The liabilities section of the balance sheet shows the amounts that the firm owes to other people and businesses. The balance sheet in Table 1-4 shows $2,000 of accounts payable and a $1,000 loan payable. Presumably, the $2,000 of accounts payable is the money that you owe to the vendors who supplied your hot dogs and buns. The $1,000 loan payable represents some loan you’ve taken out — perhaps from some well-meaning and naive relative.
The owner’s equity section shows the amount that the owner, the partners, or shareholders have contributed to the business in the form of original funds invested or profits reinvested. One important point about the balance sheet shown in Table 1-4: This balance sheet shows how owner’s equity looks when the business is a sole proprietorship. In the case of a sole proprietor, only one line is reported in the owner’s equity section of the balance sheet. This line combines all contributions made by the proprietor — both amounts originally invested and amounts reinvested.
I talk a bit more about owner’s equity accounting later in this chapter because the owner’s equity sections look different for partnerships and corporations. Before I get into that discussion, however, let me make two important observations about the balance sheet shown in Table 1-4:
A balance sheet needs to balance. This means that the total assets must equal the total liabilities and owner’s equity. In the balance sheet shown in Table 1-4, for example, total assets show as $4,000. Total liabilities and owner’s equity also show as $4,000. This equality is no coincidence. If an accounting system works right, and the accountants and bookkeepers entering information into this system do their jobs right, the balance sheet balances.
A balance sheet provides a snapshot of a business’s financial condition at a particular point in time. I mention in the introductory remarks related to Table 1-4 that the balance sheet in this table shows the financial condition of the business immediately before the day’s business activities begin.
By convention, businesses prepare balance sheets to show the financial condition at the end of the period of time for which an income statement is prepared. A business typically prepares an income statement on an annual basis. In this orthodox situation, a firm also prepares a balance sheet at the very end of the year.
At this point, I return to something that I allude to earlier in the chapter: the fact that the owner’s equity section of a balance sheet looks different for different types of businesses.
Table 1-5 shows how the owner’s equity section of a balance sheet looks for a partnership. In Table 1-5, I show how the owner’s equity section of the business appears if, instead of having a sole proprietor named S. Nelson running the hot dog stand, the business is actually owned and operated by three partners named Tom, Dick, and Harry. In this case, the partners’ equity section shows the amounts originally invested and any amounts reinvested by the partners. As is the case with sole proprietorships, each partner’s contributions and reinvested profits appear on a single line.
TABLE 1-5 Owner’s Equity for a Partnership
| Partners’ equity | |
|---|---|
| Tom, capital | $500 |
| Dick, capital | 250 |
| Harry, capital | 250 |
| Total partner capital | $1,000 |
Go ahead and take a look at Table 1-6, which shows how the owner’s equity section looks for a corporation.
TABLE 1-6 Owner’s Equity for a Corporation
| Shareholders’ equity | |
|---|---|
| Capital stock, 100 shares at $1 par | $100 |
| Contributed capital in excess of par | 400 |
| Retained earnings | 500 |
| Total shareholders’ equity | $1,000 |
This next part is a little bit weird. For a corporation, the amounts that appear in the owner’s equity or shareholders’ equity section actually fall into two major categories: retained earnings and contributed capital. Retained earnings represent profits that the shareholders have left in the business. Contributed capital is the money originally contributed by the shareholders to the corporation.
The retained-earnings thing makes sense, right? That’s just the money — the profits — that investors have reinvested in the business.
The contributed-capital thing is more complicated. Here’s how it works. If you buy a share of stock in some new corporation — for, say, $5 — typically, some portion of that price per share is for par value. Now, don’t ask me to justify par value. It stems from business practices that were common a century or more ago. Just trust that typically, if you pay some amount — again, say $5 — for a share, some portion of the amount that you pay — maybe 10 cents a share or $1 a share — is for par value.
In the owner’s equity section of a corporation’s balance sheet, capital that’s contributed by original investors is broken down into the amounts paid for this mysterious par value and the amounts paid in excess of this par value. In Table
