Walking Through the Equity Section of the Balance Sheet

01
of 04

Sole Proprietors Equity Section of the Balance Sheet

Young woman checking bill, close-up'
Gone Wild/ Photographer's Choice/ Getty Images

Equity which shows the combined total of your investment in your arts and crafts business is one of the sections on your balance sheet. Another term for equity is net assets, which is the difference between assets, which are resources a your company owns, and liabilities, which are claims against your company. Depending on the organization of your business, how you record owners' interest in the equity section of the balance sheet differs. The basic concept remains the same, but with the exception of retained earnings you use different accounts to record owners equity.

There are three different types of entities you can use to organize your arts or crafts business: sole proprietorship, flow-through entity such as a partnership and a corporation. This page shows the equity section for a sole proprietorship.

Characteristics of a Sole Proprietorship

Like the name implies, a sole proprietorship has one and only one individual owner. And this owner can't collectively own the business with anyone else like their spouse or another relative or friend. While there can be only one owner, the sole proprietorship can hire as many employees as it needs. Formation is a snap. In most states there is no formal filing for a sole proprietorship like there is for a corporation. Once the company makes its first sale or incur its first business expense it is officially in business as a sole proprietorship.

The sole proprietorship has two unique equity accounts: owner capital and owner draw. Here's information about each:

Owners' Capital

The owner capital accounts shows a few different items:

  • Cash Contributions: This is any money you used to start the business. Many sole proprietorships also have an on-and-off need over the years for an influx of cash from the owner. It's a simple fact of doing business that sometimes you have to pay for businessexpenses before you collect the money from your customers.
  • Non-Cash Contributions:When you started your sole proprietorship, you may have already personally owned computer equipment and furniture that you converted to business use. If you decide to make these assets properly of the business, you increase your owner's capital for the fair market value, which is what an unrelated third party would pay in an open marketplace, of the assets. For example, you have a desk that originally cost $500. Comparable used desks are selling online for $100. Your fair market value is $100.
  • Net Income (Loss): Net income (loss) is the difference between your arts and crafts revenues and expenses. If your business revenues are more than your expenses, you have net income. If your business expenses are more than your revenue, you have a net loss. How much money your arts or crafts business brings in at the end of day affects your capital account. Net income increase it and net loss decreases it.
  • Retained Earnings: This shows the combined total of all net income (loss) over the years the arts and crafts business is operating. For example, the net income for Metropolitan for 2012 is $15,000. Let's say they have net income of $20,000 in 2013, retained earnings at 12/31/2013 is $35,000 ($15,000 + $20,000).

Owners' Draw

Owners' draw shows money and other assets the owner takes from the business to use personally. This account is used pretty frequently by sole proprietors as this is how they get paid. This is because a sole proprietor doesn't receive a paycheck with taxes withheld, reported on a W-2 at the end of the year. They just write themselves a check, adding to their draw account and reducing their overall capital and owners' equity.

02
of 04

Corporation Equity Section of the Balance Sheet

Stockholders' Equity Section of the Balance Sheet. Maire Loughran

The equity section of the balance sheet for a corporation shows the claim shareholders of the corporation have to the arts and crafts business net assets. There are three common components to stockholders' equity: paid-in capital, treasury stock and retained earnings. Paid-in capital and treasury stock involve transactions dealing with the corporate stock issuances. Retained earnings shows income and dividend transactions.

Defining Paid-in Capital

Paid-in capital represents money the shareholders in the corporation invest in the business (contributed capital). It consists of common stock, preferred stock (although if you've opted to incorporate your arts and crafts business you'll probably only have common stock) and additional paid-in capital. Don't worry - you're not seeing double! Additional paid-in capital is a sub-set of paid-in capital.

Common Stock

Common stock shows your residual ownership in your arts and crafts corporation which consists of any remaining net assets after preferred stockholders claims are paid. In order to be a real business, at least one share of common stock has to be issued. After all somebody has to be in charge of the corporation! Common stockholders elect the board of directors, who oversee the business. The board of directors elects the corporate officers, ((president, vice president, secretary and treasurer) who handle the day-to-day operations of the business.

Preferred Stock

Most arts and crafts businessess don't go through all the hoopla of issuing anything but common stock. However, it's a good idea to at least know what preferred stock is. Like common stock it shows ownership in the corporation. However, preferred stock shows traits of both debt and equity. What this means is if your arts and crafts business sells its assets and closes its doors, preferred shareholders get back the money they invested in the corporation plus any dividends owed to them, which is income the corporation pays to the shareholders.

