Opening balance equity is the offsetting entry used when entering account balances into the Quickbooks accounting software. This account is needed when there are prior account balances that are initially being set up in Quickbooks. It is used to provide an offset to the other accounts so that the books are always balanced.
Once the account entry process is completed for all accounts, compare the total opening balance equity to the sum of all beginning equity accounts listed in the prior account balances. If the balances match, then the initial entry of accounts was accurate. If not, then review the initial account balances entry to see if there was a data entry error.
This article will describe what opening balance equity is, why it exists, and how to close it out so that your balance sheets are presentable to banks, auditors, and even potential investors.
What Is Opening Balance Equity?
Opening balance equity is an account created by accounting software to offset opening balance transactions.
Opening Balance Equity accounts show up under the equity section of a balance sheet along with the other equity accounts like retained earnings.
It may not show up on the balance sheet if the balance is zero. This is a good thing because opening balance equity should be temporary by design.
Balance Sheet 101: Understand Opening Balance Equity Accounts
Here is just a quick recap on balance sheets to help you better understand opening balance equity.
A balance sheet is broken down into three parts: assets, liabilities, and equity.
The basic balance sheet equation is:
Assets = Liability + Equity
Transactions in balance sheet accounts must always cancel out at zero.
As a result, if you create a new asset account with a balance, you must usually offset it by the same amount on the other side of the equation.
Assume an asset account, such as a checking account, with a balance of $100 is added to accounting software. Another account must be affected by $100 in order for your balance sheet to be balanced.
In this case, it’s most probably the open balance equity account. To adjust the opening balance of the bank account, the balance of this account will now be temporarily set to $100.
Reasons for Opening Balance Equity
The software creates an opening balance equity account for several reasons, including:
- Creating a data file for new businesses with beginning balances
- Initial addition of bank and credit cards with account balances
- First entry into a new accounting software
- Adding a new item to chart of accounts such as new inventory
- New vendor or customer entry with value balances (for example, outstanding balances which results in an accounts receivable opening balance)
Common mistakes to Avoid
Opening balance equity should only be used for a short period of time. However, it is common to carry a balance for an extended period of time.
A common cause of a residual balance on your opening balance equity account is incorrect bank reconciliation adjustments, which result in an opening balance. When performing a bank reconciliation, make certain that the bank statement balances transaction accounts for uncleared bank checks and other factors.
If the amount of the journal accounting entry does not support the amount on your bank statement, and you close it out, the software will rearrange the opening balance equity account balance.
Bringing an Opening Balance Equity Account to Zero
Clear the balance in this account to make your balance sheet look more professional and clean.
You or your bookkeeper can close this account in a variety of ways by making journal entries.
The most common method is as follows:
- If your business is a corporation, change the balance equity to “Retained Earnings.”
- If your business is a sole proprietorship, change the balance equity to “Owner’s Equity.”
If it’s a positive balance, put a debit entry to the opening balance equity account and a credit to the owner’s equity account (or retained earnings account.)
If it’s a negative balance, put a credit entry to the opening balance equity account and a debit to the owner’s equity account (or retained earnings account.)
Keep in mind that closing the balance equity to retained earnings or to owner’s equity is essentially the same concept. These equity accounts are just labelled differently to represent the ownership or form of a business.
Managing Opening Balance Equity for Presentable Balance Sheets
Opening balance equity should only be used for a limited time. The presence of a balance on your opening balance equity account makes your balance sheet appear unprofessional.
It is best to transfer opening balance equity accounts to retained earnings or owner’s equity accounts.