# Equity

Equity is in the economics that part of the capital of business entities , which in the balance sheet as a positive difference between assets and liabilities shows, so that the capital the net assets corresponds. An equal definition assumes that the equity is available to the economic entities indefinitely and is therefore not subject to any repayment obligation.

The complementary term to equity is debt , which includes debt.

## General

The compound equity is made up of “own” for owners ( shareholders ) or their own financing and “capital” as a subtype of capital. Etymologically , the generic term “capital” was later used to derive “equity”. If economic entities operate self-financing, they form equity. Companies , foundations , other associations of persons , the state and its subdivisions ( public administration , public companies , municipal companies ) and private households can be considered as economic subjects .

## Definition variants

In business administration, there is no generally applicable, uniform definition, but rather a “multitude of different equity definitions, each of which brings different aspects to the fore”. From the many definitions, at least three main definitions emerged, which emphasize questions of origin, balance sheet or repayment aspects. The first group speaks of equity when it is a question of capital that has been contributed directly or indirectly to the company by the owners / shareholders. Reinhard Schmidt categorically stated in 1983: "Whoever gives equity is owner and entrepreneur". This overlooks the fact that shareholder loans are also covered by this. The second group defines equity as the balance sheet residual figure from assets and liabilities. The third group finally focuses on the lack of repayment obligation and the lack of termination options, both of which are core characteristics of equity capital that distinguish it from debt capital. A lack of repayment obligation is always associated with unlimited availability and a lack of termination options. As early as 1932, the business economist Alexander Hoffmann pointed out that in contrast to loan capital, equity is free of encumbrances (no loan collateral ) and, since it cannot be terminated or repaid, is legally responsible. The business economist Erich Gutenberg defined equity as the capital in which the "capital providers legally have the position of owners ...". The Deutsche Bundesbank uses the terms “own funds” and “borrowed funds” in the sense of equity and borrowed capital.

Today, the balance sheet-oriented definitions are widespread in business administration, refer to equity as the positive difference between assets and debts and equate it with net worth. After IASB it is the residual amount (residual) between assets and liabilities thereof withdrawn ( English "the residual interest in the assets of the entity after deducting all of its liabilities" (IASB F.49 (c) 595). For insolvency may therefore only come when there are debts.If an economic entity only has equity, there are no repayment claims and consequently no risk of insolvency.

## Functions

Equity fulfills several functions for all economic entities:

## history

Functional equity appeared for the first time in connection with the establishment of companies . In the case of the Kommenda founded in Venice in May 1072, in addition to the shareholders' equity, there was also the raising of capital in the form of risk capital ( Italian accommandita ) and fixed-income capital ( Italian depositum ). The limited liability of such a company in the event of default was documented for the first time in 1408 in Florence. As a systematic element of double-entry bookkeeping , equity was first presented by Luca Pacioli in his text Summa de Arithmetica, Geometria, Proportioni et Proportionalità , completed in 1487 . The mathematician Pacioli noticed that there was often an excess of wealth over debts, which he called "il cavedale" (from Latin caput , "main part", "most important element").

The medieval interest prohibition favored the formation of equity. Equity was apparently considered productive as early as the 16th century and led to the establishment of stock corporations , because the issue of shares brought them equity.

The word equity appeared relatively late in German law . The ADHGB of May 1861 still spoke of deposits or shareholders in company assets, which as a rule even had to pay interest regardless of profit (Art. 106 Para. 1, Art. 161 Para. 1 ADHGB). Equity as “the owner of the company's capital” did not emerge until the late 18th century; the Commercial Code (HGB), which came into force in May 1885 , recognized reserves . For a long time, equity was an indefinite legal term .

## Equity of individual economic entities

The specialist literature in business administration describes the equity of a company most comprehensively . The Public Business Administration deals with the object of knowledge of equity in the state budget and public budgets , while the Home Economics equity of households studied.

### Companies

When a company is founded, equity is created through a cash or non- cash contribution by the shareholders. According to commercial law, the equity of a company is a balance sheet item in the annual financial statements ( Section 266 (3) lit. A HGB ). According to this, in corporations equity subscribed capital , capital reserves , retained earnings , profit carried forward / loss carried forward and annual surplus / annual deficit . In partnerships , the balance sheet presentation of equity is less detailed than in corporations.

Balance sheet as of December 31, xxx
assets liabilities
Capital assets Equity
Current assets Borrowed capital
Total assets Total assets

The revenue reserves are divided in accordance with the above provision into legal reserves , reserves for shares in a controlling or majority-owned company, statutory reserves and other revenue reserves. The term subscribed capital ( Section 272  (1) sentence 1 HGB, Section 152 (1) sentence 1 AktG, Section 42 (1) GmbHG) is intended to clarify that this is paid-in equity. Outstanding capital does not increase equity until it has been called in and paid in. Uncalled capital is to be openly deducted from the subscribed capital ( Section 272  (1) sentence HGB).

