What is the difference between equity and assets?

Question

I am (going to be) using GNU Cash, which uses the double-entry method; I use it for personal finance.

Reading various tutorials for GNU cash, it lists 5 types of accounts: income, expense, assets, liabilities, and equity, followed by various examples. For assets, it gives stuff likes houses and cars, but it doesn't give an examples for equity. Couldn't all those things also be put under an equity account (and, mathematically, liabilities could also be put under equity accounts too.)

Here is my guess: Equity represent various "organizations." For example, if I had three ice cream divisions, chocolate, strawberry, and vanilla, they would be examples of "equities." If strawberry uses $100 of advertising using the company bank account, the company would incur $100 of advertising expenses, loss $100 of from the asset of the bank account, and the equity of strawberry would go down $100. This doesn't seem to satisfy the accounting equation though.

If my above assumption is correct, a household would only have on equity account (you aren't going to tell your kids after they graduate how negative their equity has been to the family.)

I suppose I am having trouble seeing the point of the equity category.

How can I determine whether to categorize something as equity or income.

Answer 1

Accounts track value: at any given time, a given account will have a given value. The type of account indicates what the value represents. Roughly:

• An asset is something you control that's worth something, and the value is how much it's worth.
• A liability is something you owe someone else, and the value is how much you owe them.
• Equity is your net worth: the total asset value minus the total liability value.

On a balance sheet (a listing of accounts and their values at a given point in time), there is typically only one equity account, representing net worth, I don't know much about GNUCash, though. Income and expenses accounts do not go on the balance sheet, but to find out more, either someone else or the GNUCash manual will have to describe how they work in detail.

Equity is more similar to a liability than to assets. The equation Assets = Equity + Liabilities should always hold; you can think of assets as being "what my stuff is worth" and equity and liabilities together as being "who owns it." The part other people own is liability, and the part you own is equity.

See balance sheet, accounting equation, and double-entry bookkeeping for more information.

(A corporate balance sheet might actually have more than one equity entry. The purpose of the breakdown is to show how much of their net worth came from investors and how much was earned. That's only relevant if you're trying to assess how a company has performed to date; it's not important for a family's finances.)

Answer 2

Not to detract from the other answers at all (which are each excellent and useful in their own right), but here's my interpretation of the ideas:

• Equity is the answer to the question "Where is the value of the company coming from?" This might include owner stakes, shareholder stock investments, or outside investments. In the current moment, it can also be defined as "Equity = X + Current Income - Current Expenses" (I'll come back to X).

• This fits into the standard accounting model of "Assets - Liabilities = Value (Equity)", where Assets includes not only bank accounts, but also warehouse inventory, raw materials, etc.; Liabilities are debts, loans, shortfalls in inventory, etc. Both are abstract categories, whereas Income and Expense are hard dollar amounts. At the end of the year when the books balance, they should all equal out.

• Equity up until this point has been an abstract concept, and it's not an account in the traditional (gnucash) sense. However, it's common practice for businesses to close the books once a year, and to consolidate outstanding balances. When this happens, Equity ceases to be abstract and becomes a hard value: "How much is the company worth at this moment?", which has a definite, numeric value.

• When the books are opened fresh for a new business year, the Current Income and Current Expense amounts are zeroed out. In this situation, in order for the big equation to equal out:

  Assets - Liabilities = X + Income - Expeneses

  the previous net value of the company must be accounted for. This is where X comes in, the starting (previous year's) equity. This allows the Assets and Liabilities to be non-zero, while the (current) Income and Expenses are both still zeroed out. The account which represents X in gnucash is called "Equity", and encompasses not only initial investments, but also the net increase & decreases from previous years. While the name would more accurately be called "Starting Equity", the only problem caused by the naming convention is the confusion of the concept Equity (X + Income - Expenses) with the account X, named "Equity".

Answer 3

Equity does not represent production divisions in a company (i.e. chocolate, strawberry, and vanilla does not make sense).

In Sole proprietorship, equity represents 1 owner.

In Partnership, equity has at least two sub-accounts, namely Partner 1 and Partner 2.

In Corporations, equity may have Common Stockholders and Preferred Stockholders, or even different class of shares for insiders and angel investors.

As you can see, equity represents who owns the company. It is not what the company does or manufactures.

First and foremost, define the boundary of the firm. Are your books titled "The books of the family of Doe", "The books of Mr & Mrs Doe", or "The books of Mr & Mrs Doe & Sons".

Ask yourself, who "owns" this family. If you believe that a marriage is perpetual until further notice then it does not make any sense to constantly calculate which parent owns the family more. In partnership, firm profits are attributed to partner's accounts using previously agreed ratio. For example, (60%/40% because Partner 1 is more hard working and valuable to the firm.

Does your child own this family? Does he/she have any rights to use the assets, to earn income from the assets, to transfer the assets to others, or to enforce private property rights? If they don't have a part of these rights, they are certainly NOT part of Equity.

So what happens to the expenses of children if you follow the "partnership" model? There are two ways. The first way is to attribute the Loss to the parents/family since you do not expect the children to repay. It is an unrecoverable loss written off. The second way is to create a Debtor(Asset) account to aggregate all child expense, then create a separate book called "The books Children 1", and classify the expense in that separate book.

I advise using "The family of Doe" as the firm's boundary, and having 1 Equity account to simplify everything. It is ultimately up to you to decide the boundaries.