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OWNER’S EQUITY
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1.16 OWNER’S EQUITY
Elements of Accounting

Assets

Liabilities

Owner’s Equity

Revenues

Expenses

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 1.16 OWNER’S EQUITY
Owner’s Equity

Definition:

Owner’s equity is:

• The owner’s residual interest in the Assets of the firm after the
deduction of Liabilities

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 1.16 OWNER’S EQUITY
Owner’s Equity
 Example: you need $800 for a new phone but you only have $600 in your bank
account

 To make up the dif ference, your parents give you $200 as a loan to buy the
phone to be repaid by the end of the year

Your $800 Asset is made up of…

Assets
$800
How much are
your Assets?
Liabilities
How
, $200 much are
your Liabilities?
Liabilities
$200
So what is your
“residual interest”
Owner's
in the Asset?
Equity, Owner’s
$600 $600
Equity
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 1.16 OWNER’S EQUITY
 This relationship between Assets, Liabilities and Owner’s Equity is
expressed as the “Accounting Equation”

Owner’s
Assets = Liabilities + Equity

$800 = $200 + $600

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 1.16 OWNER’S EQUITY
 The “Accounting Equation” can also be expressed another way…

Owner’s
Assets = Liabilities + Equity

Owner’s
Equity = Assets — Liabilities

$600 = $800 — $200

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 1.16 OWNER’S EQUITY
 The “Accounting Equation” also applies in your personal life… Example: you
decide to buy a house worth $500,000:
 You have $100,000 in cash in the bank
 You will need to borrow the remaining $400,000 from the bank

How Owner’s
How much do you “own”
Assets
$500,000
of the house? = Liabilities
$400,000 + much does the bank
$100,000
“own”?
Equity

$100,000 $400,000
The $100,000 is your The $400,000 is your
Owner’s Equity in the House value Liability or how much you
house owe on the house
$500,000
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 1.16 OWNER’S EQUITY
 The “Accounting Equation” will change over time…

 This year you pay off $50,000 from the loan

 Next year you pay off $70,000 from the loan

$500,000
$500,000 = $400,000
$350,000
$280,000 + $100,000
$150,000
$220,000

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 1.16 OWNER’S EQUITY
 You buy $200,000 of shares in JB Hi-Fi with a $150,000 loan and $50,000
cash of your own…

Owner’s
$200,000
$250,000
Assets = $150,000
Liabilities + $100,000
$50,000
Equity

 A year later, there’s a rise in the share market and your shares are now
wor th $250,000

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 1.16 OWNER’S EQUITY
 How do people and businesses go broke? They end up with a negative
balance in Owner’s Equity…

Owner’s
$100,000
Assets = $110,000
Liabilities + —$10,000
Equity

 So being broke happens when you have Negative Owner’s Equity

 In other words…

Assets < Liabilities = BROKE

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 1.16 OWNER’S EQUITY
 You buy a $900,000 house with a $800,000 loan and $100,000 cash of
your own…

Owner’s
$900,000
$600,000
Assets = $800,000
Liabilities + —$200,000
$100,000
Equity

 A year later, there’s a crash in the proper ty market and your proper ty is
now wor th only $600,000

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 TASK

In-class Homework
Cambridge Exercise 1.6 –
Owner’s Equity X

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