Financial Accounting

(PGDM- 2018-20)

Session -16: Accounting for Equity

Sriranga Vishnu
Faculty (F&A Area)
 Types of Businesses

• Sole Proprietorship - Business entity is owned by an

individual for selling of goods or one’s services
– Simplest kind of business entity
– No incorporation fee; no report to be submitted
– Profits are subjected to I-Tax , not Corporate Tax
– Difficult to raise large amount of capital
– Can’t issue shares
– Unlimited liability of the proprietor
– Debt repayment from business assets as well as personal
assets
 Types of Businesses

• Joint Partnership - Business entity is owned by two or

more persons called partners
– Unlimited liability of each partner
– Action of each partner affects all other partners
– To recover debt, personal assets can also be attached
– Income is taxed on the basis of share in the business
– In case of limited partnership, General Partner functions on
behalf of Sleeping partners
– While taxation is as per the share, liability is limited
 Types of Businesses

• Corporation - Business entity created by a statute

– Perpetual Existence, Limited liability
– Business entity is an artificial person
– Taxation on the net income of the entity, not the owner’s
– Subject to regulations, fee payments, double taxation
– Activities are limited to those in the Articles of Association
– Easy to raise large amount of capital
– Ownership can be liquidated – transfer of title
– Public company – Shares are traded on stock exchange
– Private company – Shares are closely held among few
individuals
 Accounting for Proprietor’s Equity

• All entries related to the infused capital are recorded in

the capital account

• Annual Income derived from operations are added to the

capital account

• Drawings by the proprietor are deducted from the capital

account to arrive at net equity

• Drawings A/c can be maintained separately as well

 Accounting for Partnership Equity
• In partnership, there is separate account for each partner

• In the infused capital, individual income (as agreed) for

the year is added. Can be equally distributed as well

• Individual withdrawals are deducted from the Partner’s

account to derive net equity

• Salary paid to partners and interest payments on the

infused capital are treated as Drawings
 Types of Ownership in Corporations

• Preference Stocks – Cumulative and non-cumulative

– The stock holders get preference over Common Equity
holders in Dividends, Liquidation, etc.
– Dividend non-payment – not subject to legal recourse
– Dividend- Not an expense; Distribution of owners’ equity
– Dividends- Not tax deductible; No tax shield
– Convertible preferred stock can be converted into specified
number of common stock
– Normally preferred stocks are indefinitely outstanding; but
can be redeemable as well
 Types of Ownership in Corporations

• Common Stock – Book Value (Capital + Retained

Earnings)
– Authorized, Issued, Subscribed and Paid-up Share Capital
– Issued at Par Value (Face value), – Minimum amount that
the investor must pay on a share
– Par value is the company’s minimum legal capital
– Additional Paid-in Capital; Share premium
– Issuance Costs are deducted from the amount received
– Secondary market trading
 Types of Ownership in Corporations

• Treasury Stocks- repurchased stocks

– Not treated as an asset; Can be reissued
– Shown on B/S as reduction in shareholders’ equity
– Gain/loss is adjusted with Retained Earnings and not in
Income Statement; Not recognized for Income Tax
 Types of Ownership in Corporations
• Retained Earnings

• Reserves – a portion deducted from RE. Decreases

shareholders’ expectation; No effect on asset side

• Dividends – Cash or Stock Dividends

• Stock Split – Shareholders’ proportional interest remains

the same

• Spin-offs – Shares held of other Companies are

distributed to the shareholders
 Types of Ownership in Corporations

• Warrants – Right to purchase shares of common stock at

pre-stared price within the stated time period; Negotiable
instruments – can be bought and sold

• Stock Options – Similar to warrants but not negotiable;

offered to select employees; ESOP – for general purpose

• EPS – calculated for equity share capital

• Diluted EPS