In existing companies, equity arises through capital increases , retained earnings , capitalization of asset items , and through revaluation of assets or lower valuation of liabilities . Emission-looking companies with access to the stock market are organized in the legal form of AG / KGaA and can equity through emission of shares procure. Companies that are not able to issue are small AG / KGaA or other legal forms that rely on their shareholders, private equity or retained earnings. In consolidated financial statements minorities Shares are (shares of vollkonsoliderten subsidiaries that are not the parent company include) shown separately ( § 307 para. 1 HGB).

The assets financed with equity are the most important debt coverage ratio for the company's creditors. The higher the equity and the equity ratio, the better the creditworthiness of a company and the more favorable, ceteris paribus, the debt ratios .

### Capital market

Equity securities ( English securities equity ; shares , participation certificates , convertibles , GmbH shares ) are characterized in that their through participation in the net profit (possession dividend is paid out), while the borrowing rate is configured regardless of performance. Equity securities are traded on the capital market (on the stock exchange or over the counter). Your owner keeps them either short-term intention to sell ( English available for sale ) or indefinitely ( english held to maturity ). In the case of companies, this leads to capitalization as current assets or financial assets .

The dividend and membership rights are documented in a share that is traded on the stock exchange as a free float and / or is permanently owned by shareholders over the counter . In the event of liquidation , lenders are given priority, followed by equity providers. If there are no more realizable assets after the repayment of all debts, the equity providers go away empty-handed. For these reasons, the equity investors bear a much greater risk than the debt investors. A shareholder of an AG or a partner of a GmbH is liable with his capital share, the partner of a partnership ( GbR , OHG , KG ) or the sole trader is also liable with his private assets . He is therefore given his return expectation with a risk premium that compensates him for this risk assumption. The average returns on the capital market, consisting of the dividend yield and the rate of change in the price of the security , are therefore generally higher than the average interest rate on risk-free bonds . Without a risk premium, the shareholder will usually not be prepared to take on the entrepreneurial risk that an equity investment represents.

### Country

The state and public administration draw up state budgets and public budgets which, in the case of cameralistic budgets, do not include any inventory variables such as equity. With them, the equity is the residual amount from the positive difference between government assets and government debt . According to Section 7a of the HGrG , the use of the double- entry system is permitted, so that equity capital can be presented from state level downwards. At the community level, initiatives such as the new municipal financial management system ensure that the Doppik also applies to municipal accounting.

Municipalities do not have equity providers; rather, “their own resources” are created by allocating the financial requirements . Equity is also offset by inalienable administrative assets ( Latin res extra commercium ), so that equity does not represent a suitable debt coverage ratio in the municipal annual financial statement analysis. This is due to the fact that public buildings or other public structures (such as schools , roads , bridges ) do not have a market price and are hardly usable. Public companies and municipal companies prepare annual financial statements according to the HGB.

### Private households

If private households were to draw up a balance sheet in their private financial planning , the assets side would consist of residential property , motor vehicles , household effects and receivables ( cash in hand , bank balances , securities ), the liabilities side would consist of liabilities and net worth or equity. Private households finance themselves with equity until they need to take out a first loan . In private real estate financing , equity includes those financing instruments that are available to the buyer of real estate ( cash , savings deposits , time deposits , securities, building society savings and existing, unencumbered real estate ). The own work in the form of so-called muscle mortgage are expected to equity. In contrast, loans from relatives , employer loans or public grants represent borrowed capital, insofar as they are associated with a repayment obligation.

## Differentiation from borrowed capital and other liabilities

The - not always easy - distinction between equity and debt capital is of major importance for creditors and analysts . If there is even the slightest possibility of repayment, then the corresponding balance sheet item belongs to outside capital. Therefore, all types of provisions (including pension provisions ) form part of the debt, since there is at least a 50% repayment probability. A non-performance-related interest rate also speaks in favor of outside capital. Hybrid forms of equity are a hybrid between equity and debt capital and are therefore also called mezzanine capital :

