In a company, money from shareholders and profits kept for them are equity, and money owed to outsiders is a liability. One question sorts almost every item: does this belong to the owners or is it owed to an outsider?
This lesson is part of the limited companies chapter. Read it before reading company financial statements, because that lesson assumes you can place each item.
What are the three groups?
Share capital is what shareholders paid in when they bought shares. Reserves are profits that stay in the company, such as retained profits and a general reserve. Liabilities are amounts the company owes to outsiders, such as a bank loan or trade payables.
| Item | Belongs to | Section |
|---|---|---|
| Ordinary share capital | Shareholders | Equity |
| Retained profits | Shareholders | Equity |
| General reserve | Shareholders | Equity |
| Bank loan due in five years | Bank | Non-current liabilities |
| Trade payables | Suppliers | Current liabilities |
Worked example: sorting one list
Bina Jaya Berhad has these balances: ordinary share capital RM200 000, retained profits RM45 000, bank loan repayable in five years RM60 000, trade payables RM18 000.
Apply the owner-or-outsider test to each item. The share capital came from shareholders, so it is equity. Retained profits are profits kept for shareholders, so they are equity too.
The bank loan and trade payables are owed to outsiders, so both are liabilities. The loan is non-current because it is repaid after more than a year. Trade payables are current because suppliers are paid within the trading cycle.
Totals:
- Equity: 200 000 + 45 000 = RM245 000
- Non-current liabilities: RM60 000
- Current liabilities: RM18 000
- Total equity and liabilities: 245 000 + 60 000 + 18 000 = RM323 000
If the assets are non-current assets RM250 000 and current assets RM73 000, they also total RM323 000, so the statement balances.
The mistake that costs marks
One slip is to write retained profits under liabilities, because the profit feels like something the company “owes” its owners. The statement may still balance, which makes the error hard to see.
| Step | Wrong | Right |
|---|---|---|
| Ask who the item belongs to | “The company owes it” | The shareholders own it |
| Section | Liabilities | Equity |
| Effect on totals | Equity RM200 000, liabilities RM123 000 | Equity RM245 000, liabilities RM78 000 |
The test catches this. A liability must be paid to an outsider, but retained profits are only paid out if the company declares a dividend.
A special case: dividends declared
A dividend that has been declared but not yet paid is owed to shareholders. Until it is paid, it is reported as a current liability. After payment, it is gone from the statement and the bank balance falls. Follow your textbook’s wording if a question treats it differently.
Check yourself
A company has: 80 000 ordinary shares issued at RM1 each, general reserve RM12 000, retained profits RM9 000, an 8% loan of RM40 000 repayable in four years, and accrued expenses RM3 000. Find total equity and total liabilities.
Answer
Share capital is 80 000 × RM1 = RM80 000.
Equity = 80 000 + 12 000 + 9 000 = RM101 000.
The loan is a non-current liability of RM40 000 and the accrued expenses are a current liability of RM3 000, so total liabilities are RM43 000.
What to study next
Next, see where these items sit in a full company statement in reading company financial statements. You can also log your own errors in the mistake log and paper-error review tool.
If you want a teacher to work through company accounts with you, see online one-to-one Accounting tuition.