Equity

Equity

Equity is a pivotal term in finance and accounting, referring to the value remaining in an asset after deducting liabilities. It reflects ownership and value returned to stakeholders after liabilities are settled. Below are the key facets of equity:

1. Beneficial Interest in an Asset

This refers to an individual’s stake in an asset after subtracting debts associated with it. For example, if a person owns a house worth £250,000 with an outstanding mortgage of £100,000, they have an equity of £150,000 in the house.

2. Equity in Mortgage or Hire-Purchase Agreements

This involves the money returned to a borrower after selling a specified asset and fully repaying the lender. It ensures the borrower’s share after debt clearance.

3. Net Assets of a Company

Equity also denotes a company’s net assets after all creditors, including preference share holders, are paid off. This value represents the shareholders’ residual claim on the company’s assets.

4. Ordinary Share Capital

In corporate finance, equity may refer to the ordinary share capital of a company. It signifies ownership interests in the form of shares, reflecting the investors’ involvement in the company’s equity.

5. Market Value of Ordinary Shares

Equity includes the market value of a company’s issued ordinary shares. These shares reflect public valuation and trading dynamics, providing a measure of a company’s worth in equity markets.

Examples

1. Personal Equity Example:

   • Ownership: Jane owns a car worth $20,000.
   • Loan: Jane has an outstanding auto loan of $5,000.
   • Equity: Jane’s equity in the car is $15,000 ($20,000 - $5,000).

2. Corporate Equity Example:

   • Company: ABC Corp has total assets worth $500,000.
   • Liabilities: The company owes $200,000 in liabilities.
   • Equity: ABC Corp’s equity is $300,000 ($500,000 - $200,000).

Frequently Asked Questions (FAQs)

1. What is equity in a mortgage context?

   • Answer: Equity refers to the difference between the current market value of a property and the outstanding mortgage balance.

2. Can equity be negative?

   • Answer: Yes, negative equity occurs when the amount owed on a mortgage exceeds the property’s current market value.

3. How is equity calculated for a business?

   • Answer: Business equity is the residual interest in the assets of an entity after deducting liabilities. It is calculated as Total Assets - Total Liabilities.

4. What are ordinary shares?

   • Answer: Ordinary shares are equity securities representing ownership in a company. Holders of ordinary shares have voting rights and may receive dividends.

5. Why is equity important for investors?

   • Answer: Equity represents ownership in a company, and a higher equity value can translate to greater returns for investors through capital gains and dividends.

Related Terms

• Negative Equity: When the value of an asset falls below the outstanding balance of the loan secured against it.

• Preference Shares: A type of share that typically provides dividends before ordinary shares and has priority during asset liquidation.

• Share Capital: The funds raised by a company through the issuance of shares.

Online References

• Investopedia: Equity
• Financial Accounting Standards Board (FASB) - Equity

Suggested Books for Further Studies

• “Equity Asset Valuation” by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, John D. Stowe.
• “Equity Management: The Art and Science of Modern Quantitative Investing” by Bruce I. Jacobs and Kenneth N. Levy.
• “Financial Accounting and Reporting” by Barry Elliott, Jamie Elliott.

Accounting Basics: Equity Fundamentals Quiz

Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!