There are three main parts of the Balance sheet. The parts comprise assets, liabilities, and Equity. These three parts are also based on the accounting equation is:
Shareholder’s equity= Assets – Liabilities
In simple words, the primary difference is that equity is the investors’ resources in the company and liabilities are the outsiders’ resources used by the company for time being for consideration called interest or for operating purposes. Now, let’s discuss the top 7 differences on the basis of the following:
Equity is the capital of the business. It is the money that is invested by the owner of the business i.e., the shareholders of the company.
In other words, equity can be defined as the assets which are created by the company after discharging its liabilities. It is always shown on the liabilities side of the balance sheet. It has a credit balance.
Liabilities are the obligations of the company arising out of past actions where is a probable outflow of money in the future. It is shown on the left side of the balance sheet. It is classified as a current and non-current liability.
Equity is two types with various iterations in them in terms of features. These are equity share capital and preference share capital. The retained earnings are attributable to equity shareholders.
Hence, it also forms part of equity. Equity is also termed stockholders’ equity. Technically equity does not have any classification.
Liabilities can be classified into two categories as Long-term liabilities or Non-current liabilities and Current Liabilities.
Long-term liabilities are those liabilities that are payable after one year. Current liabilities are those liabilities that are payable within the current year.
3) Line Items
Line items are the presentation items as shown in the balance sheet. Equity consists of contributed capital, treasury stock, preferred shares, and retained earnings. It is shown on Liabilities and Capital Side and under journal entries, these items are always credit items.
While making journal entries, liabilities are always credited unless there is a decrease in liabilities. Liabilities consist of Non-current liabilities and Current liabilities. The line items consist of notes payable, long-term debts, advance receipts, accounts payables, etc
Equity is the kind of fund invested by the shareholders to accrete value i.e. generate profits and optimize the value of the company as a whole.
On the other hand, liabilities are resources from the outsiders for the time being either a result of arrangement or transaction. The liabilities out of arrangements are long-term liabilities and out of transactions are current liabilities.
5) Accounting Equation
The fundamental concept of the accounting equation is based on
Assets = Liabilities + equity
Here, Equity can be derived by subtracting liabilities from assets. Liabilities on the other hand are derived by subtracting equity from assets.
6) Link with Income Statement
Assets and Equity both are balance sheet items. However, they are closely linked to profit and loss statements. Retained earnings are part of equity.
Every year, the net profits are transferred to retained earnings after making the required payment of dividends.
On the other hand, liabilities are not directly related to the income statements. However, all those payables which are accrued for the current year are still being shown on both the income statement and balance sheet due to the concept of accruals.
Under equity, outflows are necessary only in the case of dividend distribution or when the company is liquidated.
On the other hand, there are regular payments being made to current liabilities and occasional cash flows to long-term liabilities.
A summary of the differences between them is given below:
|Basis of difference||Equity||Liability|
|Definition||It is the money invested by owners in the business||It is the money owed by the company.|
|Purpose||Used for buying assets or discharging debts of the company||Liabilities are a burden to the company and are paid off by the company in due course.|
|Classification||Divided into equity share capital, preference share capital, reserves, surplus, etc.||Classified as current and non-current liabilities.|
|Ownership||Equity is the fund of the owner.||Funds go out from the company in payment of liabilities.|
|Accounting equation||Equity= Assets- Liabilities||Liabilities = Assets- Equity|
|Nature||Equity is the source of funds to acquire resources||Liabilities arise during the procurement of funds and application of funds.|
|Link with the income statement||Retained earnings link equity with the income statements.||There is no direct link between liabilities and income statement|
|Line items||Equity consists of contributed capital, treasury stock, preferred shares, and retained earnings.||The line items consist of notes payable, long-term debts, advance receipts, accounts payables, etc|