Definition
Equity is the residual interest of the owners in the assets of a business after deducting all liabilities. It comprises share capital, share premium, retained earnings, and other reserves, presented at the bottom of the balance sheet and reconciled in the statement of changes in equity. The accounting identity (Assets = Liabilities + Equity) ensures that equity equals assets minus liabilities at every point in time.
What equity means in practice
For a bookkeeper, equity is the section of the balance sheet that captures everything owed to the shareholders rather than to third parties. It splits into two main types: contributed capital (what shareholders put into the business through share purchases) and accumulated retained earnings (cumulative profit the business has earned and not distributed as dividends).
The size and composition of equity tell a reader several things at a glance. A high retained-earnings balance relative to share capital usually signals a mature profitable business that has accumulated wealth from operations. A high share capital relative to retained earnings usually signals a younger business that has raised external funding before generating sustained profits. A negative retained-earnings balance signals accumulated losses that have eroded shareholder wealth.
A practical example: a UK consultancy at 31 March 2027. Total equity 103,250. This splits into share capital 1,000 (the original founders’ 1,000 shares at 1 each) and retained earnings 102,250 (six years of accumulated profit after dividends). Almost all the equity is profit-built, not capital-built. This is the signature of a well-run service business with low capital requirements.
How equity works by country
United Kingdom
Equity components under FRS 102 Section 22 are “called up share capital”, “share premium account”, “revaluation reserve”, “other reserves”, and “profit and loss account” (the FRS 102 term for retained earnings). The distributable reserves rules under Companies Act 2006 section 830 restrict what can be paid as a dividend: only realised profits can be distributed, which generally excludes revaluation reserves and unrealised gains.
Australia
Equity components under AASB 101 are “issued capital”, “reserves”, and “retained earnings”. AU companies often present “contributed equity” as the term for issued capital. Dividend distributions are restricted by the solvency test in Corporations Act section 254T: a dividend can only be paid if the company’s assets exceed liabilities and the payment is fair and reasonable to shareholders as a whole.
Canada
Equity components under ASPE Section 3251 are “share capital”, “contributed surplus”, “retained earnings”, and “accumulated other comprehensive income” (for IFRS adopters). The CRA’s tax-paid retained-earnings concept affects whether dividends are categorised as eligible or non-eligible, which in turn affects the personal tax rate the shareholder pays on the dividend.
New Zealand
Equity components under NZ IAS 1 are “share capital”, “retained earnings”, and any “other reserves” or “asset revaluation reserve”. The Companies Act 1993 section 4 solvency test must be met before any distribution: the company must be able to pay its debts as they fall due and the value of its assets must exceed the value of its liabilities including contingent liabilities after the distribution.
Singapore
Equity components under SFRS(I) 1 are “share capital”, “capital reserves”, “retained earnings”, and any “other comprehensive income” reserves. Section 403 of the Companies Act prohibits dividends out of capital; only distributable profits qualify. The solvency test in section 75 of the Companies Act also applies for share buybacks.
Related terms
Equity is the third component of the accounting identity and the bottom of the balance sheet:
- The balance sheet is where equity is presented.
- Share capital is the contributed-capital component.
- Retained earnings is the accumulated-profit component.
- Retained profit is the UK synonym for retained earnings.
- The statement of changes in equity walks through every movement in equity over the period.
- A dividend is the most common way equity decreases.
See also
For the SOCIE that explains every movement in equity, see the statement of changes in equity entry.
FAQ
See the answered questions above for why equity is the residual interest, share capital vs retained earnings, and negative-equity scenarios.