An owner's capital account is the equity account used by a sole proprietorship to record the owner's claim on the business's assets. It increases when the owner invests cash or other assets and when the business earns net income, and it decreases when the business has a net loss or the owner withdraws assets for personal use. Its balance appears on the balance sheet as owner's equity, usually labeled with the owner's name, such as "J. Rivera, Capital".
In a partnership, each partner has a separate capital account, and in a corporation the comparable equity is split between paid-in capital and retained earnings. Unlike those corporate accounts, a proprietor's capital account combines investments and accumulated earnings in a single balance. It is a permanent account, carried forward from year to year.
The owner's capital account in plain terms
Think of the capital account as a running score of how much of the business belongs to the owner. When the owner puts in $20,000 of savings to get started, the score goes up by $20,000. When the business makes a profit, the score goes up again, because the profit belongs to the owner.
When the owner takes money out to pay household bills, or the business has a bad year and loses money, the score goes down. At any moment, the balance shows what would be left for the owner if all the business's assets were sold at their book values and all its debts were paid.
What increases and decreases the account
- Owner investments. Cash or other assets contributed by the owner are credited to capital. If the owner transfers a $15,000 van to the business, the entry debits Vehicles and credits Capital.
- Net income. At year-end, net income is closed from the income summary into capital as a credit.
- Net loss. A loss is closed into capital as a debit.
- Withdrawals. Owner draws are first recorded in the owner's drawing account and then closed to capital as a debit.
The capital account normally has a credit balance. A debit balance would mean the owner has withdrawn more than they invested and the business earned, leaving negative equity.
Closing entries and the statement of owner's equity
During the year, revenue, expense and drawing accounts collect the period's activity. At year-end, closing entries transfer their balances into the capital account, leaving the temporary accounts at zero. Only the permanent accounts, including capital, then appear on the post-closing trial balance.
Suppose Rivera's capital account starts the year at $50,000. During the year she invests another $10,000, the business earns net income of $42,000 and she withdraws $30,000. The statement of owner's equity shows:
| Item | Amount |
|---|---|
| Capital, beginning of year | 50,000 |
| Add: investments | 10,000 |
| Add: net income | 42,000 |
| Less: withdrawals | (30,000) |
| Capital, end of year | 72,000 |
The ending balance of $72,000 is reported in the equity section of the balance sheet, and it equals total assets minus total liabilities.
Capital accounts in partnerships and LLCs
Each partner's capital account tracks that partner's contributions, share of profits and losses under the partnership agreement, and withdrawals. Partners' capital balances matter when a partner joins or leaves, when profits are divided based on capital, and when the business is liquidated. A limited liability company taxed as a partnership keeps similar member capital accounts. For tax purposes, partnerships also report each partner's capital account on Schedule K-1, which may be prepared on a tax basis different from the book capital account.
Capital account and tax
A sole proprietor is taxed on the business's net profit, reported on the owner's personal return, whether or not the profit is withdrawn. Withdrawals reduce the capital account but are not deductible expenses, and the owner does not pay themselves a salary that the business can deduct. Owners sometimes confuse a growing capital balance with cash available to spend; in fact the capital account is a claim on all the business's net assets, which may be tied up in equipment, inventory and receivables. The capital account also falls if the owner covers losses or makes withdrawals beyond the business's earnings.