Additional Paid-in Capital

This is the excess of what you paid to buy stock in your arts and crafts business over the par value of the stock. Par value is what's printed on the face of the stock certificate reflecting the cost of the stock. Wondering how par value is determined? Whoever was in charge of originally forming the corporation (probably you) decided on the amount of par value. Most of the time it's an insignificant amount selected at random.

For example, the par value for Metropolitan Arts and Crafts common stock is $10 per share. You buy buy 20 shares for $15 a share. The addition to Metropolitan's common stock account is $200 (20 shares at $10 par value). Additional paid-in capital is $100 which is calculated by multiplying those 20 shares by the excess you paid for the stock over their par value (20 shares times $5).

Retained Earnings

This account shows your arts and crafts business net income/loss since you opened shop, reduced by any dividends you paid yourself or other shareholders.

03
of 04

S-Corporation Balance Sheet Equity Section

The equity section of the balance sheet for an s-corporation is the same as the equity section for a regular C corporation. This is because the S-Corporation designation is a tax rather than accounting issue. All S-Corporations have to start out as c corporations. First, you file whatever paperwork (usually a corporate charter or articles of incorporation) your Secretary of State needs to recognize your corporation. After you get notification from the Secretary of State that your paperwork is a-ok, a business can opt to be taxed as an S-Corporation.

You do this by filling out Form 2553 with the Internal Revenue Service. However, nothing about making the election changes the corporation's equity accounts. You'll still have retained earnings and additional paid-in capital.

Next up - the equity section of the balance sheet for a partnership.

04
of 04

Partnership Equity Section of the Balance Sheet

Partnership Equity Section of the Balance Sheet.

First, a quick tutorial on partnershops:

A partnership must have at least two partners holding any percentage of partnership interest. For example, one partner can have 99% interest and the other can have 1% or any combination that adds up to 100%. Keep in mind that a partnership is not limited to two partners; there can be as many partners as the partnership wants to have.

Limited Liability Partnership

Many states allow for limited liability partnerships, which basically means if you are a limited partner your liability for partnership debt is limited to your investment in the partnership. However, as a limited partner, you may not have any say so in how the partnership is run.

Partners' Capital

The partner capital accounts shows a few different items:

  • Cash Contributions: This is any money you used to start the business. Many partnerships also have an on-and-off need over the years for an influx of cash which can come from any of the partners. It's a simple fact of doing business that sometimes you have to pay for businessexpenses before you collect the money from your customers.
  • Non-Cash Contributions:When you started your partnership, you or one of your partners may have already personally owned some office, computer or shop assets that you gave to the partnership for business use. Therefore, you increase your partners' capital for the fair market value, which is what an unrelated third party would pay in an open marketplace, of the assets. For example, you have a computer that originally cost $800. Comparable used computers are selling online for $50. Your fair market value and additional to your partner capital is $50.
  • Current Net Income (Loss): Net income (loss) is the difference between your arts and crafts revenues and expenses. If your business revenues are more than your expenses, you have net income. If your business expenses are more than your revenue, you have a net loss.

    How much money your arts or crafts business brings in at the end of day affects your partner capital account proportionately based on what's in the partnership agreement. For example, if the partnership agreement states you have a distributive share of 25% and the net income is $15,000, your distributive share is $3,750.

Partners' Draw

Partners' draw shows money and other assets the partner takes from the business to use personally. The amount of draws a partner is allowed to take can be different than their partnership interest. So even though you have two equal partners, it doesn't mean they have to take the same draw amount. This is cause of the differences in beginning and ending partners' capital accounts between partners shown on this page.

Format
mla apa chicago
Your Citation
Loughran, Maire. "Walking Through the Equity Section of the Balance Sheet." ThoughtCo, Aug. 3, 2016, thoughtco.com/equity-section-of-the-balance-sheet-192803. Loughran, Maire. (2016, August 3). Walking Through the Equity Section of the Balance Sheet. Retrieved from https://www.thoughtco.com/equity-section-of-the-balance-sheet-192803 Loughran, Maire. "Walking Through the Equity Section of the Balance Sheet." ThoughtCo. https://www.thoughtco.com/equity-section-of-the-balance-sheet-192803 (accessed December 14, 2017).