4. Owners’ Equity

The Accounting Equation is essentially expressed as follows in all of the textbooks used to teach finance and accounting:

Assets = Liabilities + Owners’ Equity

This simple algebraic statement is actually stating that:

The more the owners invest in a business, the poorer they will be.

This obvious fallacy can be demonstrated by a simple example. For the sake of simplicity, let us take a simple startup business that has no liabilities. The owners have chosen to not borrow money and, as a startup, there are no accrued expenses that have not been paid. The sole financial transaction recorded by the company is the owners’ contribution of $100. Without any liabilities, we can reduce the accounting equation to the following:

Assets = Owners’ Equity

By the rules of accounting, the Owners’ Equity account (or one of it sub-accounts) must be credited with their contribution, indicating that the Owners’ Equity is the source of the $100 and that amount is effectively withdrawn from that account. That means that the balance of the Owners’ Equity is as follows:

Owners’ Equity = $100.00 (credit)

And, since our Accounting Equation states that:

Assets = Owners’ Equity

We can substitute the balance of the Owners’ Equity account ($100.00 credit) for the term itself, giving us:

Assets = $100.00 (credit)

But a credit balance for the Assets means that the company has had more resources withdrawn from it than it has had deposited into it. Because of the owners’ contribution of $100.00, the company’s asset value is negative.

The owners’ have made the company (and their stake in it) poorer by contributing to it.