Opening balance equity is a crucial topic that anyone distantly related to accounts and their maintenance needs to understand.
One needs a sound comprehension of opening and closing balance to do so. Once you have a grasp of the basics of opening balance equity, you will be able to correct it and reduce it to zero.
In this blog, we will explore the opening balance and closing balance, how to reduce the opening balance equity to zero, and how to correct it when it’s negative.
Moreover, we will also guide you on preventing a large opening balance equity. The article will explore other important aspects, such as retained earnings and balance sheets. Alright then, let’s begin.
Knowing Opening Balance and Closing Balance
The opening balance is the amount of money at the beginning of an accounting period. The opening balance can be the starting amount of a bank account or financial records.
It might be zero, positive, or negative. The opening balance is often called Brought Forward (BF) from the last financial period.
Conversely, the closing balance is the amount of money available to the business or entity at the end of an accounting period. Often, the closing balance in the last accounting period is brought forward to the next accounting or financial period.
Assets, Liabilities and Equity
To understand the position of opening balance equity account in the chart of accounts and balance sheet, one should understand the following equation.
Assets = Liabilities + Equity
Therefore, there are three major types of accounts in the chart of accounts and balance sheets.
Assets can be considered credit or capital in hand, and liabilities are debts the business is liable to pay. Equity is the capital shared by the owners or shareholders at the beginning of the business. These three values must balance each other according to the above equation.
Opening balance equity is listed in the equity account on the balance sheet and the chart of accounts. ‘Retained earnings’ is another equity account besides common stock and paid-in capital.
What is Opening Balance Equity?
Opening balance equity is an offset account used in accounting software to help in balancing books. It represents the difference between assets and liabilities or simply between the credit and debit at the start of the accounting period.
The opening balance equity account appears in the equity section of the chart of accounts. When you connect the bank account to your accounting software such as Zoho Books, the software creates this account.
It has the exact value of the balance of your bank account at the beginning of the financial period. It is a kind of equity, the capital supplied by the owner at the beginning of the financial period.
Is Opening Balance Equity the Same as Retained Earnings?
Opening balance equity and retained earnings are similar in the sense that they are both equity accounts. However, they aren’t the same thing. Retained earnings can be understood as the retained profit stored in the form of profit.
However, opening balance equity is a temporary account created at the beginning of the accounting period until the books are accurately imported, balanced, and corrected. It is then adjusted to zero and closed.
Is Opening Balance Equity an Asset?
It can be considered as an asset or liability that is brought forward from the previous financial period. It could be positive, negative, or zero and can mean either cash or debt for the business.
This is why it is not wise to define opening balance equity as an asset or liability.
Instead, it belongs to the equity section in the chart of accounts and balance sheet. It is a type of equity, a capital resource provided by the owner at the beginning of the financial period.
This is why when you connect the accounting software to your bank account, it considers this as the beginning and shows the initial balance in the bank account as the opening balance equity.
When you import journal entries for the previous financial period, you can adjust and close it off.
What Causes a Large Amount in the Opening Balance Equity?
Sometimes, when you begin with a new account or financial period, you might see a large amount in the opening balance equity.
The main reason for this is that the bank reconciliations weren’t done properly in the previous accounting period. This is in the condition when you usually keep this account zero, which is the standard convention.
Opening balance equity is temporary and must be corrected to zero and closed off.
Negative Opening Balance Equity
Negative opening balance equity can show owing to reasons like incorrect or duplicate entries, mistakes in bank reconciliation, bank reconciliation not done, etc. To fix this, first, verify all the journal transactions are entered correctly.
Now, perform the bank reconciliation and, in the end, balance the accounts. To correct the negative opening balance equity, you will need to credit an amount and make it zero.
Do You Need to Zero the Opening Balance Equity?
Opening balance equity is an equity account and shows up in the equity section in the chart of accounts balance sheets.
It is one of the equity accounts and is listed alongside the other equity accounts like retained earnings. Opening a balance equity account is temporary and, therefore, should be zero.
A non-zero value of the account is only justified when you have no prior records of the last financial period.
Once you have imported the detailed records of the last financial period, the opening balance equity must be corrected to zero, except in case it was non-zero in the last accounting period as well.
However, that is not recommended. A non-zero value in this account at the beginning of the accounting period is the result of issues in accounting operations like bank reconciliation. It should be corrected by making an adjustment in the accounts.
- If the opening balance equity in the last financial period was non-zero, its value should be the same at the beginning of this accounting period.
- However, it is not an advised practice to keep a non-zero balance for the opening balance equity for an extended period, and should be only temporary.
- When the value of the opening balance equity doesn’t match that of the last year, it should be corrected. The standard convention is to have a zero-opening balance equity account every financial period.
- To correct the opening balance account, make the required adjustments and ensure the bank reconciliation.
How to Correct a Non-Zero Value of Opening Balance Equity?
Correcting a non-zero opening balance equity is straightforward when you have detailed records of the previous accounting period. In accounting software like QuickBooks and Sage, this is also called closing the opening balance equity account.
The tips listed below will guide you on how to zero or correct the opening balance equity account. Here are the steps to correct the non-zero or non-matching value of opening balance equity.
- Connect the bank account to the software at the beginning of the financial period.
- Make and import all the journal entries and data from the last accounting period.
- Once all the initial values and accounts have been entered for the prior, match all the values and ensure bank reconciliation.
- Once that is done, debits any amount included for retained earnings and common stock in the equity account.
- After the amount in the opening balance equity account is transferred to normal equity accounts, it will become zero and closed.
Equity vs Capital: Knowing the Difference
Equity and capital represent very similar aspects of the company, i.e., resourced with a minor difference. These two terms are often used interchangeably but do not imply the same thing.
Equity is the total amount that the shareholders would receive if they liquidated, or in layman’s terms, sold off, every stock they own. However, these stocks are company stakes and are not available to spend until liquidated.
The financial assets available to spend are called capital. These are the financial resources that the company can spend and invest in company operations, employee benefits, leisure, buying new companies or their stocks, etc.
How Can Equity be Used to Generate Funds?
Equity is also called stocks or shares and is categorized into common stocks, preferred stocks, etc. They can be used to generate funds when the company requires them.
For instance, the company wants to invest in a new project, expand the business, or repay a debt. The company, therefore, invites the investors to buy a portion of the company (i.e., stocks or shares) at the market value.
Wrapping It Up
The above article will guide you on correcting an opening balance equity account. However, that is not the end of accounting tasks, and it might be better to outsource it to an accounting firm.
We invite all mid-sized and small businesses to take a free trial of accounting services.
If they are your cup of tea, you can leave the accounting operations to us and focus on your core business activities and management. Dial +1(800) 580-5375 now and talk to our accountant.