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Capital and Drawings

Meaning of capital, owner's equity, the business entity concept, and drawings with examples.

Notes

Capital and Drawings

Class 11 Accountancy — Accounting Terminology

Capital — Meaning and Definition

Capital
Claim of the owners or proprietor in the business.

Capital refers to the amount invested in an enterprise by the proprietor (in a proprietorship) or by partners (in a partnership business). This investment can be in the form of money or assets that have a monetary value. In companies, individuals contributing capital are known as shareholders. Capital is also known as Owner's Equity or Net Worth.

Capital Formula

$$\\text{Capital} = \\text{Assets} - \\text{Outside Liabilities}$$
Capital is considered a liability of the firm towards its proprietor or partners. This is because, under the “Business Entity Concept”, the business is treated as a separate and distinct entity from its owners. Transactions are recorded from the business's perspective, showing the owner's claim on the business assets.

Key Takeaways

  • Capital = Assets − Outside Liabilities
  • Capital is also called Owner's Equity or Net Worth
  • Capital increases with net profit and additional capital introduced
  • Capital decreases due to net losses and drawings

How Capital Changes

Closing Capital = Opening Capital + Additional Capital + Net Profit − Net Loss − Drawings

Business Entity Concept

The Business Entity Conceptis a fundamental accounting principle stating that a business is considered a separate entity from its owners. Therefore, the owner's capital invested in the business is treated as a liability of the business towards the owner. This distinction helps in accurately recording business transactions and assessing the financial health of the enterprise independently of the owner's personal finances.

Business

A separate legal entity. Owns its assets, incurs its own liabilities. Transactions are recorded from the business's point of view.

Owner

Separate from the business. Capital contributed is treated as the business's liability towards the owner. Personal finances are kept separate.

Drawings

Drawings
Amount, goods or assets taken by the proprietor for personal use.

Drawings represent the amount of money, goods, or assets withdrawn by the proprietor or a partner for personal use. When goods are taken, they are valued at their purchase cost. Drawings reduce the owner's investment (or capital) in the business. These withdrawals are debited to a Drawings Account and are subsequently deducted from the proprietor's or partner's capital when preparing the Balance Sheet.

Key Takeaways

  • Drawings reduce capital
  • Goods taken as drawings are valued at purchase cost
  • Drawings are debited to a Drawings Account
  • Deducted from capital in the Balance Sheet