Discover the ins and outs of drawings in UK accounting with our comprehensive guide. Learn what drawings are, their significance in financial management, and more.
What are Drawings?
It’s important to document these drawings in order to maintain accurate records of the business’s finances and determine its taxable income.
Generally, drawings are recorded in a separate drawing account within the double-entry bookkeeping system of accounting. This makes it easier to track money withdrawn and the remaining equity in the business account.
Drawings do not affect the business expenses on the profit and loss account (income statement), but instead are recorded as a reduction in assets and a reduction in the business owner’s equity.
Types of Drawings
There are two primary types of drawings: capital drawings and personal use drawings.
Capital drawings refer to withdrawing cash from the business that is used to acquire assets or make long-term investments. This type of drawing is most commonly used by business owners who aim to reinvest their profits back into the business.
Personal use drawings are those withdrawals that are used for personal expenses. This type of drawing is used by business owners to cover their personal financial needs or acquire assets for personal use.
It’s important to note that a drawing account encompasses not only cash withdrawals but also includes all types of assets.
Characteristics of a Drawing Account
The purpose of a drawing account is to keep a record of the amount of business capital that owners withdraw for personal use.
It separates the use of funds and assets between personal and business purposes, allowing for the tracking of the total equity withdrawn by owners. This helps maintain the overall balance of the company’s capital, especially in an unincorporated business like a partnership or sole proprietorship.
Unlike expense accounts that record necessary costs incurred by a business for its operations, a drawing account is not considered an expense. Expenses, such as inventory, sales, and rent, are recorded in the profit and loss (P&L) account.
Adversely, when owners make drawings, the withdrawn money or assets don’t contribute to the business operations. Instead, they reduce the company’s available capital. Therefore, drawing accounts aren’t recognized as expense accounts. Rather, it reflects a reduction in the owner’s equity and is recorded in the balance sheet.
A drawings account is also not considered a continuing or permanent account. These accounts, like inventory, accounts receivable, and accounts payable, carry their balances forward from one accounting period to the next without being closed.
However, the drawing account is a temporary account that is opened at the beginning of the financial year and closed at the end. To close a drawing account, a credit entry is made in the ledger of the business accounts. The remaining balance is transferred to the owner’s equity side of the balance sheet through a debit entry.
Can Drawings be Viewed as a Loan from the Business?
Although drawings can resemble loans, it’s important to remember that they are not formal loans. Instead, drawings represent the owner’s personal use of company assets and don’t typically involve interest or repayment terms in the same way as a loan would.
How Drawings Are Recorded in Accounting Books
Drawings are typically recorded as a debit entry to the ‘Drawings’ or ‘Owner’s Equity’ account and a corresponding credit entry to the relevant asset or equity account. For example, if cash is withdrawn, the ‘Cash’ account is credited.
Can Drawings be Repaid to the Business?
Yes, drawings can be repaid to the business. If the business owner returns the withdrawn assets to the drawing account or compensates the company for their value, a journal entry is made. This entry will reverse the original drawings entry and restore the assets or funds in the appropriate accounts.
The drawings account of a company should be closely monitored for several reasons. Not only does it help to track an owner’s equity, but it is also essential for financial transparency, tax compliance, and cash flow management. In most cases, it’s best to hire an accountant to manage any drawing accounts.