Capital or Owners Equity

1 Oct

Capital or Owners Equity

Capital-or-Owners-Equity

We are able to define assets and liabilities in the previous topics.  Now we are going to discuss about Capital or Owner’s Capital.

When we hear the word Capital or Owner’s capital, what comes to mind is the amount of money or resources that an owner invest in his business.  Capital always involve investments of sum of money.  However, owners can always contribute capital in form of other assets like machinery and equipment or properties.  What comes to mind is the investment made by the owner when he set up his business or the additional amount of money, properties being contributed or put up in the course of business operations.

However, in the business setting and accounting world, capital is considered the sum total of owner’s investment that may consist of money or properties, less any withdrawals or drawings. The net amount of investments less the amount of withdrawals or drawings are then added to the net income or lessened by the net loss of the business to arrive at the computed capital or owner’s investment.  For example, if the owner has invested S$10,000 cash and S$5,000.00 of office furniture and equipment, his capital investment amounted to S$15,000.00

During the first year of operations, net profit from the business amounted to S$8,000.00 while his capital withdrawals or drawings amounted to S$2,500.00.   To compute his capital or owner’s equity, we calculated S$20,500.00 capital as follows:

Beginning Capital Investment                         S$15,000.00

Add:  Net Profit from Operations                           8,000.00

Less:   Drawings                                             (      2,500.00)

Capital at end of first year operations            S$20,500.00

In Accounting, Capital is the difference between Assets and Liabilities so capital also mean Net Assets.  Net Assets is the remaining balance of the total company or business assets after paying off all company debts and liabilities to all suppliers and debtors. For example, XYZ company have a total assets of S$25,000.00 and total liabilities of S$15,000.00, that means the Capital or Owners equity is S$10,000.00

Correct and accurate recording of business financial transactions is very important in order to have reliability on the level of accuracy contained in the accounting information of the business.  Assuming that a company with high volume of transactions have erroneously recorded $5,000.00 cash contribution from its owner as a payment from a customer.  To correctly record the transaction the following entry should be made:

Debit  –  Cash                                      S$5,000.00

Credit – Capital                                                                       S$5,000.00

If the bookkeeper have erroneously recorded the investment transaction as:

Debit –  Cash                                      S$5,000.00

Credit – Accounts Receivable                                                S$5,000.00

Erroneous recording of transactions result to erroneous financial information which in this case, resulting in understatement of owners capital.  In the next topic you will get to know how to correctly analyze and record transactions using the basic principles and the normal balance debit and credit of accounts. You will get to know what is the normal balance side of an account which is the key to correctly recording transactions of the business.

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