Understanding Drawing Accounts

Understanding Drawing Accounts

Typically, the businesses which are in the form of sole proprietorship or partnership will use the drawing account. It is an accounting record that documents all the distributions made to the business owners. In fact, they are the funds that the business owners have drawn from the business, and this is where the name “drawing account” comes from. The withdrawn funds do not have any tax impact on the business as the individuals or the partners will pay tax for those withdrawals.

How would the accountants in an accounting firm in Johor Bahru record the transaction when the business owners withdraw cash from their company? Usually, they will record a debit in the drawing account and a credit in the cash account. As the drawing account acts as a contra equity account (Also see What is a Contra Account?), the accountants will report it as a deduction in the total equity of that company. This means that the deduction made due to the drawing account will cause a decrease in both the equity and the asset in the balance sheet simultaneously.

You should not categorise the drawing account as an expense. Instead, it shows that the owners’ equity of a company has reduced. The purpose of creating drawing accounts is to monitor the distributions of business funds to the owners in a year (Also see Introduction to Capital Account). After that, the accountant will close it with credit before transferring the balance to the owner’s equity account and record it as a debit. Then, in the next year, the accountant will use the drawing account again to monitor the distributions. Hence, the drawing account falls into the category of temporary account but not the permanent account (Also see Introduction to Permanent and Temporary Accounts).

As an instance, XYZ Partnership distributes RM10,000 to both partners monthly, and it records the transaction by debiting RM20,000 to the drawing account and crediting the same amount to the cash account. At the year-end, the sum of withdrawal from the partnership will be RM240,000. Then, the accountant will transfer this amount to the owners’ equity account by debiting the owners’ equity account and crediting the drawing account (Also see Accounting – Rules for Debits and Credits).

Creating a schedule by using the drawing account can be helpful as it shows the distributions made to the partners. Hence, this ensures an appropriate final distribution at the year-end so that each partner will receive the share or the business’s earnings correctly according to the terms in the partnership agreement. This is crucial because the risk of dispute between the business partners may arise if there are some issues in the sum distribution.

Businesses which are in the form of companies would not use the drawing account. This is because the owners will obtain compensation through dividends or wages. For corporations, they may compensate the owners by repurchasing their shares (Also see Why Do Companies Repurchase Their Own Shares?) in treasury stock transactions. Nevertheless, this will reduce the ownership percentage of those owners towards the business if the corporation only repurchases the stock from them. If a corporation does not want to affect the ownership positions of the owners, then it should repurchase the stocks from all of its shareholders equally.