Drawings: Understanding Withdrawals from Unincorporated Businesses

Drawings refer to the withdrawal of assets, typically cash or goods, from an unincorporated business by its owner. This concept is essential in differentiating between unincorporated businesses and corporations, and comprehending how owners can access business assets.
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Definition of Drawings

Drawings represent the withdrawal of assets, typically in the form of cash or goods, from an unincorporated business by its owner. For incorporated businesses, withdrawals usually take the form of dividends, including scrip dividends (dividends paid as additional shares rather than cash). The amount withdrawn is recorded in a drawings account, which serves as a detailed record of owner withdrawals.

Key Points:

  • Drawings Account: A financial record used to track the assets withdrawn by owners in a partnership or sole proprietorship.
  • Asset Types: Typically cash or goods.
  • Unincorporated vs. Incorporated: In unincorporated businesses such as sole proprietorships and partnerships, withdrawals are termed as drawings; in incorporated businesses, withdrawals are in the form of dividends.

Examples of Drawings

  1. Sole Proprietor Withdrawal: Jane runs a small bakery as a sole proprietorship. At the end of the month, she withdraws $1,000 from her business account for personal use. This withdrawal is recorded in the drawings account.

  2. Partnership Withdrawal: Mark and Ryan are partners in a consulting firm. Ryan decides to withdraw office equipment, valued at $500, for personal use. This withdrawal is noted in the firm’s drawings account for accurate financial tracking.

  3. Incorporated Business (Dividends): XYZ Corp. decides to issue dividends to its shareholders. Tim, a shareholder, receives $200 in cash dividends. If XYZ Corp. chooses to issue scrip dividends, Tim receives additional shares instead of cash.

Frequently Asked Questions (FAQs)

Q1: How are drawings treated in financial statements?

  • Drawings reduce the owner’s equity in the business. They are recorded in the drawing account, which ultimately lowers the equity balance in the owner’s capital account.

Q2: Are drawings taxable?

  • Drawings themselves are not taxed; however, they represent a form of non-deductible personal use of business funds. The business income remains taxable.

Q3: What is the difference between drawings and salary?

  • Drawings are not salary or wages; they represent a withdrawal of the owner’s share of equity in the business. Salary is an expense paid to employees, including owners, if the business is incorporated and they hold salaried positions.
  • Capital Account: Represents the owner’s equity in the business, adjusted for drawings, contributions, and net income or loss.
  • Dividends: A portion of a company’s earnings distributed to shareholders, typically in cash or additional shares.
  • Scrip Dividends: Dividends issued in the form of additional shares rather than cash, often used by corporations to conserve cash.

Online References

  1. Investopedia - Drawings
  2. Corporate Finance Institute (CFI) - Drawings Account
  3. AccountingTools - Drawings

Suggested Books for Further Studies

  1. “Financial Accounting for Dummies” by Maire Loughran
  2. “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
  3. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield

Accounting Basics: “Drawings” Fundamentals Quiz

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Thank you for engaging in our deep dive of the term “drawings” and tackling the related quiz questions. This is crucial for understanding withdrawals in unincorporated businesses and highlighting important distinctions in business structures!

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Drawing Account