An Alternative Approach to Distinguishing Liabilities from Equity
43 Pages Posted: 18 Dec 2017 Last revised: 28 Sep 2019
Date Written: September 17, 2019
In response to a longstanding debate within the accounting profession on how to clearly distinguish liabilities from equity, we offer an alternative liability-equity classification scheme in which capital acquired in exchange for issuing claims (“external capital”) is classified as liabilities and capital acquired in exchange for providing goods and services (“earned capital”) is classified as equity. This alternative approach to distinguishing liabilities from equity differs from the existing approach because in that it is based on a fundamental distinction between the firm and its claimants rather than a distinction between groups of these claimants (e.g., owners versus creditors). In this paper, we discuss the motivation for our alternative approach to distinguishing liabilities from equity, its conceptual underpinnings, and its financial reporting implications.
Keywords: Liabilities Versus Equity, Financial Reporting, Capital Structure
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