Equity accounts are the financial representation of the ownership of a business. Equity can come from payments to a business by its owners, or from the residual earnings generated by a business. Because of the different sources of equity funds, equity is stored in different types of accounts.
Equity Account Types
There are several types of equity accounts illustrated in the expanded accounting equation that all affect the overall equity balance differently. Here are the main types of equity accounts.
Capital – Capital consists of initial investments made by owners. Stock purchases or partnership buy-ins are considered capital because both are comprised of cash contributions made by the owners to the company. Capital accounts have a credit balance and increase the overall equity account.
Withdrawals – Owner withdrawals are the opposite of contributions. This is where the company distributes cash to its owners. Withdrawals have a debit balance and always reduce the equity account.
Revenues – Revenues are the monies received by a company or due to a company for providing goods and services. The most common examples of revenues are sales, commissions earned, and interest earned. Revenue has a credit balance and increases equity when it is earned.
Expenses – Expenses are essentially the costs incurred to produce revenue. Costs like payroll, utilities, and rent are necessary for business to operate. Expenses are contra equity accounts with debit balances and reduce equity.
The following equity accounts are commonly used by corporations:
- Common stock. This is the par value of the stock sold directly to investors. Par value tends to be quite small or nonexistent, so the balance in this account may be minimal.
- Preferred stock. This is the par value of preferred stock. These shares have special rights and privileges beyond those accorded to common stock. Some organizations have never issued preferred stock, while others may have issued a number of tranches of it.
- Additional paid-in capital. This is the amount paid by investors in excess of par value on stock sold directly to them by the issuer. The balance in this account can be quite substantial, especially in view of the minimal par value amounts assigned to most stock certificates.
- Retained earnings. This is the amount of earnings generated by a business to date, less the amount of any distributions back to shareholders in the form of dividends.
- Treasury stock. This is a contra account that contains the amount paid to investors to buy back shares from them. This account has a negative balance, and so reduces the total amount of equity.
All equity accounts, with the exception of the treasury stock account, have natural credit balances. If the retained earnings account has a debit balance, this implies that either a business has been experiencing losses, or that the business has issued more dividends than it had available through retained earnings.