A company’s balance sheet is a picture of the company’s financial standing at a given time. Many companies choose to produce a balance sheet at the end of the month as part of their monthly closing procedures. Others simply produce an annual balance sheet that shows the company’s standing at year's end. The balance sheet shows the company's assets and liabilities. It also shows owner’s equity, which represents the shareholders’ portion of the assets. When shareholders borrow money from the company, it shows as a loan on the balance sheet.
Where Do Shareholders' Loans Appear on the Balance Sheet?
When reporting shareholder loans on the balance sheet, most accountants will classify them as a notes payable. Notes payables appear in the assets section of the balance sheet because they represent money owed to the company, which is an asset. In some instances, shareholders' loans can be classified as dividends. In this instance, they would be a liability to the company and appear in the liabilities section because it is money owed by the company. If the company does not expect to be paid back for the loan, it is probably better off classifying the loan as a dividend.
Paying the Loan
When shareholders pay back the loan, the notes payable amount gets reduced, and, in contrast, the owner’s equity amount increases. Shareholder loans are not viewed favorably by banks or auditors, because of the risk of default and the appearance of equity manipulation. An alternative to a shareholder loan is a dividend payout or equity withdrawal. Auditors prefer this because it directly affects owner equity and does not increase company assets like a notes receivable entry will. However the company chooses to report the loan, care must be taken due to the tax implications of each scenario.
A notes payable entry for loans appearing on a balance sheet is a red flag to the IRS. Seeing loans on a balance sheet may prompt an audit to determine the credibility of the loans. The reason for the scrutiny is that some business owners take loans from the company to sidestep taking an actual paycheck and paying payroll tax liabilities. The IRS wants to make sure this is not happening, and it will audit to make sure the loan is documented as a loan with interest and payment terms. To avoid this, a company can choose to reclassify the loan as a dividend. If the company is a C corporation, the shareholder will only need to pay a flat 15 percent in taxes. The shareholder may have to pay a little more if the company is an S corporation.
Balance Sheet Facts
The balance sheet is a financial document that “balances” a company’s assets and liabilities. Typically the layout of the balance sheet is in two parts. The assets of a company, which include accounts receivable, inventories, cash, notes receivable and any prepaid expenses show at the top of the balance sheet with a total. Next, the liabilities are listed and totaled. Liabilities include bank loans, lines of credit, expenses, and payroll. The difference between assets minus liabilities is owner’s equity. Typically owners want this to be a positive number because it shows their share of the business. Assets must equal liabilities plus owner's equity for the financial report to balance.
- Medioimages/Photodisc/Photodisc/Getty Images