Drawings Transfer in Accounting

Understanding Drawings

• Drawings represent the withdrawal of assets (usually cash or inventory) from the business by the owner for personal use.
• Drawings are a decrease in Owner’s Equity.
• Although classified as an Owner’s Equity account, it is a negative Owner’s Equity account.
• Drawings are not expenses. They are a distribution of profits, not costs incurred to generate revenue.
• Drawings are recorded in a separate Drawings account to track the owner’s personal withdrawals.
• The Drawings account helps in comparing drawings against net profit to determine if the level of withdrawals is appropriate.
• At the end of the reporting period, the balance of the Drawings account is transferred to the Capital account.

KEY TAKEAWAY: Drawings are the owner’s withdrawals from the business and represent a decrease in owner’s equity. They are not expenses and are transferred to the capital account at the end of the reporting period.

Recording Drawings Transactions

• When the owner withdraws assets:
  • Debit the Drawings account (to show the increase in drawings, which decreases owner’s equity).
  • Credit the asset account that is being withdrawn (e.g., Bank if cash is withdrawn, Inventory if inventory is withdrawn).

Example:

The owner withdraws \$500 cash for personal use.

The owner takes inventory worth \$200 for personal use.

STUDY HINT: Practice recording different types of drawings transactions to solidify your understanding.

Transferring Drawings to Capital Account

• At the end of the reporting period, the balance in the Drawings account is transferred to the Capital account.
• This transfer shows the net effect of all transactions with the owner in the Capital account.
• The transfer is done through the General Journal.

General Journal Entry for Transferring Drawings

To transfer the drawings, the following journal entry is made:

• Debit the Capital account (to decrease owner’s equity).
• Credit the Drawings account (to set the Drawings account to zero).

Example:

The Drawings account has a debit balance of \$2,000 at the end of the period.

General Journal Entry:

REMEMBER: Debit Capital, Credit Drawings.

General Ledger After Transfer

After posting the General Journal entry to the General Ledger:

• The Drawings account will have a zero balance.
• The Capital account will be reduced by the amount of the drawings.

Example:

Before Transfer:

• Drawings account has a debit balance of \$2,000.
• Capital account has a balance of \$30,000.

After Transfer:

• Drawings account has a zero balance.
• Capital account has a balance of \$28,000 (\$30,000 - \$2,000).

EXAM TIP: Be prepared to prepare General Journal entries and General Ledger entries related to drawings and their transfer to the capital account.

Why Drawings are not Closed Through Profit and Loss Summary

• Drawings are not revenues or expenses.
• Transactions with the owner are excluded from the definition of revenues and expenses.
• Including drawings in the calculation of profit would breach the principle of Relevance.
• Profit is calculated based on revenues and expenses. Drawings do not fit into either category.

COMMON MISTAKE: Do not close the Drawings account through the Profit and Loss Summary. It is directly transferred to the Capital account.

General Ledger Example with Drawings Transfer

Here’s how the relevant General Ledger accounts might look:

Drawings (-OE)

Capital (OE)

| | | 32,300 | | | 32,300 |
| Oct. 1 | Balance | 30,300 | | | |

APPLICATION: Understanding how drawings are recorded and transferred is essential for accurately reflecting the owner’s equity in the business’s financial statements.

Ethical Considerations

• The correct recording of Drawings is important for ethical financial reporting.
• Misrepresenting drawings as expenses (or vice versa) can distort the financial performance of the business.
• Accurate accounting ensures the owner’s equity is fairly presented.

VCAA FOCUS: VCAA often tests the understanding of the difference between drawings and expenses, and the correct accounting treatment for each. Make sure you understand the relevance principle.