State BPA Fundamental Accounting Practice Exam

What type of account is Capital considered?

1. Asset

2. Equity

3. Revenue

4. Liability

The correct answer is: Equity

Capital is classified as an equity account because it represents the owner's residual interest in the assets of the business after deducting liabilities. In accounting, equity encompasses the investments made by the owners, as well as retained earnings, which are the profits that have been reinvested in the business rather than distributed as dividends. When a business is established or when additional investments are made, the capital contributed by the owners increases the equity of the company. This equity serves as a financial cushion for creditors since it is what remains for the owners after all debts are settled. Thus, capital reflects the ownership stake in the business, making it a fundamental component of the equity section on the balance sheet. While assets, revenues, and liabilities each play important roles in financial accounting, they do not define the concept of equity in the same way that capital does. Assets represent resources owned by the business, revenues reflect income generated from operations, and liabilities denote what the business owes to others. Each serves distinct functions in the financial framework, but capital specifically pertains to the ownership equity within that framework.