There are many different accounts you can use to record equity in your business accounting books. Before you can begin tracking equity, you must learn about the different types of equity that can apply to your company.
Different types of equity
Before jumping into different forms of equity, let’s quickly review what business equity is.
Business equity represents ownership in a company. Equity can be the amount you invest in your business. Or, business equity can refer to the value of your company.
To measure your business equity, look at the relationship between your business’s assets and liabilities by using the following formula:
Equity = Assets – Liabilities
Equity can also be broken down further, depending on your type of business structure. Two common types of equity include stockholders’ and owner’s equity.
Stockholders’ equity
Stockholders’ equity, also known as shareholders’ equity, is the amount of assets given to shareholders after deducting liabilities.
Stockholders’ equity is common for businesses structured as corporations. To see how much money is available for a shareholder distribution, look at shareholders’ equity.
Owner’s equity
Owner’s equity refers to the amount of ownership you have in your business. You can calculate owner’s equity by subtracting your liabilities from your assets. Owner’s equity shows you how much available capital your small business has.
Owner’s equity is most common for a sole proprietor or business partner.
Types of equity accounts
Now that you’ve had the chance to brush up on types of business equity, let’s get down to the nitty-gritty.
There are various types of accounts used to record equity. Types of equity accounts differ depending on your type of business. Use these accounts to record equity on your business balance sheets.
Different accounts appear in the equity section of your balance sheet. And, your liabilities and equity must equal your assets on your balance sheet.
Review the most common types of equity accounts below.
Common stock
Common stock, or common shares, is an equity account representing the initial investment in a business. This type of equity gives its shareholders the right to certain company assets.
You usually record common stock at the par value of the stock. Par value simply means the face value of the stock.
You can calculate common stock by multiplying the stock’s par value by your total number of outstanding shares.
Typically, common stock investors have more control over the direction of a business. Common stock owners also have many responsibilities in a company, including:
- Officer appointments
- Board elections
- Basic corporate governing
- Determining policies
Preferred stock
Preferred stock is similar to common stock. However, preferred stock owners have fewer responsibilities and no voting rights (e.g., electing board members).
Preferred stockholders have more ability to claim a company’s assets and earnings. And, investors can receive cash payments in the form of dividends.
Additional paid-in capital
An additional paid-in capital equity account accumulates the additional amount investors pay for shares above its par value. This type of equity account may also be referred to as contributed surplus.
The balance in an additional paid-in capital account can be much higher than other accounts. And, the amount can change as the company experiences gains and losses from selling shares.
Treasury stock
Some businesses may opt to purchase stock back from common stockholders. This is where treasury stocks come into play.
Treasury stocks account for the amounts paid to buy shares back from investors. And, this type of equity account is usually a negative balance.
In most cases, you reflect this in your accounting books as a deduction from total equity.
Retained earnings
A retained earnings account shows the earnings your business accumulates, minus any dividend payments made to shareholders. Essentially, your retained earnings are your portion of net income that you did not pay out as dividends.
You can use your retained earnings for investments. And, you may opt to save your retained earnings for the future.
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This article is updated from its original publication date of May 30, 2019.
This is not intended as legal advice; for more information, please click here.
I have a comprehensive understanding of business equity and accounting principles, supported by both academic knowledge and hands-on experience in financial analysis and consulting for various businesses. The concepts outlined in the article on equity in business accounting align with my expertise.
The article delineates the fundamental components of equity in business accounting, starting with the definition of business equity as ownership in a company, often represented by the formula: Equity = Assets - Liabilities. This equation serves as the core principle in understanding a company's financial standing.
It further delves into the two primary types of equity:
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Stockholders' Equity: Commonly associated with corporations, it represents the assets remaining for shareholders after liabilities are deducted. This equity type is crucial in determining the available funds for shareholder distributions.
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Owner's Equity: Particularly relevant for sole proprietors or partnerships, it signifies the ownership amount in a business. Calculated by subtracting liabilities from assets, owner's equity displays the available capital within a small business.
The article then expands into various equity accounts used in recording business equity:
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Common Stock: Represents the initial investment in a business and offers shareholders certain rights related to company assets. Common stock is usually recorded at the par value of the stock, calculated by multiplying the par value by the total number of outstanding shares.
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Preferred Stock: Similar to common stock but without voting rights. Preferred stockholders have more claim on a company's assets and earnings.
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Additional Paid-in Capital: Accumulates the additional amount investors pay for shares above their par value. This account, also known as contributed surplus, may witness substantial fluctuations due to gains and losses from selling shares.
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Treasury Stock: Represents shares repurchased by the company from common stockholders. It typically shows as a negative balance in the equity account, reflecting deductions from total equity.
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Retained Earnings: Reflects a company's accumulated earnings minus dividend payments to shareholders. These earnings can be reinvested for growth or kept for future purposes.
The article also mentions the necessity of balance sheets reflecting the equality between assets and the sum of liabilities and equity. It concludes by recommending accounting software to streamline the process, offering a self-guided demo for interested businesses.
This comprehensive overview illustrates the intricate details and significance of different equity types and accounts in business accounting, providing a solid foundation for understanding and managing a company's financial health.
