Owner’s equity, often called net assets, is the owners’ claim to company assets after all of the liabilities have been paid off. In other words, if the business assets were liquidated to pay off creditors, the excess money left over would be considered owner’s equity. That is why it is often referred to as net assets. According to the accounting equation, owner’s equity equals total company assets minus total company liabilities.
The term owner’s equity is used as a generic equity account, but it’s most commonly used for sole proprietorships. Partnerships typically call their equity accounts members’ equity and corporations use shareholders’ equity.
There are several different components that contribute to the owner’s equity formula. Owner’s capital is the permanent account that maintains the cumulative balance of draws, contributions, income, and losses over time. This balance could be positive or negative depending on the next few components.
Withdrawals happen when an owner takes money or other assets out of the company. This obviously reduces the owner’s capital account and the overall owner’s equity.
Contributions, often called owner investments, happen when an owner puts money or other assets into the company. This increases the equity accounts.
As the business earns income or incurs losses, the net income or loss is closed to the capital accounts and reflected in the overall equity balance.
Thus, owner’s equity can be calculated by adding up the owner’s capital account, current contributions, and current revenues and subtracting withdrawals and expenses.
Take Tony’s Pizzeria for example. He just started the company this year, so there is no beginning capital account. At the end of the year he made $20,000 of profit, contributed $10,000 of equipment, and took out $5,000 in cash. Tony’s ending owner’s equity would be $25,000 ($20,000 + $10,000 - $5,000).
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