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, 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 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, 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 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.
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.
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.