In order to understand the nature of drawings account in accounting and why is it deducted from capital or equity total the better is that we look at the definitions of expense, liability and possibly the drawings as well.
Expense can simply be defined as outflow of resources of entity in order to earn revenue or in other words a cash outflow with a purpose to generate cash inflow. In for-profit organisations cash outflow is made to generate higher cash inflow which ultimately increase shareholder’s wealth. This outflow of resources can either be in form of cash or in kind i.e. asset other than cash or cash equivalents. According to IASB the definition of expense includes losses as well.
Technically speaking expense arises out of such business transactions that result in decrease of asset or increase in liabilities but one thing to remember is that expenses are incurred to generate revenue in the ordinary course of business i.e. expense is such outflow that is made with an intention to bring more cash in afterward. On the other hand losses represent decrease in the economic benefit of assets for example loss of asset by fire or decrease in production capacity of machinery because of raw material ban and thus resulting decrease in the value of machinery causing impairment.
Liability can simple be defined as entity’s present obligation in respect of which payment is outstanding. Such payment can be made either in cash or in kind but the fact is that obligation exists and outflow of resources is inevitable. Liability may arise in the ordinary course of business as a result of acquisitions made to further business operations like buying stock or other assets. Liabilities also arise if we have taken the benefits of services offered by others but haven’t paid the consideration for such services yet.
Now lets ask ourselves the question what are drawings and whether drawings fulfill definition or characteristics of expense or liability as noted above.
Drawings are simply withdrawal of resources of the entity by the owner for personal use. Resources include cash or other assets like inventory etc. It is neither an expense nor a liability rather it is a reduction in the residual interest of the owner in the entity or in layman terms reduction in the amount of investment made by the owner.
Although drawings are outflow of resources from entity’s perspective yet they are not expense because such outflow is not permitted with an intention generate higher cash inflows. It is neither a liability because drawings are not an obligation of entity that it has to fulfill every year. Its up to the owner how much amount he wants to keep in the business.
In full blown accounting terms drawings account is a contra-equity or contra capital account. Instead of debiting equity to record decrease on withdrawals, a debit is recorded by maintaining a separate account called drawings account which records the decrease in equity amount. This way the amount of initial investment made is not disturbed and users of financial statements can know the amount of original investment at any moment. But for reporting purposes, total of drawings account is subtracted from total of equity to let users know the net residual interest owners have in the organisation.
Drawings account is one of the temporary accounts and is closed at the end of accounting period. But this account is not closed in the income statement i.e. trading account or profit and loss account rather it is closed in the capital account of the owner which is reported in the statement of financial position.
are drawings expense or assests
drawings are neither expense nor assets
1.There are two types of drawings, cash drawing and stocks/goods drawings. How do we account for drawings in the Income statement and Statement of Financial Position?
2. When Drawings is found on the credit side in the Trial Balance, what does this mean and how it should be recorded?
3. When Drawings is found on the debit side in the Trial Balance, what does this mean and how it should be recorded?
nice work sir hassan
Is drawing is a prsnl reprentativ a/c…if yes than what is nature of drawing out of profit…
if i buy my secretary ajacket,Is it adrawing or an ooerational expenses
Consider the nature of expense. If it is given as part secretary’s job (like part of uniform) then it is an expense. If it is a gift for which business paid on behalf of the owner then it is a withdrawal.