What Type of Account Is an Owner’s Draw?

An owner’s draw is a financial mechanism allowing business owners to take funds or other assets from their company for personal use. This practice is common in specific business structures, serving as a way for owners to receive personal income from their business. It allows for flexibility in compensation, differing from a fixed salary.

Owner’s Draw as an Equity Account

An owner’s draw is classified as an equity account, specifically a contra-equity account. This means it reduces the owner’s capital or investment in the business, rather than being considered a business expense.
In sole proprietorships and partnerships, owners directly utilize draws to access business profits for personal needs. This differs from corporations, such as S-corporations and C-corporations, where owners typically receive compensation through salaries, which are subject to payroll taxes and withholding, or dividends. For owners of sole proprietorships, the entire net income of the business passes through to their personal tax return, regardless of whether a draw is taken.
An owner’s draw is not considered a salary or an operating expense of the business. Therefore, it does not reduce the business’s taxable income. Instead, it represents a direct reduction of the owner’s equity in the company.

Financial Statement Impact

An owner’s draw does not appear on the income statement because it is not an operating expense. Business expenses reduce a company’s net income, but owner’s draws do not fall into this category. Consequently, taking an owner’s draw does not lower the business’s net profit or loss.
The impact of an owner’s draw is solely on the balance sheet, specifically within the equity section. A higher amount of draws will result in a lower owner’s equity at the end of an accounting period.
This reduction reflects that assets have been withdrawn from the business for personal use, decreasing the owner’s investment in the company. While the draw impacts the balance sheet and cash flow, it does not influence the business’s profitability as reported on the income statement.

Recording Owner’s Draw

Recording an owner’s draw in the accounting system involves a specific journal entry. The general entry requires debiting the Owner’s Draw account and crediting the Cash or Bank account from which the funds were withdrawn. For example, if an owner takes $2,000, the entry would be a debit to Owner’s Draw for $2,000 and a credit to Cash for $2,000.
Tracking these draws is important for accurate financial reporting and tax compliance. Although draws are not taxed at the time of withdrawal, the owner is taxed on the business’s overall profits reported on their personal tax return, and self-employment taxes apply to the net earnings of the business, which draws do not reduce.
At the end of an accounting period, the Owner’s Draw account is closed out. This is done by debiting the Owner’s Capital account (or Retained Earnings) and crediting the Owner’s Draw account. This process resets the Owner’s Draw account for the next fiscal year.