Key Concepts
In a sole proprietorship, the owner's stake in the business is the Capital. It grows when the owner puts assets in or the business earns profit, and shrinks when the owner takes assets out or the business makes a loss.
| Part | What it means | Effect on Capital |
|---|---|---|
| Contributions | Personal assets the owner puts into the business for its use — cash, office equipment, a motor vehicle, and so on. Recorded as capital. | Increase |
| Profits (− Losses) | Profits earned belong to the owner; losses are borne by the owner. | Profit → increase; loss → decrease |
| Drawings | Business assets the owner takes out for personal use — cash, inventory, and so on. Recorded as drawings. | Decrease |
Capital is a credit-natured account. Like all equity, it normally carries a credit balance: it increases on the credit side (contributions, profit) and decreases on the debit side (drawings, loss).
Drawings is the owner taking business assets for personal use. It is not an expense of the business — it is a reduction of the owner's equity. Drawings are recorded in a separate Drawings account during the year and closed to Capital at year-end.
What counts and what does not (accounting entity theory). Only transactions that affect the business are recorded. If the owner receives a personal gift and keeps it at home, nothing is recorded. If the owner brings that asset into the business, it becomes a capital contribution.
In the Statement of Financial Position, always show the working for Capital inline — e.g. Capital ($30,000 + $5,000 − $2,000), not just the final figure.
Capital is the owner's scoreboard. Two things push it up — money/assets the owner puts in (contributions) and profit earned. Two things pull it down — money/assets the owner takes out (drawings) and loss made. In → up, out → down.
Treating drawings as an expense. Drawings are not a business expense and never appear in the Statement of Financial Performance. They reduce Capital in the Statement of Financial Position.
Recording the owner's personal transactions. By the accounting entity theory, a gift the owner keeps at home, or a bill the owner pays for personal reasons, is not the business's transaction.
Putting capital on the wrong side. Capital is credit-natured: contributions and profit are credited to Capital; drawings and loss are debited.