Download What is owners equity in accounting? Peter Baskerville The

What is owners equity in accounting?
Peter Baskerville
The definition and application of 'owners equity' in Accounting - Foundation level
This answer will help you understand definition of 'owners equity' and the way 'owners
equity' is classified in Accounting. 'Owners equity' is one of the three elements in the
accounting equation; the other two are 'assets' and 'liabilities'.
'Owners equity' in Accounting
Accounting entity assumption and 'owners equity'.
To understand 'owners equity' we must first revisit the 'accounting entity assumption'.
The 'accounting entity assumption' states that in accounting, a business must be treated
as a distinct entity. The business, as a distinct entity, will record its financial transactions
in a separate book of accounts to that of the owners of the business. By applying the
'accounting entity assumption', the business is able to give accurate reports on its own
financial position and performance. The 'accounting entity assumption' also determines
the perspective that the business will take when recording financial transactions.
We know that a business is created to make profits for the owners of that business.
Now when the business is first created, it owns nothing in its own right and it owes
nothing to anyone. It is an empty shell. However, from this point on, the business will
view every financial transaction from its own perspective. It will not record transactions
from the owner's perspective.
Source URL: http://knol.google.com/k/what-is-owners-equity-in-accounting#
Saylor URL: http://www.saylor.org/courses/bus103/
Attributed to: Peter Baskerville
Saylor.org
Page 1 of 4
Owners Equity
The first transaction a business records into its books of account, is the initial
investment of funds by the owners of the business. These investment funds, that are
provided to the business by the owners, are called 'owners equity'. 'Owners equity'
funds remain in the business until the business ceases to trade. The business views
these funds as belonging to the owners but the business is not obliged to repay them.
'Owners equity' funds are investment funds. Investment funds entitle the owners to all
the profits that the business makes. 'Owners equity' funds are known as Equity Funds.
Soon after the business is created it also receives funds that are provided by nonowners. Banks and suppliers are typical non-owners who provide funds to the business.
Funds provided to the business by non-owners are called 'liabilities'.
The business will then use both the Equity funds (Owners equity) and the Debt Funds
(Liabilities) to purchase assets. Assets are those items of financial value that the
Source URL: http://knol.google.com/k/what-is-owners-equity-in-accounting#
Saylor URL: http://www.saylor.org/courses/bus103/
Attributed to: Peter Baskerville
Saylor.org
Page 2 of 4
business will use to make profits for the owners. Typically assets include equipment,
inventory and cash reserves.
So, from the business perspective, the value of the assets the business controls must
be equal to the combined value of the Equity funds (owners equity) and the Debt Funds
(liability). The relationship between assets, liabilities and owners equity is known as the
accounting equation.
Definition of 'owners equity' in accounting.
Owners equity represents the resources invested by the owners in the business. It is
often known as the 'residual' claim over the assets because the claim of the debt
funders (liabilities) must be satisfied before the claim of the owners. Some
characteristics of 'owners equity' are:
1. Owners equity represents investment funds that the business is not
required to repay.
2. Owner's Equity = Assets - Liabilities
3. Owners equity is also called net assets or just 'equity' or the book
value of the company.
4. Owners equity is funds provided to a business by owners.
5. When the assets of a business are liquidated, the debts are paid
first. The Equity funders are entitled to what money is left over.
Another definition - 'Owners Equity' is an accounting term used to describe the net
investment of owners or stockholders in a business. Under the accounting equation,
equity also represents the result of assets less liabilities.
Changes in 'owners equity' in accounting.
'Owners equity' is increased by:
1. From the initial or additional investments by the owners
2. From the current earnings (profits) of the business.
Source URL: http://knol.google.com/k/what-is-owners-equity-in-accounting#
Saylor URL: http://www.saylor.org/courses/bus103/
Attributed to: Peter Baskerville
Saylor.org
Page 3 of 4
3. From previous period profits not distributed to the owners (Retained
earnings)
'Owners equity' is decreased by:
1. Equity withdrawals in the form of:
1. Drawings by sole proprietors
2. Dividends by shareholders of companies
2. Losses from the business operations
Source URL: http://knol.google.com/k/what-is-owners-equity-in-accounting#
Saylor URL: http://www.saylor.org/courses/bus103/
Attributed to: Peter Baskerville
Saylor.org
Page 4 of 4