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 a separate legal and 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 weekend money!
2. Types of Drawings
Under the GCE O-Level syllabus, you need to know that 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): The owner takes inventory (stock) 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 isn't making a "profit" from the owner!
3. How Drawings Affect the Accounting Equation
Recall our basic Accounting Equation:
\( \text{Assets} = \text{Liabilities} + \text{Equity} \)
Equity (also known as the owner's interest) represents how much the business "owes" the owner. When the owner takes something out (Drawings), their stake 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 is usually a Credit balance, the Drawings account itself will always have a Debit balance. Think of it as a "temporary" account that keeps track of everything the owner took during the year.
Journal Entry for Cash Drawings:
Debit Drawings
Credit Cash at Bank / Cash in Hand
Journal Entry for Drawings of Goods:
Debit Drawings
Credit Purchases
(Note: We credit "Purchases" because the amount of goods available for sale has decreased.)
Memory Aid: Use the mnemonic D.E.A.D.
Debit: Expenses, Assets, and Drawings. These three accounts increase on the Debit side!
5. Closing the Drawings Account
The Drawings account is a temporary account. We don't want it to keep growing forever! At the end of the financial year, we must "empty" or close the Drawings account by transferring its total balance to the Capital account.
The Transfer Entry:
Debit Capital
Credit Drawings
This entry effectively reduces the owner’s Capital balance by the total amount they withdrew throughout the year.
Did you know? This process is like a "reset" button. It clears the Drawings account to zero so you can start tracking the owner's withdrawals for the brand-new financial year.
6. Presentation in Financial Statements
In your examinations, you will often be asked to show how Drawings appear in the Statement of Financial Position (SOFP). They are shown in the Equity section.
The syllabus requires you to be able to present this as a single line item or as part of the Capital calculation. Usually, it looks like this:
Equity Section Extract:
Opening Capital
Add: Profit for the year (or less Loss)
Less: Drawings
-------------------------
Closing Capital
Pro-Tip: If the question asks for an extract showing "Capital less Drawings" as a single line item, you simply calculate the final figure and label it clearly as "Capital".
7. Common Mistakes to Avoid
1. Using Selling Price for Goods: If the owner takes a shirt from his clothing store 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 van's petrol, it's an expense. If they pay for their personal car's petrol using business cash, it's a Drawing.
3. Forgetting to Credit Purchases: When goods are taken, the credit entry goes to the Purchases account, not the Inventory account (unless using a specific system, but for O-Levels, stick to Purchases).
Quick Review Box
- Definition: Resources taken by the owner for personal use.
- Theory: Accounting Entity Theory (Owner and Business are separate).
- Effect: Decreases Equity (Owner’s Capital).
- Double Entry: Debit Drawings, Credit Cash/Bank/Purchases.
- Year-End: Closed to the Capital account.
- SOFP: Subtracted from Capital in the Equity section.