Farwah Jafri | December 14 2022
Accounting software are gaining popularity rapidly, especially among small and large enterprises. However, there are a lot of accounts that are unfamiliar to business owners; one such account is opening balance equity.
This account is not found in traditional bookkeeping, regardless of whether it’s done on paper or on any other platform like Excel.
Opening-balance equity is a special account specifically created by any accounting software to showcase the difference between the debit and credit balance of the general ledger.
Accounting software such as QuickBooks, Deskera, FreshBooks, Xero, etc., use the opening balance equity. This account helps in offsetting the opening-balance of the transactions. It is not necessary to display the opening balance account on the balance sheet if the balance is zero.
Let’s dig in to find out more about this specially curated account:
As mentioned above, this account is basically a difference between credit and debit balances. It can be created in different case scenarios, such as:
– When you make the first entry in their accounting software and connect it with your bank to import all the transactions into the software, that is when this account is created. It will have a balance equal to the amount available in the bank.
– There is a possibility that you use software but make the entries manually. For that, you need to add an opening-balance equity account to maintain the accounts equally.
– This account is also created whenever a new vendor or a customer is added to the records. For instance, you can add an account receivable, opening a balance equity account for an outstanding balance.
– New data files addition to the record of the business, also requires this account opening.
Let’s have a recall of a balance sheet to understand the opening balance equity account better.
A balance sheet comprises three main categories; assets, liabilities, and equity.
The account transactions in a balance sheet must always cancel out at zero. In simple words, if a new post is added on the asset side of the balance sheet, the same amount usually goes on the other side of the equation.
For instance: If a $100 balance is added on the asset side of the balance sheet, then another account will also be affected by this $100 transaction, and for that, the balance sheet must be balanced.
To balance out the sheet, an open balance equity account is opened. It will be a temporary account showing the $100 balance to match the opening balance of the bank account.
Opening a balance equity account is supposed to be a temporary account. However, it is very common that the balance of this account is carried forward for a reasonable time period.
If the balance remains lingering in the opening balance equity account, then it should be ensured that there are no mistakes while carrying it forward.
There are a lot of errors that can occur when you are compiling a final statement with an opening balance equity account.
Some of the most common errors are:
– Transaction gets mislabeled in the opening balance equity account.
– Forgot to illuminate the opening balance equity account when the need was over.
– An opening balance that is incorrect if the bank reconciliation adjustments are not made properly.
To make your balance sheet appear cleaner and more professional, you need to clear the balance in this account and bring it to zero.
You can make journal entries to close the opening-balance equity account in various ways.
Some of the most common methods are:
– Close the account to “Retained Earnings”. This journal entry is usually added when the company is a corporation.
– Close the balance equity to “Owner’s Equity” if the company is a sole-proprietorship organization.
If the balance is positive, then a debit entry is made in the opening-balance equity account and a credit entry on the owner’s equity account or in the corporation scenario in the retained earnings account, and vice versa situation if there is a negative balance.
It is extremely important for a business to maintain its financial records to showcase the company’s real state. An opening balance equity account is created to ensure that the balance sheet is transparent and shows no ambiguity.
Opening balance equity helps offset the opening balance transactions, providing the correct start for a balance sheet and the financial records in the long run.
See Also: Profitability Models – How They Help In Forecasting The Future
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.