welcome to my explanation about what is owner's equity in this video I will try to give you a
conceptual overview it will only be about 60 seconds of a boring discussion before I give
you a very clear and common-sense down-to-earth example owner's equity officially is defined as
the amount of ownership rights or ownership claim that someone has in an asset or even
an entire business in accounting we can measure owner's equity in dollar amounts the ideas are
common sense and we deal with the ideas of owner's equity every day all the time without any object
or any business can be owned by more than one person in any case the value of the object or
the whole business will always be equal to the ownership claim that people have in that business
so whether you're talking about two people buying a car together two people buying a house together
or even two people owning a company it will always be the case that the value of the car or the house
or the company is equal to the ownership claim or the ownership rights of the people who own
it what owner's equity does is it helps you measure how much of the object do you actually
own of course the person who owns more has more claim or more ownership rights that doesn't mean
that the person who contributed less cannot use the car or cannot have a say in the running of
the company it just means we measure the amount of claim or the amount of rights in asset or a
business based on how much someone sacrificed and invested an owner's equity works the same on one
object or an entire business so if I give you an example of an asset it would behave the same as if
I were talking about an entire business so let's start with a simple example Sally and Sharon buy
a car together the car costs a thousand dollars Sally gives six hundred towards the purchase of
the car and Sharon pays the other four hundred obviously Sally has sixty percent ownership claim
and Sharon has forty percent ownership claim in the car so here's the car and the value of the
asset is equal to who has a claim to the asset Sally has sixty percent ownership claim because
she paid sixty percent of the purchase price and Sharon has 40 percent claim because she paid forty
percent of the purchase price question one can Sally tell Sharon that Sharon cannot use the car
well of course not if you contributed some of the money for purchasing the car you get to use the
car this does not mean that you can only use the front half of the car because you only contributed
approximately half we're not talking about physically measuring what parts of the car are
owned by which owner it doesn't work that way the whole car is owned by both and they both have a
certain amount of rights to use it question two if they agree they must paint the car only one color
should it be the color that Sharon wants or the color that Sally wants well this is an either-or
situation this is not a question of distributing the time that the car will be used and of course
it's not a question of physically how much of the physical car is owned by both we're talking about
car has to be either this color or that color and I think you know in a situation like this
obviously the person who contributed more will get their way in an either-or situation like
deciding what color to paint the car now here is the second example let's imagine that you want
to buy a house and the price of the house which is the value of the house is a hundred thousand
and we know the value of the house is equal to the claim against the house so how do you buy a house
well you have to come up with a down payment for yourself from your own personal money and let's
imagine the down payment that your bank required was twenty thousand and let's imagine the bank
would give you eighty thousand in a mortgage that would give you the ability to buy the entire house
for a hundred thousand dollars in this example the house is a metaphor for an entire business
you would invest money from your own pocket and then borrow money from the bank so here
we represent your investment coming from your own pocket this would represent the money you
buy from the bank and the house would represent all the assets together of a business now it
introduces you to the fundamental accounting equation which is the assets of a business are
equal to the liabilities plus the owner's equity of the business the value of the business which
all the assets together is equal to what the business owes because we know that liabilities
like a mortgage is money that the company owes and the owner's equity represents the amount that the
owner took from their own personal pocket and put into the business just like the person took from
their own pocket and put into the house now you can see this is represented by the fundamental
accounting equation and what I'm now going to demonstrate is that the accounting equation stay
equal after each transaction for example let's pay $5,000 towards the mortgage to reduce the mortgage
well if we pay $5,000 towards the mortgage the mortgage will decrease by 5,000 however if we
are the ones taking from our personal pocket and paying the mortgage that means the amount that we
invested in the house from our personal money is now more we originally invested 20,000 but
now we're investing an additional five thousand to pay down the mortgage so the house is still
worth a hundred thousand but now the mortgage has decreased to 75 thousand because we just
paid some down and our owner's equity goes up to twenty-five thousand because we now invested
an additional five thousand let's invest Chen found by the way now the numbers look like this
now the numbers are a hundred thousand dollars is still the value of the house the mortgage is
now seventy five the down payment or at least the owner's equity which is now twenty five thousand
let's invest ten thousand to add a room well if we add physically something to the house that
we paid ten thousand for it would make sense that the value of the house would deep would
increase by approximately ten thousand dollars but that means that we invest in ten thousand
more dollars from our own personal pocket into the house which makes our owner's equity go up
by ten thousand and now the value of the house is one hundred ten thousand the mortgage didn't
change when we built the room but our owner's equity went up to thirty five thousand because
we put ten thousand more in the house therefore the equation remains equal after each transaction
now let's try an example but this time instead of a house or a car we'll use an entire company
and you will see that the value of the assets of the company are equal to the liabilities meaning
all of the debt of that company plus the owners investment or the owner's equity in that company
so let's imagine this company has 10,000 in cash 20,000 and equipment and the car worth $5,000 well
an elementary school child can tell you that means the total assets on the left are $35,000 that
means the liabilities and the equity on the right side of the equal sign should also total 5 $35,000
so let's imagine this company has a $15,000 bank loan outstanding and that would mean that
the owner had to invest from his or her pocket $20,000 at least in order to buy these assets
that total $35,000 15 came from the bank and 20 came from the owner now let's imagine our first
transaction let's imagine the company buys another car for 3,000 and of course if it comes from the
company money that means the company's cash will decrease by $3,000 however even though the company
has 3,000 dollars less in cash the company has $3,000 more of a car that means that after this
transaction the company only has $7,000 in cash but it actually has $8,000 in cars instead of just
5,000 and of course the equipment didn't change and we didn't have to take a bank loan for this
car we paid from the company cash and it didn't come from the owners investment so after the
transaction of the company giving cash and buying the car the accounting equation stays the same now
let's look at this transaction the owner invests 5,000 more of personal equipment this means that
the owner took equipment that he or she was using at home not for the business and actually brings
it to the business to use for the business well that means that the company has $5,000
more of equipment but it also means that the owner invested $5,000 more of their personal value into
the company so that means that we now have $25,000 of equipment and that means the total value that
the owner invested was $25,000 of course all the other numbers stay the same they have not changed
in this transaction let's try another one let's imagine that we pay $2,000 to decrease the bank
loan well if we pay 2,000 to decrease the bank loan that means that the company has $2,000 less
cash equaling 5,000 but it means that we have two thousand dollars less in debt we owe the
bank two thousand less because we just paid the bank loan so after this transaction we only owe
the bank thirteen thousand and we only have five thousand dollars cash and because none of the
other numbers changed in this transaction you can see that the total assets on the Left which happen
to equal thirty-eight thousand are still equal to the liabilities plus the equity on the right
which equals thirty-eight thousand so you see the equation will stay equal after each transaction