Expert: Shirley McAllister, CPP, PHR - 3/20/2008

Question
Hi Shirley,

Thanks for taking your valuable time to assist a perfect stranger.

I recently started a partnership in a existing small business.  I use MicrosSoft Accounting as my bookeeping application and when I set up the business in the application I created an owner equity account with two sub-accounts.  One for me and one for my partner (who was the previos proprietor).  I contrituted nothing to the startup cost.  We took the value of the existing inventory and assets and debited my partners owner equity account and credited checking and inventory accounts accordingly.

At startup my partner had a $35,000.00 balance in his owner equity acount.  Mine was $0.00.  I understood this to mean that our little company owed my partner $35,000.00 and owed me nothing.

Our business has generated a little cash flow and we need to pay ourselves a little money to live on.  I asked how to do this in the MS Accounting support group and the reply I received puzzled me.  I was told to record the money drawn from business to pay owners in the owner equity account!

I really don't understand this at all.  It seems to me that doing so would begin to reduce the 35K that our company owes my partner and the first time I drew any money I would have a negative balance in my owner equity account meaning I owed my company!

I need to find a way to draw some pay for my partner and I without it changing the fact that the business owes my partner his initial 35K investment.

Perhaps I used the owner equity account improperly when I first set up the books, perhaps I don't understand owner equity accounts.

I need your help in this area.

Thanks again.  

Answer
Okay, I am not familiar with your software and I am not an expert on the type of corporation that has Draws as the larger corporations pay salaries to the owner's.

You were told correctly. The draws are listed under the equity account for each partner. The equity accounts will show up on the Balance Sheet not on the Profit and Loss Statement. Each Partner's equity account should have two sub-accounts, 1 for investments and 1 for draws.

If only one partner has funds to invest it might be wiser instead of putting it into equity to have the partner loan the money to the company and start the equity at zero for both partners. As profits come in the amounts would be appropriated 3 ways. Loan payoff, and into each equity account. The partner with the start up funds would get his funds back and the profits would be shared equally with the two partners.

Your equation statement for this small company would be Assets= Liabilities+Owner's Capital+Revenues-Expenses-Owner's Draws.

This is beyond my knowledge, I an a Human Resources Director, not a corporate Tax council.  This is something that you really need to have a CPA help you out with.  Once he gets you set up and explains how to put everything in the system you will be fine with it. I am sorry I could be of more help, but I do not work with this type of entity and I am not a CPA. I did the best I could, but you probably need help from someone with more experience in this type of situation.

Shirley