Various Types of Transactions – Contribution of Capital from Owners (Part 2)

When owners inject cash into businesses as capital, the double entry to record this type of transactions is: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Petty cash/cash at bank

XXXX

Capital

XXXX

Cash injections could be done by way of contributing “hard cash”. If this is the case, the asset account debited is the Petty Cash account. Cash injections could also be done by way of the owners issue cheques. If this is the case, the asset account debited is the Cash at Bank account. Usually, if the amount involved is huge, cheques are issued instead of hard cash.

Following the rule of double entry recording system, whenever there is a debit entry made to an account (the Petty Cash of Cash at Bank account in this illustration), there must also be a credit entry made to an account (the Capital account in this illustration).

Please refer to Debits And Credits and The Accounting Equation if you need further explanations on double entry recording system and the accounting equation. If you need explanation on the difference between balance sheet and income statement, please refer to The Balance Sheet and The Income Statement .

For sole proprietorships and partnerships, the account to be credited whenever there are capital injections is called the “Capital Account”. Please take note that for many sole proprietorships and partnerships (especially for partnerships), there could be another account called “Current Account” maintained to record those transactions between the business and the partners such as profit attributable to each partner during the year, salary, interest on capital contributions, drawings OTHER THAN the capital transactions. Please refer to my post: Three Most Common Types of Small Businesses for an example of income statement and balance sheet of a partnership. Do not be confused with the current account opened with banking institutions. They are different. Capital Accounts and Current Accounts are maintained for each partner to show the capital position of each partner and their other dealings with the business.

For sole proprietorships, the importance of maintaining a separate Capital Account and Current account is not as apparent if compared to that of partnerships because all the transactions recorded in the Capital Account and the Current Account are attributable to only one person i.e. the owner. You may have come across many instances of the balance sheets prepared for sole proprietors with no separate Capital Account and Current Account maintained. In this case, all the transactions in the Capital Account and Current Account are recorded in one single account named “Capital Account”. Example of the equity section of the balance sheet of a sole proprietor using this method of recording is as follows: –

Capital:

$

Balance at beginning of year

5,178

Add: Additional capital injections during the year

15,000

Add: Profit for the year

3,152

Less: Net drawings during the year

(8,000)

Balance as at end of year

15,330

Some partnerships may choose this method of recording. However, the drawback is that there is no ready information available on how much is the accumulated capital amount that has been contributed by each partner. There could also be situations whereby the net drawings of some partners exceeded the capital amount that they have contributed and nobody realise this!

For private limited companies, whenever there are capital injections, the account to be credited is called “Share Capital Account”. Some call it “Paid-up Share Capital Account”. This is because there could be instances of unpaid capital by shareholders. I will explain this in another topic. The main difference if compared with the balance sheet of sole proprietorships or partnerships is no separate current account maintained. Any withdrawal or advance of money to private limited companies by shareholders are recorded separately in the balance sheet account called Amount due by Shareholder (current asset) or Amount due to Shareholder (current liability) depending on whether it is the Company who owe the shareholder money or the other way round. The amount owing usually is classified as current asset or current liability because the nature of the transactions is short term in nature. Even though there are instances where the amount due to or due by shareholders remained unpaid/unsettled for more than a year because there was no repayment fixed in the first place, it is deemed to be repayable on demand and is therefore classified as current asset or current liability.

Please take note that it may not be a straight forward matter for a company to give or obtain loan or advances from shareholders or in fact any other parties because it is the board of directors that has the power to manage the business of the company and make decisions on the company’s behalf – Not the shareholders. A shareholder may not sit on the board of directors and even though he or she does in fact sit on the board of directors, the decision making power lies with the board of directors, not on individual directors. Therefore, in making a decision whether the company should give or receive advance or loan from any party including shareholders, the board of directors has a duty to ensure that it is done on the basis that the company’s best interest is taken care of. It should also be noted that shareholders are not “powerless” entirely. They usually are given the power in the articles of association of the company such as to elect directors, set their remuneration in members’ annual general meetings and also on matters that would alter the capital of the company.

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