Is the Drawing Account a Permanent Account?

Understanding the nature of different accounts is fundamental to accurate financial reporting. The classification of an account, whether permanent or temporary, dictates how its balance is treated at the end of an accounting period. This distinction is relevant for accounts like the drawing account, which records specific financial activity within a business.

Understanding the Drawing Account

A drawing account records owners’ withdrawals of cash or other assets from a business for personal use. This account is commonly used in unincorporated business structures, such as sole proprietorships and partnerships. Its purpose is to track these personal distributions, separating them from business expenses or investments.

When an owner takes assets from the business, it reduces the overall owner’s equity. The drawing account functions as a contra-equity account, holding a debit balance that decreases owner’s equity. For example, if a sole proprietor withdraws $500 in cash for personal expenses, the drawing account is debited, and the cash account credited, reflecting the reduction in both the owner’s claim and the business’s assets.

Distinguishing Permanent and Temporary Accounts

Accounts are categorized as either permanent or temporary, based on how their balances are handled at the end of an accounting period. Permanent accounts, also known as real accounts, carry their balances forward from one fiscal period to the next. These accounts represent the cumulative financial position of a business and are reported on the balance sheet.

Examples of permanent accounts include assets like cash, accounts receivable, and equipment, as well as liabilities such as accounts payable and loans. The owner’s capital account, which reflects the owner’s investment and accumulated earnings less withdrawals, is also a permanent account. Temporary accounts, or nominal accounts, track financial activities within a specific accounting period and are closed at its conclusion. Their balances do not carry forward to the next period, resetting them to zero. These accounts include revenues and expenses, and they are reported on the income statement.

The Accounting Cycle and Closing Entries

The accounting cycle culminates in closing entries, which prepare financial records for the subsequent period. This process involves transferring the balances of temporary accounts to a permanent equity account, resetting them to zero. The drawing account is classified as a temporary account because its balance does not carry over from one year to the next.

At the end of an accounting period, the balance from the drawing account is transferred to the owner’s capital account. This closing entry involves crediting the drawing account to bring its balance to zero and debiting the owner’s capital account to reflect the reduction in equity. This procedure ensures the drawing account begins each new accounting period with a zero balance, allowing clear tracking of owner withdrawals for that period.

Effect on Owner’s Equity

While the drawing account is temporary and its balance is reset to zero at the end of each accounting period, its cumulative effect directly impacts a permanent account: owner’s capital. Withdrawals recorded throughout the period in the temporary drawing account ultimately reduce the owner’s total investment and accumulated earnings in the business. This reduction is reflected when the drawing account is closed, and its balance is transferred as a debit to the owner’s capital account.

The owner’s capital account, a permanent account on the balance sheet, shows the net effect of profits, losses, and owner withdrawals over the business’s lifetime. Even though the drawing account is cleared periodically, its activity consistently diminishes the owner’s long-term equity in the company, providing a comprehensive view of the owner’s financial stake.