For equity, as we know it in a trade balance, there are a whole series of definitions as well as special provisions for accounting. For example, equity can be defined as the difference between assets and debts. In fact, this is exactly how equity is measured. On the other hand, equity also expresses the capital used to set up. Depending on the type of company, you even use your own names for equity capital. However, equity can also change by acquiring own shares. The sale of previously acquired own shares also leads to changes in the balance sheet. In addition, in terms of equity, outstanding deposits also play a role in accounting. For all these special features, there are separate regulations in the Commercial Code.

1. Equity in the Trade Balance – Introduction

If you set up a company that you can either assume will be subject to accounting or voluntarily opt for accounting, then you have to show the capital used to set up in the trade balance. With this equity capital you can then drive the economic development of the company. But what exactly is behind the term equity?

In this article we want to explain the most important aspects of the term equity. Granted, this term is widely known and of great importance when it comes to analyzing a company. However, there are also some lesser-known aspects that we would also like to point out.

2. Definition and breakdown of equity

2.1 Definition of equity

There are many definitions for the term equity. Depending on the focus, these can appear different at first glance, but you can still recognize very similar aspects as uniform features. For example, one definition is that equity is the means (own funds) that the owners and entrepreneurs invest in setting up the company. Another definition is that equity is simply the difference between a company’s assets and liabilities. In other words, this is the net worth.

2.2 Breakdown of equity in the trade balance

No matter what definition you want to follow, in the trade balance sheet the equity is subject to a statutory structure (§ 266 paragraph 3 HGB). In this case, equity capital is composed of subscribed capital, capital reserve, retained earnings and a statutory reserve. Furthermore, the equity comprises a reserve for shares in a controlling or majority-owned company. In addition, there are statutory reserves, other retained earnings, the profit carried forward or a loss carried forward and the annual profit or loss.

2.3.

The commercial law requires that a balance sheet should provide information about the assets and liabilities of a company. This requirement also incorporates the requirement of completeness, which states that assets and liabilities must be declared in full on the balance sheet (§ 246 (1) sentence 1 HGB). There is also talk of an offsetting ban. This means that assets and liabilities, including debt, must remain strictly separate; Settlement with each other is excluded.

So how does all this affect equity? First of all, we must add that equity is indeed part of all trade balances. This may have long been known to most readers as a fact and also make sense. But this emerges from a different legal norm than the one previously cited in this context. Only through the inclusion of equity capital in § 247 (1) HGB can one find a legal basis that recognizes equity capital as part of the balance sheet. After all, a balance sheet could be drawn up purely hypothetically without showing the equity capital. However, the balance sheet totals of the assets and liabilities would then be different (the balance sheet totals of the assets would usually be higher than those of the liabilities, otherwise there would be insolvency).

3. The 3 Types of Equity Designation

In the case of equity, which initially serves to set up a company, you have to differentiate more precisely. Depending on the type of company in which an accounting company operates, different terms are known. In the case of limited liability companies, this shall be referred to in the balance sheet as subscribed capital. This therefore includes either share capital or share capital. In the case of partnerships, on the other hand, one speaks of capital shares.

3.1 Share capital of a GmbH as equity

The equity capital of a GmbH or UG (limited liability) invested in the establishment is called share capital. At the GmbH, it amounts to at least EUR 25,000, of which the shareholders must deposit at least EUR 12,500 into the GmbH to be founded. In principle, factual foundations are also permitted here. However, the value of such a substance must be demonstrated.

At UG (limited liability) the minimum share capital is EUR 1. Substantive foundations are excluded here. Another peculiarity of UG’s equity (limited liability) is that the company has to put a share of 25 % of its annual profits into the formation of a reserve every year. This applies until the reserve together with the original share capital of UG (haftungsbeschränkt) corresponds to the minimum share capital of a GmbH of EUR 25,000. If this occurs, this releases the shareholders from the obligation to form this reserve and allows them to dispose of the annual profit freely from now on. In addition, the company can henceforth call itself a GmbH.

3.2 Share capital of a public limited company as equity

The share capital used to form a public limited company constitutes the equity of the AG in the founding balance sheet. It amounts to at least EUR 50,000 and is distributed among the shareholders who hold shares in the AG.

3.3 Capital shares of a partnership as equity

In principle, partnerships are governed by the same rules as corporations. However, this is based on a special legal norm, namely § 264a HGB. Another legal standard, § 264c HGB, then regulates special features regarding the equity capital of partnerships. Thus, the equity capital there is called capital shares. A distinction is made between the capital shares of personally liable partners and that of limited partners. Special rules continue to govern how to deal with losses in relation to equity on the balance sheet. If necessary, the share of the shareholders’ capital must be adjusted accordingly. If there is a shortfall, it must appear as a claim to cover the capital injection on the asset side of the balance sheet.

4. What are the special features of equity?

There are three outstanding peculiarities to which equity is subject. This involves accounting for outstanding deposits and the acquisition and sale of own shares.

4.1. Accounting for outstanding deposits in equity

Although shareholders of a limited liability company have to make contributions to the equity capital in exchange for shares, the contribution may be less than the amount of the shares taken over fixed in accordance with the articles of association. It is solely in the power of the shareholders’ meeting to determine whether and when a shareholder has to make his outstanding contribution. Nevertheless, this consequently has an impact on the meaningfulness of the company’s balance sheet. So the legislature, certainly also with regard to the protection of creditors, has created corresponding regulations in the HGB, which require the identification of outstanding deposits in the balance sheet. It is also logical that outstanding deposits are part of the equity. However, they must appear separately from the subscribed capital as an uncalled outstanding deposit on the balance sheet. However, if the general meeting of shareholders requests an outstanding contribution, this must be recorded as a claim on the asset side of the balance sheet until the contribution has been made. All these provisions regarding outstanding deposits can be found in § 272 paragraph 1 HGB.

4.2. Accounting for the acquisition of own shares

Basically, a GmbH is allowed to acquire its own shares. However, this also has an impact on their balance sheet, more precisely on their equity. Therefore, the legislature has introduced special regulations for this. These can be found in § 272 paragraph 1a HGB. Here is the legal provision that one has to openly deduct acquired own shares with their nominal amount from the subscribed capital. Furthermore, the difference between the nominal amount and the acquisition costs must be offset against the freely available provisions. Ancillary costs must be treated separately. They are considered to be under-year expenses.

4.3. Accounting for the sale of own shares

Just as for the acquisition of own shares, there are special rules that accompany the sale of previously acquired own shares. They are contained in § 272 paragraph 1b HGB. This includes instructions on how to deal with the difference between the nominal amount and the realised proceeds of the sale. If one has made an offset against the freely available provisions when acquiring one’s own shares (see 4.2.), then one has to reverse them as far as possible when selling them. If there is still an overhang left, because an amount exceeding the acquisition cost was achieved on the sale, this overhang flows into the capital reserves. Ancillary costs in connection with the sale are, analogous to the acquisition costs, under-year expenses.

5. Special features of equity in the trade balance – Conclusion

As you can see, the legislator has also paid attention to many partial aspects in terms of equity when designing the balance sheet. In fact, this requires special arrangements. Some have only been introduced subsequently. For example, the provisions relating to the accounting for own shares were first implemented in 2016. This shows that even such a fundamental set of laws as the HGB is subject to constant adjustments. So you always have to pay attention to innovation and changes.