Equity accounts are capital accounts used in accounting when tracking financial transactions of a business on behalf of its owner or partners. When you own your own business, your accountant might set up several equity accounts in the general ledger. At the end of the business year, these equity accounts roll up into a one-line entry on the company's balance sheet known as owner's or partners' equity. This financial report includes the company's assets, liabilities and owner's equity.
Equity vs. Bank Account
The difference between a bank account and an equity account is straightforward. The bank account has actual cash in it, whereas the equity account represents a variety of transactions in accounting, including specific cash transactions, but it does not equate to the the money in the bank account. The equity or capital accounts in a business keep track of the money you or your partners have put into or taken out of the business. The owner's equity account summarizes all the transactions from the owner's draw, capital contributions and the net profit or loss accounts for the business.
Owner's or Partners' Draw
Whether your business is a sole proprietorship or a partnership, the owner's or partners' draw account includes withdrawals made by owners and partners in lieu of salary. These amounts can be whatever the business can sustain and still be profitable, but all draws from these accounts will be subject to Social Security, Medicare and federal income tax deductions.
Owners or partners might elect to take some of the money from the business and put it into the capital contributions account. When the money is withdrawn from the business and placed into this capital account, at the end of the year, the balance on this temporary account is closed. The balance is transferred into the owner's equity account, which appears on the balance sheet.
Profit or Loss
After calculating the income and expenses for a business, the number that results after subtracting expenses from income appears in the profit or loss account. At the end of the business year, if the business experienced a gain, the amount in the profit-loss account is credited to the owner's equity account. If the business experienced a loss, a credit entry is made to zero out the net profit or loss account and debited to the owner's or partners' equity account, which reduces the amount of equity the owners have.
The accountant prepares a series of financial reports that summarize these transactions that are detailed in the company's general ledger accounting system or manual record-keeping system. The income and expense statement is straightforward; expenses subtracted from income determines the amount of the profit or loss. After the temporary equity account balances are rolled into the main equity account, the net figure appears on the company's balance sheet. On the balance sheet, assets minus liabilities equal the owner's or partners' equity.
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