An owner drawing is an accounting entry that records withdrawals made by a sole proprietor from their business entity.

Owner drawings are a common element of owner-managed businesses, as they provide the owner with a way to withdraw profits from the business for their personal use.

Accounting for owner drawings presents unique challenges to businesses, as it requires a balance between accurately recording the withdrawals and their effect on the financial statements.

This entry is made to the owner’s drawing account, which is a contra-equity account that reduces the owner’s capital account.

At the end of the fiscal year, the balance in the owner’s drawing account is transferred to the owner’s capital account, which sets the drawing account balance to zero.

Accounting Treatment for Owner Drawing

Owner drawings will have an impact on the company equity section. This is because owner drawings are considered to be a form of capital distribution. The amount that is drawn will be deducted from the company capital. This can have a negative impact on the financial statement of the company, as it will reduce the overall equity.

In addition, it can also make it difficult to obtain loans or other forms of financing, as lenders will be concerned about the amount of equity that is available. As a result, owner drawings should be carefully considered before they are made.

Journal entry of drawing account

The owner drawing will decrease company’s capital and company’s cash with the following journal entry:

Example

Jake , the owner of Company ABC, withdraws $15,000 every month for his personal expenses. This money is a part of the company’s revenue generated from business operations. David uses this money to purchase items that are not related to or used for the business, such as clothing.

Since this cash is considered as a part of the company’s assets, the transaction must be recorded in the company’s accounts. To track this personal withdrawal, a “drawing account” is used in the company’s books. The drawing account is debited for $15,000 and the cash account is credited for the same amount.

It is important to note that if Jake uses the same money to buy any assets for the business, it would not be considered as a drawing. Instead, it would be recorded as a business expense in the company’s accounts.

Example 2

Liam and Amelia are partners in a manufacturing firm named ABC. Liam regularly withdraws $1,000 from the business account on a monthly basis, while Amelia does not withdraw any money.

Accountant needs to create two drawing accounts, “Drawing-Liam” and “Drawing-Amelia” to record their withdrawals separately. Each month, $1,000 is recorded in Liam’s drawing account and $0 in Amelia’s drawing account.

At the end of the year, the drawing account will be closed and its balance will be transferred to Liam’s equity account. As a result, Liam’s equity will be reduced by $12,000. On the other hand, Amelia’s drawing account has a zero balance, so there is no decrease in his equity account.

Drawing on the balance Sheet

When an owner withdraws money from the company, it is recorded in a separate account called a “drawing account”. It will reduce the company equity from the balance sheet.

At the end of the year, the drawing account is closed and its balance is transferred to the owner’s equity account. As a result, the owner’s equity is reduced by the amount of money withdrawn. This decrease in equity is reflected in the company’s financial statements.

Drawings are recorded on the statement of cash flows as a type of financial activity, and also decrease the owner’s equity. The amount withdrawn is shown as a decrease in assets on the financial statement. This affects the financial statement by showing a decrease in the company’s total assets indicated by the withdrawn amount.

The amount withdrawn is not a direct expense for the company, but it is an indirect expense. This means it is an expense that the company does not receive income from. The owner’s equity is also impacted by the withdrawal. This is because the owner’s equity is the difference between the company’s total assets and total liabilities.

What are the Tax Implications of Owner Drawings?

Given the lack of withholding taxes for owner’s draw, it is important for proprietors to understand the potential tax implications of these transactions.

Frequent draws from the business can be subject to quarterly estimates or self-employment taxes. This means that the proprietor could be liable for the payment of taxes when the draw exceeds the amount of salary or wages paid to the owner.

Drawing funds from the business can also have an impact on the owner’s ability to be eligible for certain deductions or credits. For example, the owner may not be eligible for certain deductions or credits if the amount of funds withdrawn from the business is higher than the amount of salary or wages paid to the owner. Additionally, the amount of funds withdrawn can also affect the owner’s ability to be eligible for certain retirement benefits.

What are the Alternatives to Owner Drawings?

Rather than relying on owner drawings, proprietors may consider other options for accessing funds from the business. These alternatives provide owners with an opportunity to acquire finances for personal use without incurring tax implications.

Some of these alternatives include:

1. Salary: Business owners can receive paychecks from their businesses in the form of salaries. Salaries are subject to payroll taxes, however, and must be reported on personal income tax returns.
2. Guaranteed payments: These are payments made to owners for services they have provided to the business, but are not considered wages or salaries. Guaranteed payments are subject to self-employment taxes and must be reported on personal income tax returns.
3. Dividends: Dividends are a form of payment to owners from the profits of a business. Dividends are not subject to self-employment taxes, however, they are taxable for income tax purposes.

Business owners should keep in mind that these alternatives may be subject to different tax rules depending on the type of entity and other factors. Therefore, owners should research the rules that apply to their specific situation in order to ensure they comply with applicable laws. Additionally, it is important to consult with a tax professional to ensure the best decision is made for the business.

Conclusion

The owner drawing is an important financial transaction for any business. It has a direct effect on the financial statements, and should be recorded in the accounting records in order to accurately reflect the financial position of the business.

Furthermore, it is important to understand the tax implications of owner drawings, as they can have a major impact on the business’s tax liability.

Finally, there are alternatives to owner drawings that can be employed to obtain liquidity without directly affecting the financial statements.

The post Owner Drawing in Accounting appeared first on Accounting Official.