What are the 4 owners equity accounts?

If you are a sole proprietor or partner, you or you and your partners are entitled to everything in your business. You don’t provide dividends to shareholders. You have full ownership of your business.

However, you still have liabilities that you need to handle. Failing to consider your liabilities will give you a false picture of your company’s value. Familiarize yourself with owner’s equity to determine how much ownership you truly have in your company. What is owner’s equity?

What is owner’s equity?

Owner’s equity (also referred to as net worth, equity, or net assets) is the amount of ownership you have in your business after subtracting your liabilities from your assets. This shows you how much capital your business has available for activities like investing.

Liabilities are debts your business owes, such as loans, accounts payable, and mortgages. Assets are anything your business owns, such as cash, cars, and intellectual property.

Because liabilities must be paid off first, they take priority over owner’s equity. Deducting liabilities from assets shows you how much you actually own if all your debts were paid off.

Knowing your owner’s equity is important because it helps you evaluate your finances. And, you can compare your owner’s equity from one period to another to determine whether you are gaining or losing value. This can help you make decisions such as whether you should expand. Also, you need to show your owner’s equity to investors and lenders if you are seeking financing.

Keep in mind that owner’s equity shows you the book value of your business, not its market value. Book value is the amount you paid for an asset when you purchased. Market value is the price of an asset when you sell it. Because assets either depreciate or appreciate over time, market value is very different than book value. Do not look to owner’s equity to give you a fair representation of your company’s market value.

Owner’s equity formula

Again, you can find your owner’s equity by subtracting liabilities from assets. Here is the formula you can use to calculate owner’s equity:

To find owner’s equity, you need to add up all your assets and liabilities.

Owner’s equity examples

Let’s say your business has assets worth $50,000 and you have liabilities worth $10,000. Using the owner’s equity formula, the owner’s equity would be $40,000 ($50,000 – $10,000).

Another example would be if your business owned land that you paid $30,000 for, equipment totaling $25,000, and cash equalling $10,000. Your total assets would be $65,000. You owe $10,000 to the bank and you owe $5,000 in credit card debt. Your total liabilities would be $15,000. Your owner’s equity would be $65,000 – $15,000, or $50,000.

Owner’s equity vs. shareholders’ equity

If your business is structured as a corporation, the amount of your assets after deducting liabilities is known as shareholders’ or stockholders’ equity.

Unlike in a sole proprietorship or partnership, everything does not belong to you or you and your partner in a corporation. Shareholders’ equity shows you how much money is available for distributions to shareholders after deducting liabilities.

Owner’s equity accounts

Some income statement accounts impact your owner’s equity. The main accounts that influence owner’s equity include revenues, gains, expenses, and losses.

Owner’s equity will increase if you have revenues and gains. Owner’s equity decreases if you have expenses and losses.

If your liabilities become greater than your assets, you will have a negative owner’s equity. You can increase negative or low equity by securing more investments in your business or increasing profits.

Owner’s equity on the balance sheet

Assets, liabilities, and owner’s equity are the three parts that make up a business balance sheet. On the balance sheet, your liabilities and equity need to equal your assets.

The balance sheet is a type of financial statement that shows your business’s performance during a specific time.

Different accounts appear in the equity section of the balance sheet, including retained earnings and common stock accounts.

You can compare balance sheets from different accounting periods to determine whether your owner’s equity is increasing or decreasing.

Looking for an easy way to find your business’s equity? With Patriot’s small business accounting software, you can track your assets and liabilities and use data to create balance sheets. Plus, we offer free, U.S.-based support. Get your free trial now!

This article has been updated from its original publication date of 01/08/2016.
This is not intended as legal advice; for more information, please click here.

Equity accounts represent the financial ownership in a company and are visible in the balance sheet immediately after the liability accounts. There are different kinds of equity accounts that are aggregated to form shareholder’s equity.

Almost all equity accounts have credit balances. This means that an entry on the debit side (left side of the T-account) of an equity account means a decrease in that account balance while an entry on the credit side means an increase in the account balance.

What is Equity?

Equity, which can also be called net assets, is the amount that is left after paying the business’s total liabilities. In other words, total equity is calculated by subtracting the total liabilities from the business’s total assets (this is just rearranging the basic accounting equation).

Equity is the amount contributed by shareholders to start a business and to keep the operation of the business alive. Equity can also be built by retaining the residual profits, for instance, if a company generates a net income and does not payout to the shareholders, equity increases.

Types of Equity Account

There are six types of equity account attributed to corporations which are discussed in more detail below. Sole proprietors and partnerships have different equity accounts because of different legal requirements.

