An Alternative Approach to Distinguishing Liabilities from Equity

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 (the “Earned Capital Approach”) in which capital acquired in exchange for issuing claims (“external capital”) is...

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Bibliographic Details
Published in:Accounting horizons 2021-03, Vol.35 (1), p.65-85
Main Authors: Hill, Mary S., Price, Richard A., Ruch, George W.
Format: Article
Language:English
Subjects:
Accounting
Alternative approaches
Capital
Claimants
Classification
Creditors
Equity
Financial reporting
Liabilities
Owners
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Summary: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 (the “Earned Capital Approach”) 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. The Earned Capital Approach differs from the approach underlying current financial reporting standards in that it is based on a fundamental distinction between the firm and its claimants rather than a distinction between types of claimants (e.g., owners versus creditors). In this paper, we summarize the accounting profession's ongoing attempts to distinguish liabilities from equity and discuss the conceptual underpinnings and financial reporting implications of the Earned Capital Approach.
ISSN:0888-7993
1558-7975
DOI:10.2308/HORIZONS-19-171