Learn It
In the accounting equation, equity is what remains after you subtract liabilities from assets. If the business sold everything it owned and paid off every debt, equity is what would be left for the owner.
Equity changes for several reasons:
- • Owner contributions: the owner invests personal money or property into the business. Equity goes up.
- • Owner draws or distributions: the owner takes money out of the business for personal use. Equity goes down.
- • Profit: when the business earns more than it spends, equity goes up.
- • Losses: when the business spends more than it earns, equity goes down.
A critical rule: owner contributions are not revenue, and owner draws are not expenses. Revenue comes from selling goods or services. Expenses are costs of running the business. Contributions and draws are movements of the owner's own money, not business activity.
Contributions and Draws
When an owner puts personal money into the business checking account, the business has more cash — but it did not earn anything. The cash increases, and equity increases. This is called an owner contribution or capital contribution.
When an owner takes money out for personal use, the business has less cash. The cash decreases, and equity decreases. This is called an owner draw or distribution. It is not a salary expense unless the owner is formally on payroll.
Sometimes an owner pays a business expense with personal funds. This is treated as a contribution — the owner is effectively investing the amount of the expense into the business. Equity goes up because the business no longer owes that expense.
Personal vs. Business Transactions
One of the most common bookkeeping problems is mixing personal and business transactions. The books should only reflect business activity. When personal money enters or leaves the business through the owner, it goes through equity accounts — not revenue or expense accounts.
As we saw in Banking Transactions, an owner contribution can look like a deposit in the bank register. But the bookkeeper must understand the business event to record it correctly.
Entity Types and Equity Names
The names of equity accounts can differ depending on the type of business entity. A sole proprietor might use "Owner's Equity" and "Owner's Draw." A partnership might use "Partner Capital" and "Partner Distributions." A corporation might use "Common Stock," "Retained Earnings," and "Dividends."
The bookkeeping mechanics are similar — money in from owners increases equity, money out to owners decreases equity, and profit or loss flows into equity. But the account names and tax treatment vary. This lesson teaches the bookkeeping mechanics, not tax or entity law. Always check how the business is set up before choosing equity account names.
See It
Let's follow a small business through several events and see how each one affects equity.
1. Owner contributes $15,000
The owner deposits $15,000 of personal money into the business checking account. Cash goes up. Equity goes up. No revenue is recorded.
| Account | Debit | Credit |
|---|---|---|
| Cash | 15,000 | — |
| Owner's Capital | — | 15,000 |
2. Business earns $4,000 of revenue
The business completes work and receives $4,000. Revenue is recorded. This will eventually increase equity through retained earnings.
| Account | Debit | Credit |
|---|---|---|
| Cash | 4,000 | — |
| Service Revenue | — | 4,000 |
3. Business pays $1,200 of expenses
The business pays rent and supplies totaling $1,200. Expenses are recorded. Net income so far is $4,000 − $1,200 = $2,800, which will increase equity.
| Account | Debit | Credit |
|---|---|---|
| Rent Expense | 1,200 | — |
| Cash | — | 1,200 |
4. Owner withdraws $1,000
The owner takes $1,000 for personal use. Cash goes down. Equity goes down through the Owner's Draw account. This is not an expense.
| Account | Debit | Credit |
|---|---|---|
| Owner's Draw | 1,000 | — |
| Cash | — | 1,000 |
5. Owner personally pays a $250 business expense
The owner uses a personal credit card to pay a $250 business expense. The business no longer owes this expense. Equity goes up by $250 — the owner has effectively contributed the amount of the expense.
| Account | Debit | Credit |
|---|---|---|
| Office Supplies Expense | 250 | — |
| Owner's Capital | — | 250 |
The expense is recorded (the business did consume supplies), but instead of cash going down, equity goes up. The owner paid it personally, which is the same as contributing $250 to the business.
Do It
Complete the equity roll-forward below. Enter each amount in the correct column, then calculate the ending equity.
Do It — Complete the Equity Roll-Forward
A business has beginning equity of $20,000. Several events occur. For each event, enter the amount in the correct column. Then calculate the ending equity.
Use positive numbers. The columns will add and subtract automatically: contributions and profit increase equity; draws decrease equity. For the last event, the owner paid a business expense with personal funds — this increases equity because the business no longer owes that expense.
| Event | Contribution | Profit / (Loss) | Draw | Other Adj. | Equity After |
|---|---|---|---|---|---|
| Beginning Equity | $20,000 | ||||
| Business earns $3,000 net income for the month | $ | $ | $ | $ | $20,000 |
| Owner contributes $1,500 to the business | $ | $ | $ | $ | $20,000 |
| Owner withdraws $800 for personal use | $ | $ | $ | $ | $20,000 |
| Owner personally pays a $250 business expense (reimburse owner) | $ | $ | $ | $ | $20,000 |
| Ending Equity (type your answer) | $ | ||||
Prove It
Answer each question, then read the explanation. There's no score — this is just to help the ideas stick.
Question 1
An owner deposits $15,000 of personal money into the business checking account. How should this be recorded?
Question 2
An owner withdraws $1,000 from the business for personal use. What is the correct bookkeeping treatment?
Question 3
A business earns $3,000 of net income during the month. How does this affect equity?
Ready for more than a short exercise?
This exercise isolates equity movements one at a time. Real bookkeeping requires you to identify owner activity mixed in with regular business transactions, choose the right equity accounts for the entity type, and keep personal and business activity properly separated. QBO Dojo practice clients let you apply these skills across realistic business activity inside QuickBooks Online.
Explore QBO Dojo Practice ClientsKey Takeaways
- Equity is what remains after liabilities are subtracted from assets.
- Owner contributions increase equity — they are not revenue.
- Owner draws or distributions decrease equity — they are not expenses.
- Profit increases equity through retained earnings; losses decrease equity.
- When an owner pays a business expense personally, equity increases by that amount.
- Equity account names vary by entity type, but the mechanics are similar.