Closing a ledger drawing account involves transferring its balance to the owner's capital account at the end of an accounting period to prepare for the next financial cycle. This process ensures that the owner's equity is accurately reflected on the balance sheet.
Understanding the Drawing Account
A drawing account is a temporary equity account used in sole proprietorships and partnerships to record withdrawals of cash or other assets by the owner(s) for personal use. It functions as a contra-capital account, meaning it reduces the owner's equity in the business.
- Nature: Temporary equity account.
- Purpose: To separately track all personal withdrawals made by the owner during an accounting period.
- Normal Balance: Debit, as withdrawals decrease owner's equity.
Why Close the Drawing Account?
The drawing account is a temporary account, much like revenue and expense accounts. Its balance only reflects activity for a specific accounting period. At the end of that period, its balance must be reset to zero to:
- Prepare for the New Period: Start the next accounting period with a clean slate for tracking new withdrawals.
- Update Capital: Reflect the net effect of owner withdrawals directly in the permanent owner's capital account. This is crucial for accurate financial reporting.
- Accurate Financial Statements: Ensure the Statement of Owner's Equity and the Balance Sheet present an accurate picture of the owner's stake in the business.
When to Close the Drawing Account
The drawing account is closed as part of the closing entries process, which occurs at the end of every accounting period. This period can be a fiscal year (e.g., July 1 to June 30) or a calendar year (January 1 to December 31).
The Closing Process: Step-by-Step
Closing a drawing account involves a single journal entry that transfers its cumulative balance to the owner's capital account.
Step 1: Determine the Drawing Account Balance
First, calculate the total debits posted to the drawing account throughout the accounting period. This sum represents the total amount the owner withdrew.
Step 2: Prepare the Closing Journal Entry
To close the drawing account, you need to reduce its balance to zero. Since a drawing account normally has a debit balance (as withdrawals reduce equity), you will credit the drawing account for its full balance. The corresponding debit will be made to the owner's capital account, as withdrawals directly reduce the owner's overall investment in the business.
Example of the Closing Journal Entry:
Let's assume an owner, Eve Jones, made monthly withdrawals totaling $24,000 during the accounting year (e.g., $2,000 per month for 12 months). The journal entry to close her drawing account would be:
| Date | Account | Debit | Credit |
|---|---|---|---|
| Dec 31 | Eve Jones, Capital | $24,000 | |
| Eve Jones, Drawing | $24,000 | ||
| To close drawing account to capital |
This entry achieves two key things:
- It reduces the balance of the
Eve Jones, Drawingaccount to zero. - It reduces the balance of the
Eve Jones, Capitalaccount by the total amount of withdrawals made during the year.
Step 3: Post to the Ledger
After preparing the journal entry, it must be posted to the respective ledger accounts. This update will show a zero balance in the Drawing account and a reduced balance in the Capital account, reflecting the owner's decreased equity.
Illustrative Example of Closing a Drawing Account
Consider "The Local Cafe," a sole proprietorship owned by Alex Chen. Throughout the year, Alex withdrew $1,500 each month for personal expenses.
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Total Annual Withdrawals: $1,500/month * 12 months = $18,000.
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Drawing Account Balance: At year-end, the "Alex Chen, Drawing" ledger account will have a debit balance of $18,000.
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Closing Journal Entry (December 31):
Date Account Debit Credit Dec 31 Alex Chen, Capital $18,000 Alex Chen, Drawing $18,000 To close owner's drawing account -
Impact: After posting, the "Alex Chen, Drawing" account will have a zero balance, and the "Alex Chen, Capital" account will be reduced by $18,000.
Impact on Financial Statements
The closing of the drawing account has a direct impact on the following financial statements:
- Statement of Owner's Equity: This statement will show the total withdrawals (from the closed drawing account) as a deduction from the owner's capital during the period, leading to the ending capital balance.
- Balance Sheet: The ending balance of the owner's capital, as adjusted by the closing entries, will appear under the Equity section of the balance sheet, providing an accurate representation of the owner's residual claim on the business assets.
Key Takeaways for Drawing Account Management
- Accurate Recording: It's crucial to consistently and accurately record all owner withdrawals to the drawing account throughout the period.
- Temporary Nature: Remember that the drawing account is temporary; its balance does not carry forward to the next accounting period.
- Direct Impact on Capital: Withdrawals directly reduce the owner's capital, which is reflected through the closing entry.
- Part of Closing Process: Closing the drawing account is an essential step in the overall accounting cycle, ensuring financial data is prepared correctly for subsequent periods and reports.
Understanding how to properly close a drawing account is fundamental for maintaining accurate financial records and providing a clear picture of an owner's equity in a business.
