Drawings: Understanding Withdrawals from Unincorporated Businesses

Drawings Unincorporated Business Sole Proprietorship Partnership Dividends Scrip Dividends Accounting
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 The amount withdrawn is recorded in a drawings account, which serves as a detailed record of owner withdrawals.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  • Drawings Account: A financial record used to track the assets withdrawn by owners in a partnership or sole proprietorship.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

### What does the term "drawings" refer to in accounting? - [x] Withdrawals made by the owner from an unincorporated business - [ ] Equity injections by the owner into the business - [ ] Distributions made to shareholders in an incorporated business - [ ] None of the above > **Explanation:** Drawings are withdrawals made by the owner from an unincorporated business, which reduce the owner’s equity. ### In a partnership, what is used to record the amount withdrawn by the partners? - [ ] Capital account - [ ] Expense account - [x] Drawings account - [ ] Revenue account > **Explanation:** A drawings account is specifically used to record the amounts withdrawn by the partners in a partnership or other unincorporated business structures. ### How do drawings affect the owner's equity? - [x] They decrease the owner's equity - [ ] They increase the owner's equity - [ ] They have no effect on the owner's equity - [ ] They increase liabilities > **Explanation:** Drawings decrease the owner’s equity, as they represent a withdrawal of assets from the business for personal use. ### Which type of business structure typically does not use the term "drawings"? - [ ] Sole proprietorship - [ ] Partnership - [ ] Limited Liability Company (LLC) - [x] Corporation > **Explanation:** Corporations do not use the term "drawings." Instead, they distribute profits as dividends to shareholders. ### What are scrip dividends? - [ ] Cash payments made to unincorporated business owners - [ ] Government subsidies for businesses - [x] Dividends paid in the form of additional shares - [ ] Sales discounts offered to clients > **Explanation:** Scrip dividends are dividends issued in the form of additional shares rather than cash. ### How are drawings taxed? - [ ] Drawings are taxed as personal income. - [ ] Drawings are taxed as business expenses. - [x] Drawings themselves are not taxed. - [ ] Drawings are taxed as gifts. > **Explanation:** Drawings themselves are not taxed, but the underlying business income remains taxable. ### What must an owner do to properly account for drawings? - [ ] Record them as expenses on the income statement - [x] Use a drawings account to track withdrawals - [ ] Capitalize them as business investments - [ ] Ignore them as immaterial transactions > **Explanation:** Owners must use a drawings account to properly track and account for all withdrawals. ### Can an owner still draw assets if the business is incorporated? - [ ] Yes, using the drawings account - [x] Yes, but typically in the form of dividends - [ ] No, it's legally not allowed - [ ] Only in the form of a salary > **Explanation:** In an incorporated business, owners (shareholders) can access assets typically through dividends rather than the drawings account used in unincorporated businesses. ### What principal documentation should underline the records in a drawings account? - [ ] Receipts from personal expenses - [ ] Official dividends declarations - [x] Drawings authorizations and withdrawal receipts - [ ] Shareholders' minutes > **Explanation:** Proper documentation, such as drawings authorizations and withdrawal receipts, underlines the legitimacy and accuracy of entries in the drawings account. ### How does a significant amount of drawings impact a partnership? - [ ] Increases business capital - [x] Decreases partners’ equity - [ ] Has no effect on the business - [ ] Decreases total liabilities > **Explanation:** A significant amount of drawings reduces the partners’ equity in the partnership.

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!

Tuesday, August 6, 2024
Drill Down
Drawing Account
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Profit and Loss Appropriation Account January 1, 1
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Retained Earnings, Appropriated January 1, 1
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