What Does Drawing Mean in Accounting?

“Drawings” is a fundamental accounting term, describing how owners of sole proprietorships and partnerships take money or assets from their business for personal use. Understanding drawings is important for maintaining accurate financial records and navigating tax obligations.

Understanding Drawings in Accounting

Drawings represent funds or assets that an owner withdraws from their business for personal, non-business related purposes. This concept applies specifically to unincorporated businesses, such as sole proprietorships and partnerships, where the owner and the business are legally considered the same entity. Examples of drawings include cash withdrawals for personal bills, using business funds to purchase personal items, or even taking inventory from the business for personal consumption.

It is important to distinguish drawings from business expenses or employee salaries. Unlike a salary paid to an employee, which is a deductible business expense, drawings are not considered an expense of the business. They are also different from wages, which typically involve payroll processing and tax withholdings. Drawings are simply a reduction of the owner’s investment in the business rather than a cost of doing business.

Impact of Drawings on Financial Statements

When an owner takes a drawing, it directly impacts the business’s financial statements, specifically the Balance Sheet and the Statement of Owner’s Equity. Drawings are recorded by debiting a “Drawings” account and crediting the “Cash” or other asset account from which the withdrawal was made. The Drawings account is a temporary contra-equity account, meaning it reduces the owner’s equity.

Drawings do not appear on the Income Statement because they are not business expenses and do not affect the business’s net income or loss. Instead, they reduce the owner’s capital account on the Balance Sheet, decreasing both the assets and the owner’s equity. At the end of an accounting period, the balance in the Drawings account is closed out and transferred to the owner’s capital account. The Statement of Owner’s Equity will show how drawings decrease the owner’s total capital during the period.

Tax Considerations and Best Practices for Drawings

Drawings have specific tax implications for the business owner. They are not considered taxable income to the owner, as they represent a return of capital or a distribution of already-taxed profits for pass-through entities. The business itself does not deduct drawings as an expense, and the owner pays personal income tax on the business’s overall profits, not on the individual draws. Owners of sole proprietorships and partnerships are responsible for self-employment taxes (Social Security and Medicare) on their net earnings from the business, which drawings do not reduce.

Maintaining records for all drawings is important for accurate financial reporting and tax compliance. Business owners should keep separate business and personal bank accounts to clearly distinguish funds. Documenting each draw with the amount and date helps maintain clear financial records and simplifies tax reporting. The Internal Revenue Service (IRS) recommends keeping tax records for at least three years from the date the tax return was filed. Some situations may require longer retention periods, such as underreporting income.