Welcome to the Chapter on Drawings!
In this chapter, we are going to look at what happens when a business owner takes something back from their business for personal use. While "drawings" might sound like art class, in accounting, it’s all about the movement of resources from the business to the owner. Understanding this is vital because it helps us keep the business's money and the owner's personal money separate.
Don't worry if this seems tricky at first! Once you understand the core reason why we record drawings, the rest will fall into place naturally.
1. What are Drawings?
Drawings refer to any resources (like cash or goods) that the sole proprietor (the owner) takes out of the business for their own personal use.
Example: If Mr. Tan owns a grocery store and takes a bottle of milk home for his daughter’s breakfast, or takes \$50 from the cash register to pay his own home electricity bill, these are both considered Drawings.
The Accounting Entity Theory
Why do we bother recording this? It is because of the Accounting Entity Theory. This theory states that the business is treated as a separate accounting entity from its owner. Therefore, any personal transaction by the owner must be recorded so that the business's financial performance isn't blurred by the owner's personal spending.
Quick Review:
Always remember: Business ≠ Owner. We only want to see how the business is doing, not how the owner spends their personal money!
2. Types of Drawings
Under the GCE O-Level syllabus, drawings can happen in two main ways:
1. Drawings in Cash: The owner withdraws money from the business bank account or the cash till for personal use.
2. Drawings in Kind (Goods / Inventory): The owner takes inventory from the business to use at home.
Important Point: When an owner takes goods for personal use, we always record them at cost price, not the selling price. This is because the business does not earn revenue or make a profit from the owner.
3. How Drawings Affect the Accounting Equation
Recall our basic Accounting Equation:
\( \text{Assets} = \text{Equity} + \text{Liabilities} \)
Equity (also known as owner's equity) represents the owner's claim on the net assets of the business. When the owner withdraws resources for personal use, their equity in the business decreases.
Key Takeaway: Drawings reduce the owner's Equity in the Statement of Financial Position.
4. Recording Drawings (Double-Entry)
Since Drawings reduce Equity, and Equity has a normal credit balance, the Drawings account has a debit balance. It tracks all withdrawals made by the owner during the financial year.
Journal Entry for Cash Drawings:
Debit Drawings
Credit Cash at Bank / Cash in Hand
Journal Entry for Drawings of Goods (Inventory):
Debit Drawings
Credit Inventory
(Note: Under the perpetual inventory recording system used in the syllabus, withdrawing goods directly reduces the Inventory account at cost.)
Memory Aid: Use the mnemonic D.E.A.D.
Debit: Expenses, Assets, and Drawings. These accounts increase on the Debit side!
5. Closing the Drawings Account
The Drawings account is closed only at the end of the financial year by transferring its balance to the Capital account.
The Year-End Closing Entry:
Debit Capital
Credit Drawings
This entry closes the Drawings account and reduces the owner’s Capital balance by the total amount withdrawn during the year.
6. Presentation in Financial Statements
In the Statement of Financial Position, drawings are presented in the Owner's Equity section. Drawings reduce equity and appear as capital less drawings in one line, or as part of the equity movement for the period.
Equity Section Format:
Capital at beginning of year
Add: Profit for the year (or Less: Loss for the year)
Less: Drawings
-------------------------
Capital at end of year
7. Common Mistakes to Avoid
1. Using Selling Price for Goods: If the owner takes an inventory item that costs \$10 but sells for \$25, record \$10 as Drawings. Never use the selling price!
2. Confusing Drawings with Expenses: If the owner pays for a business delivery van's fuel, it is an expense. If they pay for their personal car's fuel using business cash, it is Drawings.
3. Crediting the Wrong Account for Goods Taken: Under perpetual inventory recording, credit Inventory (at cost), not Sales or Purchases.
Quick Review Box
- Definition: Resources taken by the owner for personal use.
- Theory: Accounting Entity Theory (Business is accounted for separately from the owner).
- Effect: Decreases Owner's Equity.
- Double Entry: Debit Drawings, Credit Cash at Bank / Cash in Hand / Inventory.
- Year-End: Closed to the Capital account.
- Statement of Financial Position: Subtracted from Capital in the Equity section.