Sole Proprietorship and Partnerships

A sole proprietorship is a business owned by a single owner and a partnership is owned by two or more individuals. The following are the most common equity accounts that are associated with these two business entities.

• Owner’s capital. The owner’s capital which is known as members’ capital for partnerships is the equity account consists of capital that has been contributed or invested by a single owner or two or more members.

  The essence of this account is much the same as retained earnings for corporations. The ending owner’s capital is equal to beginning balance reduced by any withdrawals, increased by any new investment, and increased or decreased by net profit or loss for the period accordingly.

• Owner’s distribution. This is a contra equity account that records all the income distributions made to the owners. In other words, this account tells us the amount of money that has been taken out of the business.

  This reduction in money is not an expense rather this account is intended to note all the distribution that has been made to the owner for a year.

Corporations

Common Stock (Capital contributed by shareholders or issued capital)

This is an equity account where the amount contributed initially by shareholders is recorded. The right to vote and the residual claim on the company’s assets depends upon the share entitled in this equity account.

The value of this equity account is usually recorded at par value of share times the number of shares outstanding. The number of shares outstanding must also be disclosed in the balance sheet and it is equal to issued shares subtracted by treasury shares.

For example, 10 million shares with $1 of par value would result in $10 million of common share capital on the balance sheet.

Preferred Stock

This account has the par value of the preferred stock. These shares have precedence over the common shares – precedence that pertains to receipt of dividends and receipt of assets in case the company declared bankrupt.

The preferred stocks have the characteristics of both debt security and common stock. Preferred stockholders do not have the voting rights, but they are usually guaranteed by cumulative dividend, which means the dividend can be accrued until paid off.

For example, preferred stock with a fixed $10 dividend per year. The company has not paid the dividends for the past three years. For the current year, the preferred stockholder will be entitled to receive a total of $40.

Additional Paid-In Capital

This equity account is also known as contributed surplus is the excess amount that investors have paid in addition to the par value of the stocks (equity or preferred), it is seen as the gain which a company has earned when it issues the stocks initially.

Additional paid-in capital can be reduced when a company repurchases its shares. This account can also increase or decrease in value when the gain and loss occur due to the sale of shares.

For example, a company issues 100,000 $5 par value shares for $10 per share. A total of $500,000 will be recorded in a common stock account and the excess amount of $500,000 (100,000 shares x ($10-$5)) will go in the additional paid-capital account.

Retained Earnings

Retained earnings are the part of the company’s net earnings which is retained after paying dividends to shareholders. The motive of retaining such earning is to use those proceeds to pay off debt, launch a new product or business, or acquire other beneficial companies.

For example, a company has retained earnings of $100,000. For the current year, the company has earned a profit of $10,000 (net profit) and decided to pay $2000 in dividends. So the ending retained earnings for the year will be equal to $108,000 ($100,000 + ($10,000 – $2000)).

Other Comprehensive Income

This account includes all the changes in equity of a business for a year except those resulting from investments by the shareholders or distributions to them. In other words, other comprehensive income excludes the profit that has not been realized yet.

A classic example of this equity account is the portfolio of bonds that the company has invested in. Profit & loss due marked to the market value of this portfolio can be determined in other comprehensive income. Once the bonds have matured or sold the realized gain/loss is moved into net income.

Treasury Stock

This is one of the equity accounts that have a debit balance. A contra account that represents the amount a company has paid to repurchase its common stock. These stocks are kept as treasury stocks instead of canceling them, a company can sell (reissue) them.

Some of the motives behind to repurchase its shares is when management think that shares are undervalued or when employees of the company want to exercise stock options. The acquisition of treasury stocks reduces the number of shares outstanding.

FAQs

1. What are equity accounts?

Equity accounts represent the financial ownership in a company and are visible in the balance sheet immediately after the liability accounts.

2. What are the types of equity accounts?

There are six main types of equity accounts which are common stock, preferred stock, additional paid-in capital, treasury stock, comprehensive income, and retained earnings.

3. What are equity accounts on a balance sheet?

Equity represents the shareholders' stake in the company, identified on a company's balance sheet. This means that equity accounts always have a debit balance.

4. Is cash an equity account?

No, cash is not an equity account, but it is a current asset. Equity accounts are found on the balance sheet under the Assets section.

5. Why are equity accounts important?

Equity accounts are important because they show the financial health of a company and how much money shareholders have invested in it. In addition, these accounts help to track a company's progress over time.

When an owner invests money in a company, they are buying a piece of the company. The equity account shows how this ownership is broken down into shares and who owns them. This information can be helpful for shareholders when making important decisions about the company.