Question

Several theories try to explain and defined equities but lead to different application in accounting, explain these theories and some applications in accounting? Use equity components in your explanation to define equity and its main characteristics?

Answer 1

1. Equity in a business enterprise stems from ownership rights. It involves a relation between an enterprise and its owners as owners rather than as employees, suppliers, customers, lenders or in some other non-owner role.

a) Equity is the same as net assets, the difference between the enterprise’s assets and its liabilities and

(b) Equity is enhanced or burdened by increases and decreases in net assets from sources other than investments by owners and distributions to owners. Owners’ equity is the interest that, perhaps in varying degrees, bears the ultimate risk of enterprise failure and reaps the ultimate rewards of enterprise success.

2. Equity represents the source of distributions by an enterprise to its owners, whether in the form of cash dividends or other distributions of assets. Owners’ and others’ expectations about distributions to owners may affect the market prices of an enterprise’s equity securities, thereby indirectly affecting owner’ compensation for providing equity or risk capital to the enterprise. Thus, the essential characteristics of equity centre on the conditions for transferring enterprise assets to owners.

Equity—an excess of assets over liabilities—is a necessary but not sufficient condition. Generally, an enterprise is not obligated to transfer assets to owners except in the event of the enterprise’s liquidation unless the enterprise formally acts to distribute assets to owners, for example, by declaring a dividend. In this way, owners’ equity has no maturity date.