The biggest differences between sole props and corporations in their chart of accounts have to do with Equity. Equity is what the owners put into the business. It is whatever is left after liabilities are paid off using the assets (or Assets – Liabilities = Equity). On a ledger, equity works the same way as liabilities: you increase the account by crediting, and decrease it by debiting (the opposite of assets).
Sole Proprietorship Equity Accounts
Equity accounts are quite simple: Owner’s Draw and Owner’s Contribution. If you have a single-member LLC or sole proprietorship, and you don’t see these accounts, make them. Owner’s Contribution is credited (increased) when the owner deposits money into the business bank account. Owner’s Draw (or Withdrawals) is when an Owner takes profits out of the business (to pay themselves). At the same time as an owner’s contribution, cash is debited. At the time of an owner’s draw, cash is credited (reduced).
Equity Accounts for Corporations
S Corps are different from C Corps. S Corps cannot have more than one hundred shareholders / investors, and they must not be located outside of the United States. C Corps can have many more investors, and they can be international, but there are limits for private companies. For more information on those limits, UpCounsel has a decent blog post.
However, for the sake of a private company that does issue stock, let’s explain these equity accounts:
Common stock – Stock issuance is an owner’s contribution made by investors. It increases cash by par value. Par Value is usually a very low number that expresses the minimum at which a share can be sold. It is set for legal reasons and does not reflect the market value of the stock.
Additional Paid in Capital (APIC) – This is the amount of owner contribution from stock purchases above par value. Let’s go into an example:
Allen Luxury Towers becomes a C Corp and issues stock to its investors. It sells 10,000 shares and each share has a par value of 1$. The stocks are sold for a price of $40 each. The cash in this case would be debited 400,000, while $10,000 would be credited under equity – common stock, and $390,000 ($400,000 market price – $10,000 par value) would be credited to equity – Additional Paid In Capital.
Preferred Shares – Preferred shares are different from common shares. They don’t get voting rights, but they usually get a dividend. If the company goes under and needs to pay people back, preferred shareholders get paid before common share owners. Also, if a company issues dividends to common and preferred shareholders, the preferred shareholders get priority. For the purposes of accounting, we list preferred shares first on an accounting balance sheet and treat them the same way as common stock example above, with par value and APIC.
Treasury Shares – Ever heard of something called a stock buyback? That’s what this is. Treasury shares is the inventory of shares the company owns. A company’s decision-maker uses cash to repurchase shares. This can be a great way to keep dividends healthy for remaining investors, because then there are fewer shareholders to pay dividends to. This is why stock prices trend up (but not always) after many firms decide to buy back their shares. This can even be done to privatize a company, as Dell famously did in 2013, even though it became public again later. Don’t worry about making this account until issuing shares and deciding to buy them back later.
To record a buyback, just credit cash and debit treasury shares (aka treasury stock) for the dollar amount totalling the # of shares repurchased and the market price at the time it occurred. Document these things because they are important.
Retained Earnings – Retained earnings comes from closing the company’s accounts at the end of a year. A journal entry transfers the net profits accumulated at year’s end into Retained earnings. Just make an Income Summary account (Asset) that is credited (lowered) and a Retained Earnings account (equity) that is credited (increased). If you paid out dividends throughout the year, a simple equation for retained earnings is:
Beginning of the year Retained Earnings + Net Income / Loss – Dividends = End of Year Retained Earnings
Dividends – Dividends are usually paid out every quarter, or each year to shareholders, if the decision makers at the company decide to do so. This is done by declaring and then paying the dividend.
How to declare the dividend: Debit Retained Earnings (Equity) and Credit Dividend Payable (Liability) for the same amount. Notice that cash hasn’t gone down because no money has actually left the firm yet; you are simply moving money around to different accounts on one side of the ledger (liabilities and equity).
How to pay the dividend: Credit Cash and Debit Dividends Payable.
Of course, if you haven’t issued or sold shares in your company to any investors, you could pay yourself via dividend or owner’s withdrawal, though see a CPA for specifics about your unique situation.
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