Scope note:Owner's equity — capital and drawings for a sole proprietorship — is studied by both G2 and G3 students (Sections 14.1–14.3). Shareholders' equity — share capital, dividends and retained earnings for a private limited company — is G3 only (Sections 14.4–14.6). G2 students stop after the owner's equity sections.
Equity is the owner's stake in the business — what the business owes back to its owner(s) after all liabilities are settled. Who the owner is depends on the form of business:
- In a sole proprietorship, there is one owner, and their stake is called owner's equity. It has a single line item — Capital.
- G3 In a private limited company, the owners are the shareholders, and their stake is called shareholders' equity. It has two line items — Share capital and Retained earnings.
By the accounting entity theory, the business is separate from its owner(s): only transactions that affect the business are recorded. The owner's equity changes whenever the owner puts assets into the business, takes assets out, or the business earns a profit or loss. This chapter shows how to record, present, and interpret those changes.