Examining Liability and Equity Accounts for Your Business - dummies

Examining Liability and Equity Accounts for Your Business

In addition to an Assets section, the balance sheet for a business includes sections for reporting accounts relating to Liabilities and Equity. The Liabilities section is divided into two categories: current liabilities and long-term liabilities.

Liability accounts in a balance sheet

The Liabilities section of the balance sheet comes after the Assets section and shows all the money that your business owes to others, including banks, vendors, contractors, financial institutions, or individuals. Like assets, you divide your liabilities into two categories on the balance sheet:

  • Current liabilities: All bills and debts you plan to pay within the next 12 months. Accounts appearing in this section include Accounts Payable (bills due to vendors, contractors, and others), Credit Card Payable, and the current portion of a long-term debt.

  • Long-term liabilities: All debts you owe to lenders that will be paid over a period longer than 12 months. Mortgages Payable, Loans Payable, and Bonds Payable are common accounts in the long-term liabilities section of the balance sheet.

Most businesses try to minimize their current liabilities because the interest rates on short-term loans, such as credit cards, are usually much higher than those on loans with longer terms. You should always look for ways to minimize your interest payments by seeking longer term loans with lower interest rates than you can get on a credit card or short-term loan.

Equity accounts in a balance sheet

Every business has investors. Even a small mom and pop grocery store requires money upfront to get the business on its feet. Investments are reflected on the balance sheet as equity. The line items that appear in a balance sheet’s Equity section vary depending upon whether or not the company is incorporated. (Companies incorporate primarily to minimize their personal legal liabilities.)

If you’re preparing the books for a company that isn’t incorporated, the Equity section of your balance sheet should contain these accounts:

  • Capital: All money invested by the owners to start up the company as well as any additional contributions made after the start-up phase. If the company has more than one owner, the balance sheet usually has a Capital account for each owner so that their individual stakes in the company can be tracked.

  • Drawing: All money taken out of the company by the company’s owners. Balance sheets usually have a Drawing account for each owner in order to track individual withdrawal amounts.

  • Retained Earnings: All profits that have been reinvested into the company.

For a company that’s incorporated, the Equity section of the balance sheet should contain the following accounts:

  • Stock: Portions of ownership in the company, purchased as investments by company owners.

  • Retained Earnings: All profits that have been reinvested in the company.