The Contra Costa County Small Business Community

Equity: Accounting for the Stuff

January 7, 2010, 6:00 am

Copyright © 2010 Integrated Profitability ^TM

Accountants are indispensable for setting up and maintaining the financial records of your business. They are never more valuable than when accounting for the capital in your business.

Earlier, we covered the two main sources and uses of capital. Here is a high-level overview of how one accounts for the two main sources of capital:

1. Initial Investment

Event:

● Issue 100,000 shares of stock at $1.00 each

● Investors buy the 100,000 shares for an average, net-price of $17.83 per share

● All investors pay for their shares in cash

Balance Sheet

Asset                                                               Liabilities

Cash    $1,783,000                                          Liabilities                      $ 0

Capital

Par Value                     $   100,000

Excess over Par            $1,683,000

Total:              $1,783,000                              Total: $1,783,000

2. Retained Earnings

Good news! The first year of business was excellent and your business made money. Being the first year, no dividends were paid and you poured net profit, after tax, back into the business.

Income Statement

Revenue                                   $1,000,000

Expenses                                  $   875,000

Pre-tax Net Income                  $   125,000

Tax                                          $     43,750

Net-Profit                                 $     81,250

Since this is a high-level overview, all the in-&-outs of all the activity of the business are not included: for example, cash from the initial stock offering was used to pay the expenses to generate the revenue; as well as buying a few assets necessary to the running of the business.

So, focusing on the capital accounts:

Balance Sheet

Asset                                                               Liabilities

Cash    $   112,000                                          Liabilities                      $ 0

Capital

Equip   $   552,000                                          Par Value                     $   100,000

Other   $1,200,250                                          Excess over Par            $1,683,000

Retained Earnings         $     81,250

Total:              $1, 864,250                             Total: $1,864,250

That’s the accounting in a nutshell. The migration of “Net Profit” from the Income Statement to the capital account on the Balance Sheet is one of the most intricate accounting processes.

But it is, for owners, the bottom line.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 48

Telephone: 925-202-6244

Copyright © 2009 Integrated Profitability ^TM

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