Equity is the residual interest in the assets of the entity after deducting all the liabilities (IASB Framework).
Equity is what the owners of an entity have invested in an enterprise. It represents what the business owes to its owners. It is also a reflection of the capital left in the business after assets of the entity are used to pay off any outstanding liabilities.
Equity therefore includes share capital contributed by the shareholders along with any profits or surpluses retained in the entity. This is what the owners take home in the event of liquidation of the entity.
The Accounting Equation may further explain the meaning of equity:
Assets – Liabilities = Equity
This illustrates that equity is the owner’s interest in the Net Assets of an entity.
Rearranging the above equation, we have
Assets = Equity + Liabilities
Assets of an entity have to be financed in some way. Either by debt (Liability) or by share capital and retained profits (Equity). Hence, equity may be viewed as a type of liability an entity has towards its owners in respect of the assets they financed.
Examples of Equity recognized in the financial statements include the following:
- Ordinary Share Capital
- Preference Share Capital (irredeemable)
- Retained Earnings
- Revaluation Surpluses