Statement of Owner's Equity

The statement of owner's equity explains how the owner's stake in a business changed during a period. It starts with the capital at the beginning, adds what the owner put in and what the business earned, subtracts what the owner took out, and ends with the capital that goes on the balance sheet. This guide shows how to prepare one from an adjusted trial balance, including the two traps that catch most learners: an investment already included in the capital balance, and a month that ends in a loss.

What the statement shows

A sole proprietorship has one equity account that carries over from period to period, Owner's Capital. Four things change it:

• Owner investments increase it. When the owner puts personal cash or equipment into the business, Owner's Capital is credited (see owner investment and drawing journal entries).
• Net income increases it. Profit belongs to the owner.
• A net loss decreases it.
• Drawings decrease it. Cash or goods the owner takes for personal use are recorded in Owner's Drawing during the period and subtracted here.

The statement lays these out in order:

Like the income statement, it covers a period, so its heading reads "for the month ended May 31", not "as of May 31". A corporation prepares a similar statement for retained earnings, with dividends in place of drawings; the exercises here use a sole proprietorship.

Where it sits between the other statements

The statements are prepared in a fixed order because each one feeds the next:

1. The income statement gives net income or net loss.
2. The statement of owner's equity uses that net income to find ending capital.
3. The balance sheet reports that ending capital under owner's equity.

All three are prepared from the adjusted trial balance. The trial balance shows Owner's Capital and Owner's Drawing, but not net income: there is no net income account. You work net income out from the revenue and expense balances, or take it from the income statement you've just prepared.

The investment trap: which capital is "beginning"?

This is the step that needs the most care. The Owner's Capital balance on an adjusted trial balance is not always the beginning capital. If the owner invested more during the month, that investment was posted to Owner's Capital when it happened, so the trial balance shows:

Owner's Capital on the trial balance = beginning capital + investments during the period

To get the beginning figure, subtract the investments. If you use the trial balance figure as beginning capital and then add the investment again on the next line, the investment is counted twice and ending capital is overstated by exactly that amount.

Drawings and net income don't have this problem. Drawings sit in their own account, Owner's Drawing, and revenues and expenses sit in their own accounts. None of them reach Owner's Capital until the closing entries are posted after the statements.

Worked example: Juniper Landscaping, November

Juniper Landscaping's adjusted trial balance at November 30 shows Owner's Capital of $14,920 and Owner's Drawing of $2,300. On November 3, the owner invested an additional $2,000, which is included in the $14,920. The revenue and expense balances are:

Step 1: net income. Total expenses are $3,920 + $1,950 + $516 + $1,190 + $250 + $150 + $560 = $8,536. Net income = $12,036 − $8,536 = $3,500. Owner's Drawing is not in the expenses.

Step 2: beginning capital. $14,920 on the trial balance − the $2,000 investment = $12,920. That was the capital on November 1.

Step 3: the statement.

Check it a second way: the trial balance capital of $14,920 already holds the investment, so $14,920 + $3,500 − $2,300 = $16,120. Both routes must agree. The $16,120 is the figure that appears on the November 30 balance sheet and, after closing, in the post-closing trial balance.

A month with a net loss

When expenses are bigger than revenues, the method is the same but the net income line is negative. Copperleaf Studio began a month with capital of $40,430, the owner invested $5,000, the business lost $400 and the owner drew $3,400:

On a printed statement the loss is often shown on a "Less: net loss" line in parentheses. In the exercises you enter it on the net income line as a negative number, −400. Capital can still rise in a loss month, as it does here, if the owner invests more than the loss and drawings combined.

Common mistakes

Using the trial balance capital as beginning capital

For Juniper, starting from $14,920 and adding the $2,000 investment again gives an ending capital of $18,120, which is $2,000 too high. Whenever the problem mentions an investment during the period, ask whether the capital balance you are looking at already includes it. On an adjusted trial balance it does.

Forgetting to subtract drawings

Leaving drawings out gives Juniper an ending capital of $18,420 instead of $16,120. The owner's withdrawals are real reductions in what the owner has invested in the business, even though they aren't expenses.

Treating drawings as an expense

The opposite slip is to subtract drawings twice: once inside net income, as if Owner's Drawing were an expense, and again on the drawing line. Net income should come only from revenue and expense accounts; drawings belong on this statement alone. The income statement page covers why.

Adding a net loss

Entering Copperleaf's $400 loss as +400 raises ending capital to $42,430, $800 too high (the loss should have reduced capital by $400, and instead it increased it by $400). Compare total revenues and total expenses before you subtract, so you know which sign to expect.

Leaving net income out

The trial balance has no net income line, so it is easy to go straight from beginning capital to drawings. Net income always has to be calculated (or carried from the income statement) and added.

How to check your statement

• Prove it from the trial balance. Trial balance capital + net income − drawings must equal your ending capital. If it doesn't, look first at the investment line.
• Re-add net income. Count the revenue and expense accounts on the trial balance and make sure each is in your total, and that nothing else is.
• Check the signs. Investments and net income add; drawings and a net loss subtract.
• Check the dates. Beginning capital is dated the first day of the period, ending capital the last.

How the exercises check your work

Each exercise shows an adjusted trial balance for a generated company and month, says whether the owner invested during the month, and asks for five figures: beginning capital, investments (0 if none), net income, drawing and ending capital. The figures are checked by code against values computed from the same trial balance, so each line is marked right or wrong. If your answer matches one of the mistakes above, the feedback names it.

The free exercise tells you net income and has no investment. The later ones make you work out net income yourself, unpick an investment from the capital balance, and handle a loss. When you're comfortable, carry the ending capital into a classified balance sheet, then into the closing entries, which move net income and drawings into Owner's Capital in the ledger.