The Balance Sheet

In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services, or other yielding of economic benefits in the future.

A liability is defined by the following characteristics:

• Any type of borrowing from persons or banks for improving a business or personal income that is payable over a short or long time;
  
  
• A duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services, or other transaction yielding an economic benefit at a specified or determinable date, on the occurrence of a specified event, or demand;
  
  
• A duty or responsibility that obligates the entity to another, leaving it little or no discretion to avoid settlement; and,
  
  
• A transaction or event obligating the entity that has already occurred.
  
  

The accounting equation relates assets, liabilities, and owner's equity: The accounting equation is the mathematical structure of the balance sheet.

\(\text{Assets = Liabilities + Owner's Equity}\)

Accounting equation Assets = Liabilities + Owner's Equity

In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets after all liabilities are paid. If liability exceeds assets, negative equity exists. In an accounting context, shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital, or similar terms) represents the remaining interest in a company's assets, spread among individual shareholders of common or preferred stock.

At the start of a business, owners put some funding into it to finance operations. This creates a liability on the business in the form of capital, as the business is a separate entity from its owners. Businesses can be considered sums of liabilities and assets for accounting purposes: this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owner's interest in the business.

In financial accounting, owner's equity consists of an entity's net assets, which are the difference between the entity's total assets and all its liabilities. Equity appears on the balance sheet, one of the four primary financial statements.

An entity's assets include both tangible and intangible items, such as brand names and reputation or goodwill. The types of accounts and their descriptions that comprise the owner's equity depend on the entity's nature and may include Common stock, preferred stock, capital surplus, retained earnings, treasury stock, stock options, and reserve.

The total changes to equity is calculated as follows:

Equity (end of year balance) = Equity (beginning of year balance) +/- changes to common or preferred stock and capital surplus +/- net income/loss (net profit/loss earned during the period) − dividends. Dividends are typically cash distributions of earnings to stockholders on hand, and they are recorded as a reduction to the retained earnings account reported in the equity section.