A Quick Introduction of Liabilities and Stockholders' Equity

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Moving over to the other side of the balance sheet, we find the sources of financing for the firm's assets, that is, liabilities and stocksholders' equity. Current liabilities are always listed first. These liabilities generally comes from the normal routine of daily business activities. As their name implies, they are short-term liabilities that will be paid from current assets. They generally include such items as accounts payable, which most often arise from credit purchases of inventory and supplies, and from accruals, which are liabilities that have grown with the passage of time but have not yet been paid. Examples of accruals include wages earned by employees but not yet paid and interest that has accrued on loans.

Long-term debt is debt that has a maturity date somewhere in the future – usually a year or more – and that will not be paid from current assets. It will often be re-funded through additional long-term borrowing or paid by liquidating specific assets. For example, the firm may establish a special fund into which they make periodic deposits in order to retire the debt when it matures. If a firm has long-term debt, specific information regarding interest rates, maturity dates and pledged assets (if any) will be disclosed in the notes to the financial statements which accompanies the financial statements.

There are two ways in which the owners' equity in a company (corporate or otherwise) can be increased: through a direct contribution of assets to the company and through the company's earnings. In a proprietorship, there is only one owner and only one owner's equity account, Joan Doe – Capital. Both her contribution of assets to the company and the company's earnings that she has not withdrawn for personal use are combined in the capital account. Looking at the capital account for a proprietor you can not tell how much of the capital comes from her contribution of assets and how much comes from the firm's earnings that have not been withdrawn.

In a partnership, there is a separate account for each owner, although on the financial statement these individual accounts will probably be combined into one. Large accounting and law firms may have dozens or even hundreds of partners. Accounting for corporations is more complicated because their financing is more complicated. Common stock is the basic ownership unit of a corporation. It carries with it all the basic rights of ownership: the right to vote in elections for membership on the board of directors, the right to residual profits, the right to residual assets in the event the corporation is liquid and also the inalienable right to suffer losses.

Preferred stock is an interesting animal; it is neither fish nor fowl. That is, it is not a liability, nor does it represent ownership rights in the usual sense of the word. It's a bit of a hybrid. Typically, a preferred stockholder has either the protection the law agreements holders of debt nor the rights held by common stockholders. Yet it has elements of both. In a worst-case scenario when a corporation has to declare bankruptcy and liquidity, preferred stockholders' claims to the assets will come after the debt holders but before the common stockholders. Also, while preferred stock dividends are not guaranteed, preferred stockholders will receive dividends before common stockholders. Thus, preferred stockholders are in a preferred position when it comes to the distribution of dividends and assets.

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Source by Tina S Smith

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