How to account for “sweat equity”: all the voluntary unpaid work that is often required in the first years of a new business.
Notes on Sweat Equity
By Peter Hough
What is sweat equity?
Sweat equity is generally considered all the voluntary unpaid work that is often required in the first years of a new business. This work is usually unpaid because the new business cannot afford to pay wages or salaries during start-up. The commitment by members to provide sweat equity is often essential for the success of the business.
Several issues are often raised around sweat equity: How does one ensure a fair or equal contribution between members and how can the sweat equity be recognized within the accounting system?
It may be desirable to show the sweat equity within the accounting system for then the investment of work by the members is recognized on the Balance Sheet. This increase in the members’ shares makes it clear to outside lenders or investors how much the members have contributed to the business. Another result in accounting for the sweat equity is that the co-ops expenses are increased. This reduces the co-op’s net income or increases its net losses, as may be the case. In either way, the current or future tax liabilities levied upon the co-operative’s profits are reduced.
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