Types of equity accounts
/What are Equity Accounts?
Equity accounts are the financial representation of the ownership of a business. Equity can come from payments to a business by its owners, or from the residual earnings generated by a business. Because of the different sources of equity funds, equity is stored in different types of accounts.
All equity accounts, with the exception of the treasury stock account, have natural credit balances. If the retained earnings account has a debit balance, this implies that either a business has been experiencing losses, or that the business has issued more dividends than it had available through retained earnings. The following equity accounts are commonly used by corporations.
Common Stock
Common stock is the par value of the stock sold directly to investors. Par value tends to be quite small or nonexistent, so the balance in this account may be minimal. In some states, there is no par value requirement, so companies incorporating in these states do not have to separately record any par value.
Preferred Stock
Preferred stock is the par value of preferred stock. These shares have special rights and privileges beyond those accorded to common stock. Some organizations have never issued preferred stock, while others may have issued a number of tranches of it. The main feature of preferred stock is a fixed dividend payment, making this a safer investment for investors.
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Additional Paid-In Capital
Additional paid-in capital is the amount paid by investors in excess of par value on stock sold directly to them by the issuer. The balance in this account can be quite substantial, especially in view of the minimal par value amounts assigned to most stock certificates.
Retained Earnings
Retained earnings is the amount of earnings generated by a business to date, less the amount of any distributions back to shareholders in the form of dividends. A profitable and growing business may have a substantial balance in this account, since it needs cash to grow, and so cannot afford to issue any dividends to its investors. Conversely, an established business with little growth may have a more modest retained earnings balance, since it does not need the cash internally, and so issues dividends to investors on a regular basis.
Treasury Stock
Treasury stock is a contra account that contains the amount paid to investors to buy back shares from them. This account has a negative balance, and so reduces the total amount of equity. If no shares have ever been bought back (which is common for a smaller corporation), then this account is not used.
Owners Capital
The owners capital account contains the net ownership interests of investors in a partnership. This account contains the investment of the owners in the business and the net income earned by it, which is reduced by any draws paid out to the owners.