What Is a Deficit in Financial Accounting?
The word "deficit" is heard many times during the course of a day. It is used to describe all manner of situations that indicate a setback, a loss or a negative balance. The term is used so much that you probably think you understand exactly what it means and where its use originated from. The term deficit has a particular place within financial accounting systems and the corporate financial statement.
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Defining A Deficit
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A deficit is a debit balance, meaning a negative balance. The term deficit is used in corporate financial accounting systems and not usually in personal or small business accounting. A deficit is generally an accumulation of losses which are represented as a total amount in dollars. Deficits are found in corporate financial accounting as a debit balance within the retained earnings account.
Retained Earnings
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In corporate financial accounting, the retained earnings account is part of shareholders' equity, also referred to as owners' or stockholders' equity. When a deficit is noted, the account is no longer referred to as retained earnings but instead is referred to as a deficit. Retained earnings are cumulative and represent net income after taxes that the corporation has earned from inception less distributed dividends to stockholders, again from the inception of the business.
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The Opposite Of Deficit
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The opposite of a deficit is a surplus. A surplus is good news to stockholders. It is an indication of a healthy business. When there is a surplus, the business will need to decide what to do with the surplus, where to invest it to continue growing the business. With a deficit, stockholder's become concerned over how the deficit will be corrected. Often the stockholders will go without their dividends in order to correct the deficit.
Assets And Deficits
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Retained earnings are reported as part of the shareholders' equity (found as a line item in the corporations balance sheet) as a dollar amount. Rarely is retained earnings kept in cash. More often it is a combination of cash and assets. Stockholders are reinvesting their dividends (their earnings) back into the company, so retained earnings are usually invested in income-producing assets. Assets are also used to offset liabilities in order for the shareholders to continue to make a return on their investment.
Reporting A Deficit
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Financial accounting is about preparing financial statements for corporations, stockholders, banks, government agencies, employees and others who have a stake in the financial well-being of the business. Financial statements are a way of monitoring the health of a business. A deficit is not a welcome entry on a financial statement. All businesses selling and trading stock in the U.S. are required by the Securities and Exchange Commission to release to the public their financial statements. These statements are released every quarter and indicate the previous quarters earnings.
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