Dividends

Dividends are payments to the shareholders to compensate them for their ownership in the corporation. It is the same concept as utilized in large corporations. If you invested in the stock market (in IBM, let's say), you would receive a quarterly dividend check from IBM as payment on your shareholdings. When you are the share­holder of a small corporation, the same logic holds.

Dividends are a part of the equity section of the balance sheet because they are drawn out of the corporation's after-tax retained earnings. They do not represent a deduction to the company on its income statement. The year after the dividend has been declared and paid, it is merged into the retained earnings of the company, so that only the current year dividends appear separately in this column.

A sole proprietorship's equity section will look a little different from a corporation's. There are no shares, retained earnings, or contributed capital. There is only one account: Owner's Equity. There can, however, be a few sub-sections of owner's equity, but usually only the summary figure appears on the balance sheet. Here are the components:

Accumulated earnings: The concept of accumulated earnings is similar to that of retained earnings, above, but be­cause an unincorporated business has no income taxes of its own or dividends to payout, it is truly an accumulation of the income of the business for all the years it has been in existence.

Proprietor's (or partners') draws: This line represents the accumulation of money that the proprietor (or partner, in a partnership) has drawn out of the business over time. It represents funds no longer in the company. In a way, it's a little like corporate dividends in that it is withdrawals of capital, but the tax treatment of these items is completely different. (As always, talk to your accountant about taxation issues.)

Proprietor's (or partners') contributions: This represents the accumulation of money that the proprietor (or partner, in a partnership) has invested in the company.

You can see by the nature of these equity items that net income and contributions would increase the net equity account, and net losses and draws would decrease it. It's also important to note that the only difference between the equity section for a partnership and the equity section for a sole proprietorship is that in a partnership, the equity section would show each partner's draws and contributions and the net income would be split between the partners according to their ownership. Even though only the summary figure would go on the balance sheet, an equity ledger would be maintained to track each partner's equity.

Note that the partner draws and contributions relate to each individual partner. The net income for the year is split among partners based on their share of ownership in the partnership. In the example below, the partners are 50/50 owners, and each receives half of the income.