• Subordinated loans ( English junior debt ): Are loans according to § 488 Paragraph 1 BGB and thus borrowed capital, the repayment of which is linked to the condition that they only have to be repaid after the satisfaction of other (senior) creditors ( senior debt ) . The condition is known as subordination designed subordination or subordination agreement and acts both in bankruptcy and in liquidation .
• Participation rights ( English participation rights ) are to blame legally established funds with shareholder typical property rights. In view of the large number of design options, it must be checked whether the issuer assumes an obligation to repay ( puttable instruments ) or whether the issuer only has a right of termination. A conditional repayment obligation only upon liquidation leads to the classification as equity, an unconditional one is to be shown as outside capital. In the case of credit institutions ( Section 10 (5) KWG) and insurance companies ( Section 214 (1), (2 ) and ( 4) VAG), profit participation rights can be recognized as regulatory equity if certain arrangements are made (see own funds (credit institution) ).
• Dormant companies ( English silent partnership ): These have under the legal concept more in the nature of a contractual obligation and are therefore to be considered in doubt as debt. In Section 231 (1) and Section 232 (2) HGB, loss sharing is provided, but it can be excluded (Section 231 (2) first half-sentence HGB). In the case of insolvency, the silent partner can assert his contribution that has not been consumed by losses as an insolvency creditor ( Section 236 (1) HGB).
• Hybrid bonds ( English hybrid bonds ): These are bonds , an increase of debt, the first time usually tied after a period of 7 to 10 years are callable by the issuer ( English issuer call options ). They usually have a subordinate clause for liquidation, dissolution and bankruptcy. There are hybrid bonds with very long maturities (between 30 and 100 years), even "eternal bonds" ( English perpetuals ) are on the market.
• Shareholder loans ( english shareholder loans ): They are formally While borrowing, but they are considered economic equity treated. Since November 2008, shareholder loans have been taken into account in the Insolvency Code (InsO) due to the law on the modernization of GmbH law and combating abuse (MoMiG) . All loan repayment claims by shareholders of a company without a natural person as a personally liable partner are classified as subordinated insolvency claims by law, regardless of their equity substitute character ( Section 39 (1) No. 5 and Sections 44a, 135 and 143 InsO).

International rating agencies recognize such hybrid forms of financing in whole or in part as economic equity . It is assumed that there must be a long term and / or a high share of losses and can therefore lead to recognition as equity. Subordinated loans can be calculated with at least 50% of economic equity.

The differences between equity and borrowed capital can best be seen in insolvency proceedings : backward equity that a shareholder should raise can be demanded from the insolvency administrator as a performance in the masses ( Section 171 (2) HGB). The situation is different if it is a question of a shareholder's loan to the company or the debt of a non-shareholder. Here the lender can terminate the loan extraordinarily ( Section 490 (1) BGB). If the loan has already been granted, the claim for repayment takes part in the insolvency proceedings as an insolvency claim. Until October 31, 2008, equity-replacing loans were treated as equity in the insolvency proceedings. With the MoMiG , the question of whether or not the loan replaces equity has become obsolete (amendment to Section 135 (1) InsO).

Deferred tax liabilities and deferred income also reduce equity. In the narrower sense, however, they are not borrowed capital, but accounting aids for periodising profits according to the dynamic balance sheet conception .

## Legal issues

As a residual variable, equity represents an indefinite legal term and is in turn derived from the indefinite legal terms assets and liabilities. Equity remains undefined in Section 247 (1) HGB, Section 266 (3) lit. A HGB offers an enumerative list and thus makes equity a specific legal term .

Special laws are based on the non-repayability of equity. For example, Section 57 (1) of the AktG stipulates that shareholders may not be granted back their contributions; for the GmbH, the parallel provision can be found in Section 30 (1) of the GmbHG. In the case of these corporations, the capital reduction is not a repayment of equity, as is the withdrawal from partnerships. In the case of a capital reduction, equity is not repaid; instead, the nominal capital is adjusted to the reduced assets as a result of asset losses. Withdrawals also do not represent a repayment of equity, because the unlimited liability with private assets does not change the entire asset position of the shareholder.

According to IFRS, it is also crucial that equity is non-repayable. IAS 32.16 defines equity as non-repayable and non-redeemable. “A financial instrument is only an equity
instrument if (a) the instrument does not contain a contractual obligation to deliver cash or other financial assets to another company and
(b) if the instrument can or will be settled in the issuer's own equity instruments. “
Only if an investor provides the company with funds for an unlimited period of time can these be regarded as equity.

Even under Basel III , core capital must be available to credit institutions indefinitely, i.e. it must not be terminable or repayable. It is particularly important for the disclosure as equity that the company is not obliged to repay due to an unconditional right.

If equity has been used up by losses and there is a surplus of liabilities over assets ("negative equity"), the balance sheet item "deficit not covered by equity" must be created on the assets side in accordance with Section 268 (3) HGB. According to Section 286 (3) of the German Commercial Code (HGB), the disclosure of equity and annual results can be omitted if the company does not have to disclose its annual financial statements and the reporting corporation cannot exercise a controlling influence on the company concerned.

## Key figures

Within the framework of the balance sheet analysis, equity is the subject of a large number of key business figures . These include vertical indicators such as the equity ratio and horizontal indicators such as asset coverage . The most important is the equity ratio, which shows the share of equity in total financing (= total assets ):

${\ displaystyle {\ text {Equity ratio}} = {\ frac {\ text {Equity}} {\ text {Total assets}}} \ cdot 100 \, \%}$

The higher the equity ratio, the better the creditworthiness of a company and vice versa. A high equity ratio leads to a favorable cost leverage , because less profits are used for the interest expenses for the relatively low debt capital and thus the break-even point is reached more quickly.

