Many small business owners compensate themselves using a draw, rather than paying themselves a salary. I have been taking owner's draws during the year of 2015, but now I am curious how to square that with the retained earnings in 2016. Remember, this is a contra-equity account since the owners are reducing the value of their ownership by taking money out of the company. Since this money is being taken out of retained earnings in theory, would I just leave the money in the "Owners Draw" account since it will balance with the retained earnings? However, an intermediate account called Income Summary usually is created. To illustrate, Sam Sun wants to go on a beach vacation and decides to take $8,000 out of the business. An owner’s draw refers to an owner taking funds out of the business for personal use. Both closing entries are acceptable and both result in the same outcome. Retained earnings (RE) is the surplus net income held in reserve—that a company can use to reinvest or to pay down debt—after it has paid out dividends to shareholders. This is becaues temporary or nominal accounts, (also called income statement accounts), are measured periodically; and so, the amounts in one accounting period should be closed or brought to zero so that they won't get mixed with those of the next period. It is a permanent account begun at the time of the company's forming and includes the company's cumulative earnings reduced by any payouts to partners and stockholders. Owner’s Draw is an equity account on the Balance Sheet. 1. Closing entries are the journal entries used to transfer the balances of these temporary accounts to permanent accounts. It represents the sum of personal money that the owner has added and removed from the business. After the closing entries have been made, the temporary account balances will be reflected in the Retained Earnings (a capital account). I recommend that sole proprietors do the following. However, before taking an owner’s draw, you may be required to take a reasonable compensation as an employee. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Retained earnings, a balance-sheet account, is a form of income that a company has earned over time. When the partners take money out of the business, it is recorded in the Withdrawals or Drawing account. Closing journal entries are made at the end of an accounting period to prepare temporary accounts for the next period.. https://smallbusiness.chron.com/withdrawing-retained-earnings-80514.html Patty could withdraw profits generated by her business or take out funds that she previously contributed to her company. Each month the distribution of equity payments close up into this account. The retained earnings account represents equity held by the shareholders of a company. So if you have an S corp, taking out less money as a salary and more as an owner’s draw can provide your business with extra federal payroll tax savings. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. Hi all, I am closing out my 2015 Fiscal year on Xero for a small S-Corp. But unlike accounts in the income statement, which are temporary accounts subject to closure at the end of an accounting period, the account of retained earnings is a permanent account. Change the name of Retained Earnings to Owner’s Draw. IRS rules regarding a “reasonable compensation” can be found here. 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