Share capital is money put in by owners and stays in equity. A loan is money borrowed from a lender and is a liability. Both increase the bank balance, so the difference lies in who supplied the money and what they are owed.
This distinction opens company accounting. It matters in every later statement, because it decides whether a payment is interest (an expense) or a dividend (a share of profit).
How do the two sources of finance differ?
When a company issues ordinary shares, the buyers become shareholders and own part of the company. The company has no duty to repay them. They receive a dividend only if the directors decide to pay one.
When a company borrows, the lender is owed repayment. The lender receives interest at an agreed rate, and the interest must be paid whether the year was good or bad.
| Feature | Ordinary share capital | Bank loan |
|---|---|---|
| Who supplies it | Owners (shareholders) | Lender |
| Where it sits | Equity | Liability |
| Return paid | Dividend, from profit | Interest, an expense |
| Repaid by the company | Not normally | Yes, by the agreed date |
| Effect on profit for the year | None until a dividend is declared | Interest reduces profit |
Worked example
Kenari Cycles Ltd is formed to open a bicycle workshop. It needs RM 60,000. It issues 40,000 ordinary shares at RM 1 each for cash, and it borrows RM 20,000 from a bank at 8% a year.
Step 1, record the share issue. Debit Bank RM 40,000. Credit Ordinary share capital RM 40,000. Owners have put in money.
Step 2, record the loan. Debit Bank RM 20,000. Credit Bank loan RM 20,000. A creditor has lent money.
Step 3, check the bank. 40,000 + 20,000 = RM 60,000 debited to Bank. This agrees with the RM 60,000 the company needed.
Step 4, find a full year’s interest. 8% of RM 20,000 = 20,000 × 8/100 = RM 1,600. This is an expense in the income statement, charged before the profit for the year is found.
Step 5, where each item sits at year end.
| Item | Section | Amount (RM) |
|---|---|---|
| Ordinary share capital | Equity | 40,000 |
| Bank loan (repayable in 5 years) | Non-current liability | 20,000 |
Total finance supplied: 40,000 + 20,000 = RM 60,000, with 2/3 from owners and 1/3 from the lender.
The mistake to watch for
A frequent slip is to add the loan to capital because “it is money the business was given”.
Mistaken equity: 40,000 + 20,000 = RM 60,000 share capital.
The student treated the loan as owners’ money. Equity is now overstated by RM 20,000 and the liability is missing.
The correction is to ask “will this person expect repayment, and are they an owner?” The bank expects repayment and is not an owner, so it is a liability. A second slip follows from the first: once the loan sits in equity, its RM 1,600 interest is easily treated as a dividend and left out of expenses, so profit is overstated too.
Check yourself
Try these, then open each answer.
1. Sunway Stationery Ltd issues 25,000 shares at RM 1 each, and it borrows RM 10,000 at 6% a year. How much does the company receive in total, and what is a full year’s interest?
Show answer
Total received: 25,000 + 10,000 = RM 35,000. Interest: 10,000 × 6/100 = RM 600.
2. Classify each as equity, liability, expense or appropriation of profit: (a) ordinary share capital, (b) loan interest, (c) a dividend, (d) a bank loan.
Show answer
(a) equity. (b) expense. (c) appropriation of profit, which means a share of profit paid to owners. (d) liability.
3. A student writes “Loan from a bank, RM 5,000” under equity. Which section should it be in, and why?
Show answer
It belongs under liabilities. The bank is a creditor who expects repayment, and it is not an owner of the company.
Where this leads next
Next, see how profits that stay in the company build up in interpret retained profit. When you want to test where each entry lands, the double-entry and ledger trainer lets you try the share issue and the loan step by step, and the percentage-base explorer helps with the interest rate.
When the sections of a company statement still look alike, our teachers can sort them with you. See online one-to-one Accounting tuition.