When you start a business often times there are limited resources. Accordingly with start-ups much of the initial capital will need to be contributed in order to get the new business off the ground. There are probably many forms of contributed capital, but most of them will fall under one of 3 categories; cash, services, or property.
In order to account for contributed capital you will need to have the right accounts set up in the equity section of your balance sheet. This will depend on how the ownership is set up. While the concept is the same, the balance sheet accounts in the equity section of your books will vary in terms of the names. For example with a corporation (or S-Corp) you will have “shareholders”. With an LLC you have “members”, and with a partnership you have partners. Depending on how detailed you want to be you can break up the owner capital accounts into essentially 3 accounts; investments, draws, and earnings. The last account, earning would be used to allocate net income according to the proportion of ownership at the end of an accounting period. But that’s another tutorial for another day. Let’s focus on accounting for contributed capital now that we have our accounts set up.
Contributing cash is very easy to account for cash contributions. You simply record a deposit and book it to the equity account.
This one is easy. The next 2 may not be so obvious.
Services are perhaps the most tricky in terms of how to record them when they have been contributed instead of paid for. The best way to understand how to book contributed capital in the form of services is to think in terms of breaking up the transaction into smaller components. Let’s say we’re contributing web design services. We have to assess the fair value of those services. This should be done in terms of what we would realistically charge our customers for the same service. This probably means figuring the # of hours spent at an appropriate hourly rate. Let’s say we’re offering the same service to our customers at $150/hour and the project that we did for our own company took us 20 hours. The value of the services is $3,000 (20 x 150=3,000). If we had to pay someone for this we would write a check for $3,000 and record the expense, “Web Design Services”. On the other side if we had contributed the same $3,000 in cash in order to pay for the web design services, we would simply record a deposit to our bank account and the offset would be the owner’s capital account. Then we would write the check. So when we simply contribute the services we are eliminating the deposit into the bank account and the payment to an outside web designer. We are left with the $3,000 expense to the company and the same value contribution into the business, right? So the best way to record this is to book a journal entry:
|Web Design Services||3,000|
If you have contributed capital in the form of property such as equipment then the process is exactly the same as above. You have to assign fair market value to that property. In some cases, if the property is unique or rare, then you may need to hire an expert to assess the fair value of your contributed capital. Once you have a number then the entry is the same as above, but your “Debit” will most likely be to a Fixed Asset account like “Property and Equipment”. How you name it is up to you.
Watch my screen cast for step by step video instructions on all of the above and please take a minute to leave your comments and questions below. Best one gets a free Nerd T-Shirt and/or Pen!