## International

In Austria, the classification rule of Section 224 (3) UGB includes capital reserves, retained earnings and retained earnings for equity. Section 229 of the UGB describes the contributions as “nominal capital”, and tied and non-tied capital reserves as well as statutory and statutory revenue reserves are to be shown separately. In Switzerland , according to Art. 959 Para. 7 OR, the equity capital is to be shown and structured according to the legal form. According to Art. 959a Para. 2 OR, there are share, shareholder or foundation capital, statutory capital reserves as well as statutory and voluntary profit reserves.

The English legal term for the equity of a company ( English equity ; from Latin aequitas , "equality" as the demarcation between the shareholders and creditors) is specified with two sub-terms. “ Private equity ” does not mean that the capital is provided exclusively by private individuals, but rather describes the use of equity in unlisted companies. Listed companies have "public equity", joint stock companies specifically have "shareholder equity".

The International Financial Reporting Standards (IFRS) define equity largely homogeneously internationally. However, there is no single standard in IFRS that describes the delimitation, treatment and presentation of equity in the annual financial statements. IAS 1.7 knows assets, liabilities and equity. The framework defines equity ( English equity , french équité ) as the net of all debt ( english liabilities ) remaining balance ( English residual interest ) in assets ( english assets ) of an enterprise (IAS 1.98, sentence 1). This netting definition equates equity as a residual with net worth . Due to its character as a residual value, an independent equity valuation does not take place in the IFRS, but depends on the valuation of the assets and liabilities. Equity is formally an equity instrument ( English equity instrument ), is in addition to the financial assets and financial liabilities to financial instruments . According to IAS 32.11, an equity instrument is a contract that creates a residual claim on the assets of a company after deducting all debts. The IAS also associate equity as the main characteristic with the lack of repayment obligation. Equity instruments (IAS 32.15 ff.) Are only present if the instrument is not linked to a contractual obligation to deliver cash or other financial assets, as the instrument would otherwise meet the definition of a liability. As an exception, however, under certain conditions such financial instruments can instead be classified as financial liabilities (see IAS 32.16). The issuing company must in accordance with IAS 32.19 f. have an unrestricted right in the case of equity instruments to evade (potential) (repayment) obligations.

According to the list within the statement of changes in equity , equity according to IAS 1.108 can be broken down as follows:

  Komponenten des Eigenkapitals (ohne Anteile nicht beherrschender Gesellschafter):
Gezeichnetes Kapital
+ Rücklagen
+ kumulierter Saldo des sonstigen Ergebnisses der reklassifizierbaren
(d. h. in Gewinn/Verlust-Rechnung übertragbare) Posten aus:
* Währungsdifferenzen
* zur Veräußerung verfügbare finanzielle Vermögenswerte
* Cashflow – Absicherungen
+ kumulierter Saldo des sonstigen Ergebnissen der nicht reklassifizierbaren
Posten (IAS 1.96) aus:
* Neubewertungsrücklagen aus der Fair-Value-Bewertung
für Sachanlagen (IAS 36.31 ff.)
* Neubewertungsrücklagen aus der Fair-Value-Bewertung
für immaterielle Vermögenswerte (IAS 38.75 ff.)
* Kumulierter Saldo aus erfolgsneutraler Bewertung bei
leistungsorientierten Versorgungsplänen (IAS 19.57 (d))
= Summe Eigenkapitals (ohne Anteile nicht beherrschender Gesellschafter)
+ Anteile nicht beherrschender Gesellschafter (bei einem Konzernabschluss)
(evtl. mit entsprechender Unterteilung wie oben)
= Gesamtsumme Eigenkapital


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• Beck’s balance sheet commentary . 9th edition. Publishing house CH Beck, Munich 2014.
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• Michael Griga, Raymund Krauleidis : Creating and reading balance sheets for dummies. 2nd updated edition. Wiley-VCH, Weinheim 2010, ISBN 978-3-527-70598-6 .
• Gerhard Scherrer: Accounting according to the new HGB. An application-oriented presentation with numerous examples. 3. Edition. Vahlen, Munich 2010, ISBN 978-3-8006-3787-4 .
• Jürgen Weber , Barbara E. Weißenberger: Introduction to Accounting. Accounting and cost accounting. 8th revised and updated edition. Schäffer-Poeschel Verlag, Stuttgart 2010, ISBN 978-3-7910-2923-8 .
• Harald Wedell, Achim A. Dilling: Fundamentals of accounting. Bookkeeping and annual accounts. Cost and performance accounting. 13th revised edition. NWB-Verlag, Herne 2010, ISBN 978-3-482-54783-6 ( NWB study of business administration = NWB study ).

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