Capital Account Definition
The capital account in accounting refers to the general ledger that records the transactions related to owners’ funds, i.e., their contributions and earnings earned by the business after reducing any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity” in the case of a company.
However, it is represented as owner’s equity for a sole proprietorship or the entity’s net worth as on a particular day. Thus, it is the assets of a business. In case of a public limited company, it is the amount of funds contributed by investors whereas for a private limited company, it shows the fund given by each member.
- The Capital Account records all the transactions related to the capital invested in an organization. It maintains all the transactions of capital reinvestment, the balance of money, and any withdrawal or adjustment.
- The sum in this account for a sole proprietorship would be the proprietor’s payments less any sums taken or draws and current earnings.
- The capital account of a business organization consists of the stock capital, additional paid-in capital, other capital contributions, and retained earnings.
- Moreover, this account is essential to identify the number of assets funded with capital and the number of investments in debt finances.
Capital Account Explained
For a sole proprietorship, the amount in this account would consist of the proprietor’s contributions net of any amounts withdrawn, i.e., drawings and accumulated profits to date.
Similarly, for a capital account in partnership, this account would include the outstanding balances of capital contributions of the partners after accounting for drawings made by them and profit distributions done to them by the profit-sharing ratio. While drawings would reduce the capital balance, the profit appropriation to partners would increase their capital account components.
Talking about the company, it includes share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side. (both equity and preference capital), additional paid-in capitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market., retained earnings and any equity reserve.
The formula for a capital account balance can easily be derived using the accounting equationAccounting EquationAccounting Equation is the primary accounting principle stating that a business's total assets are equivalent to the sum of its liabilities & owner’s capital. This is also known as the Balance Sheet Equation & it forms the basis of the double-entry accounting system. . So let us first have a look at the accounting equation.
Assets = Liabilities + Capital
As we can see, the amount of assets in any business at any point in time is the sum of its liabilities and capital. Thus, if we want to calculate the amount in the capital account on balance sheet, we need to use the below formula:
Capital = Assets – Liabilities
We can derive the amount of capital by reducing the number of liabilities from the number of assets reflected on the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. of any business.
Let us look at the extracts of the balance sheet of a company, ABC Ltd. First; we will try to understand what the capital account on balance sheet of a company looks like:
As seen in the above balance sheet extracts, this company’s account is reflected as “Equity” in the balance sheet. The total equity includes different equity components, such as share capital, share premiumShare PremiumShare premium is the difference between the issue price and the par value of the stock and is also known as securities premium. The shares are said to be issued at a premium when the issue price of the share is greater than its face value or par value. This premium is then credited to the share premium account of the company., retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company., and so on.
- Stock Capital: This includes the amount of equity and preference stock. It represents the amount invested by the stockholders against which they have been issued units of stocks.
- Additional Paid-in Capital: It represents the amount received from the stockholders over face value. It is also known as “stock premium.”
- Other Capital Contributions: For sole proprietors and capital account in partnership, they would include the owners’ capital account, i.e., the capital balance of the sole proprietor and the partners, respectively.
- Retained Earnings: This represents the accumulated profits of a business on a particular date. Also, any reserves created out of such accumulated profits shall also be taken into account.
- The capital account balance becomes an essential part of the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. of any business because it represents the amount that remains invested in the business by the owners on a particular day.
- We can use this amount to identify how much assets have been financed with capital, i.e., owners and how much portion is debt-financed.
- This account can be used to calculate different financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. such as debt-equity ratioDebt-equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. , and so on.
- It helps the banks and other financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. decide whether to grant further loans to such a business or not.
- This account alone is not decisive for reaching any conclusion; if investors want to analyze the financial position of a business, they need to look at the entire balance sheet.
- The calculation of capital account components can vary slightly from one business form to another.
Capital Account Vs Current Account
- The former records all the owner’s capital contributed by owners less any drawings, whereas a current account shows the revenue income and expenses.
- The former records the investments heavy expenditure but the latter records inflow and outfow of funds related the the operations of the enterprize.
- The amount in the capital account is usually larger than the current account.
Frequently Asked Questions (FAQs)
Working capital, debt, equity, and trade capital are the four main categories of capital. Brokerages and other financial entities employ trading capital. A debt liability appears on the balance sheet to counteract any debt capital.
Capital account convertibility refers to the ability of residents and non-residents to move capital in and out of a country freely. These can be transferred without any government or central bank restrictions.
No capital account is not a personal account. In accounting, personal accounts are used to record transactions related to individuals and entities.
This article has been a guide to a Capital Account & its definition. We explain it with example, differences with current account, components, formula & importance. You may learn more about accounting from the following articles –