what they have built up in the business in the form of capital.
For this tutorial we are not worrying about the other forms of taking funds from a business as mentioned above, we will cover these off in future tutorials.
Drawings Journal Entries and the Accounting Equation
The drawings account is a capital contra account and therefore a debit account by nature. A contra account is an account that is allocated the opposite debit or credit nature to the type of accounts it is associated with. Another word that may explain it is to say it is an off-setting account (although in accounting that is used in different settings).
The thing to remember for moment is that it is a capital account that is used to record the owners drawings through a year, but is a debit account in nature. This provides a much neater way of keeping track of the amount of capital an owner has in the business rather than running all of these transactions through the main capital account. Lets look at an example of the accounting entries involved.
The use of the accounting equation in these explanations can be very useful; as it sets out clearly how the inflows and outflows of a business must remain in balance of how economic benefits are recorded in the double-entry system.
So lets look at an example with ABC Ltd again, this time with one of the owners, Brian Smith, drawing down $10,000 in cash from the firm. Looking at the accounting equation ABC Ltd has to record in its book a reduction of bank by $10,000 and an increase in drawings for Brian of $10,000. You will see with Table 1 below the equation stays in balance as there is an decrease and increase on the same side:
To journal entry for this drawings transaction would then be:
Now let’s say that instead of cash Brian took one of the older diggers at book value. ABC Ltd would need to again record an increase in drawings, but this time a reduction in the machinery asset account. As Table 2 shows below, bank and machinery are both asset accounts and therefore the accounting equation entry looks the same:
The journal entry to bring this entry into ABC’s accounts would look something like:
This entry of course ignores how accumulated depreciation, gain or loss on disposal etc would be accounted for. We will deal with all of that in another tutorial.
We trust the explanations and examples above have helped you gain a better understanding the impact and book entries in the proper accounting for drawings. You can find further explanations of accounting terms and concepts through the link or get in touch with a comment below or our Contact page.