Owner investments and drawings: the journal entries for a sole proprietor

In a sole proprietorship the owner and the business are one person in law, but in the books they are kept strictly apart. The business has its own bank account, its own assets and its own records, and every time money or property crosses the line between the owner's personal life and the business, a journal entry records it. Money and property going in are investments. Money and property coming out for personal use are drawings (also called withdrawals). Neither one is revenue, and neither one is an expense.

This page explains the two equity accounts involved, then works through the entries you will meet: cash invested, equipment contributed at fair value, a mixed start-up investment, cash withdrawn, personal bills paid by the business, goods taken for personal use, and a business bill the owner pays personally.

The two accounts

• Owner's Capital holds the owner's stake in the business. It has a normal credit balance. Investments increase it (credit), and so does net income when the books are closed.
• Owner's Drawing collects everything the owner takes out during the period. It has a normal debit balance and is a contra-equity account: it reduces equity. At year end it is closed into Owner's Capital, so the capital account shows the stake after the year's withdrawals.

Why not debit Owner's Capital directly for a withdrawal? You can, and the balance sheet would end up the same. Keeping a separate Drawing account lets the owner and anyone reading the statements see how much was taken out during the year, separately from how much was put in. The statement of owner's equity shows both: beginning capital, plus investments, plus net income, minus drawings, equals ending capital.

Why investments are not revenue

Revenue is earned by selling goods or services to customers. When the owner moves savings into the business account, nothing has been sold and nothing has been earned; the owner has simply increased their stake. Recording an investment as revenue would overstate profit, and it would make the business look more successful than it is. It is also not a loan unless there is an agreement to repay it. Our exercises check both of these slips.

Worked examples: putting money and property in

Cash invested

Tom Becker, the owner of Copperleaf Studio, deposited $47,500.00 of personal savings into the business bank account as an additional investment.

Equipment contributed at fair value

When the owner contributes an asset other than cash, the business records it at its fair value on the day it is contributed: what it would sell for now, not what the owner paid for it years ago.

The owner contributed equipment to the business. It was bought personally three years ago for $12,400.00; its fair value today is $6,800.00.

The $12,400.00 is history from the owner's personal life. The business acquires a three-year-old asset worth $6,800.00, and the owner's stake grows by that amount. From here on, the business depreciates the equipment from $6,800.00.

A start-up investment of cash and property

The owner started Copperleaf Studio by depositing $32,500.00 into a new business bank account and handing over a delivery van bought personally for $10,900.00, with a fair value of $6,000.00 today. The business records vehicles in Equipment.

One compound entry, with capital credited for the total value contributed: $32,500.00 + $6,000.00 = $38,500.00.

Worked examples: taking money and property out

Cash withdrawn

The owner withdrew $6,400.00 from the business bank account for personal use.

A sole proprietor does not pay themselves wages in the books. Money the owner takes out is a drawing, even if it is taken every week and thought of as a salary. Debiting Wages Expense would understate profit.

A personal bill paid from the business account

Copperleaf Studio paid $1,127.00 from the business bank account for the owner's family car repair. The bill is personal, not a business cost.

The test is who benefits. The repair is for the owner's family car, so it is a drawing, even though the business's money paid it and even though the business also has a Repairs Expense account:

Goods taken for personal use

The owner took merchandise home for personal use. The goods cost the business $715.00 and normally sell for $1,287.00. Perpetual inventory.

Nothing was sold, so there is no revenue. The goods leave Inventory at cost:

The reverse case: the owner pays a business bill

Sometimes the line is crossed the other way. The owner pays a business cost with a personal card and does not expect to be paid back.

The owner paid $1,425.00 for a repair to the shop door with a personal credit card. The cost belongs to the business; treat it as an additional investment.

The business has a real expense, so it records it. Its own cash did not move, so Cash is not credited. The owner put personal money into the business, which is an investment. (If the owner expected to be repaid, the credit would be a liability to the owner instead.)

Business or personal? A quick test

Most errors in this area come from deciding which side of the line a payment belongs on. Ask two questions. First, who benefits? If the payment helps the business earn revenue (rent on the shop, a repair to the delivery van, advertising), it is a business cost, whoever paid it. If it benefits the owner or the owner's family (the home electricity bill, a family holiday, personal insurance), it is personal. Second, whose money paid? If business money paid a personal cost, it is a drawing. If personal money paid a business cost, it is an investment (or a liability to the owner, if repayment is expected). When both answers point the same way, as with rent paid from the business account, it is an ordinary business transaction and the owner's equity accounts are not involved at all.

Keeping a separate business bank account makes these decisions rare, which is one reason bookkeepers encourage it. When personal and business spending are mixed in one account, every line has to be sorted by hand.

How it all shows up: the statement of owner's equity

Suppose Copperleaf Studio began the year with $20,000.00 of capital, and the year's investments were the $47,500.00 of cash and the $6,800.00 of equipment from the examples above. Its drawings were the $6,400.00 cash withdrawal, the $1,127.00 car repair and the $715.00 of goods, and (for illustration) net income was $18,000.00. The statement of owner's equity would read:

Notice that investments and drawings never touch net income. If the investments had been recorded as revenue, net income would be overstated by $54,300.00; if the drawings had been recorded as expenses, it would be understated by $8,242.00. Either way, ending capital might still come out right, but the income statement would mislead anyone using it to judge how the business is doing.

Common mistakes

1. Recording an investment as revenue. The business earned nothing. Credit Owner's Capital.
2. Recording an investment as a loan. Without an agreement to repay, it is equity.
3. Using the owner's original price for a contributed asset. Use fair value on the day it is contributed.
4. Expensing a withdrawal. Personal spending is a drawing, whatever it was spent on.
5. Recording goods taken at selling price, or as a sale. No sale happened; take them out of Inventory at cost.
6. Crediting Cash when the owner paid personally. The business's bank account did not change.

How the practice works

Each exercise generates a new owner, business and set of amounts. You build the entry from a standard chart of accounts, press Check, and your answer is compared line by line with an entry computed from the same facts. The lesson moves from cash investments and withdrawals to contributed equipment, goods taken from stock, and finally a business bill paid from the owner's pocket. The closing-entries lesson in this course shows what happens to the Drawing account at year end.