The Capital Account and Its Important Aspects
A person or a group of individuals who decides to venture into a business undertaking must put up a certain amount of funds called “Capital". Capital is a credit to the business founder, in the sense that it is being recognized as coming from one’s efforts or resources.
This fund is used to buy the furniture, fixture and equipment, to pay for advance deposits on rentals, to buy the goods for resale or raw materials used for production. These are the so-called capital expenditures, and they will be carried in the company’s books as real accounts. They form part of the company’s assets and will be debited as they increase.
Increasing the Capital Account -- All amounts that will increase the value of the initial capital infused will make use of a credit entry. However, these increments are relatively few, but the most common is the net income gained from annual operations. In a corporate set-up, such increments are taken-up separately as Retained Earnings, but are added to the summary of Stockholders' Equity or Ownership.
As increments from business operations, the most common account affected would be the Cash or the Accounts Receivables. Hence, if the capital account increases due to profits, it follows that the cash or receivable account will also increase.
If the capital account increases as a result of additional capital infusion, then cash or a form of asset is added as part of the business’s resources.
Decrease in Capital – Conversely, business operations that result in a net loss will result in a decrease in the capital of the company. The capital account of a single proprietorship will be reduced by a debit entry.
In a corporate structure, the corporation’s Retained Earnings account will be debited. The purpose of this is to reduce the accumulated earnings that are technically added to the value of the Stockholder’s Equity in a balance sheet presentation.
The original entries made before the loss is recognized are those that pertain to business expenditures. If the business operations cannot generate enough funds to recover the amount spent to fund its operations, then the funds that are actually used are capital funds and not fresh funds. If this condition continues, the capital funds of the business will likely be depleted because it will absorb most of the expenses incurred to operate the business.
Please proceed to the next page to read insights on how to read a financial statement, particularly the capital asset accounts.