Expanded Accounting Equation - Explained
What is the Expanded Accounting Equation?
Written by J. Mance Gordon
Updated at April 18th, 2024
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What is the Accounting Equation?
The basic accounting equation is written as:
Assets = Liabilities + Owners Equity
What is the Expanded Accounting Equation?
The expanded accounting equation is written as:
Assets = Liabilities + Contributed Capital + Beginning Retained Earnings + Revenue - Expenses - Dividends.
Different Between Accounting Equation and Expanded Accounting Equation
Looking at the two equations above, it can be observed that the owner's equity section in the basic equation has been split into contributed capital, beginning retained earnings, revenue, expenses and dividends.
The section of the basic equation which contains both the assets and liabilities remains unchanged in the expanded equation.
Why Use the Expanded Accounting Equation?
The expanded accounting equation shows the various units of stockholder equity in greater detail.
Economic analysts can get a clearer idea of how to use profits for various things like dividends which are reinvested into the firm or kept as cash by breaking down equity into smaller parts.
The expanded accounting equation allows analysts to see individually:
- the effect net income (increased by revenues, decreased by expenses) has on equity.
- the effect of transactions with owners (draws, dividends, sale or purchase of ownership interest).
Example of the Expanded Accounting Equation
Taking an example of a corporation X to see how its business transactions affect its expanded equation.
- X's assets and common stock increases when it receives cash from its new shareholders and grants them equity after it was formed at the beginning of the year. It issued 1,000 $10 par value stocks.
- X purchases new equipment worth $2,000 which decreases its assets and increases its assets.
- X employs someone to operate its new equipment and start production. Two weeks later, the worker is given a check. This reduces assets.
- X ends up with large profits and issues a $10,000 dividend to its shareholders. This reduces assets.
It can be observed that the expanded equation always balances.