Expanded Accounting Equation

26.09.2022
Ivana

Among the accounting methods, double-entry accounting is possibly the most popular, used in almost every organization nowadays. This method relies on duality, meaning that every transaction must be expressed in debit and credit. This concept is closely related to the expanded and basic accounting equation. The double-entry accounting system is used to keep the expanded accounting equation in balance. This guide will help you understand the concept in theory and teach you how to apply it in practice.

Basic Accounting Equation vs. Expanded Accounting Equation

Let’s start with the basics. The basic accounting equation is the main element of double-entry accounting, also known as the “fundamental accounting equation” or the “balance sheet equation.” The basic accounting equation states that a company’s assets equal the sum of liabilities and shareholder’s equity. Automated accounting systems are typically designed for double-entry accounting. This method is used to calculate the company’s worth based on its investments and the cost of obligations. 

  • Sole proprietorship: Assets = Liabilities + Owner’s Equity
  • Corporation: Assets = Liabilities + Stockholder’s Equity

The long accounting equation, on the other hand, is a form of the basic accounting equation that recognizes more components of the stakeholder’s equity in an organization. By dividing the owner’s equity into different parts such as dividends, revenue, shareholder capital, and expenses, the expanded equation provides a detailed view of how a company uses its profits — whether as dividends, retained as cash, or reinvested into the company. These operations can be found in accounting programs, meaning that accountants don’t have to do them manually anymore. 

The formula for the expanded basic accounting equation is as follows:

  • Sole proprietorship: Assets = Liabilities + Owner’s Capital – Owner’s Draws + Revenues – Expenses
  • Corporation: Assets = Liabilities + CC + BRE + R − E

Understanding the Expanded Accounting Equation Formula

Let’s take a closer look at the elements of both formulas and what they mean:

The basic accounting equation formula is:​

  • Assets = Liabilities + Stockholder’s Equity

Explanation of terms: 

  • Assets are the company’s resources that have a future benefit. They are calculated by combining all current assets with all non-current assets. Inventory accounting deals with assets. 
  • Liabilities represent all company’s current and long-term obligations and debts.
  • Owner’s or stockholder’s equity is the owner’s or shareholder’s available assets after all liabilities are cleared.

The formula is:

  • Assets=Liabilities+CC+BRE+R−E−D.

Explanation of terms:

  • CC (Contributed capital, also known as paid-in capital, is the capital provided by a company’s original stockholders).
  • BRE (Beginning retained earnings are earnings that have not been transferred to stockholders from the previous period). 
  • R (Revenue is the amount generated from the company’s operations within a period or until the closing month of the accounting year)
  • E (Expenses that occur from the company’s operations that need to be covered so everything can run as normal)
  • D (Dividends are a company’s earnings that are distributed to the stockholders based on how many stocks in the company they own). 

Notes: 

  • The terminology used to describe the components of the expanded accounting equation formula may vary depending on the entity type. In sole proprietorships and partnerships, “owners’ capital” is used instead of “contributed or paid-in-capital.” “Dividends” are typically replaced with “distributions or withdrawals.
  • Expenses and dividends might be negative if applicable.

Rearranging the Expanded Accounting Equation Formula

In some instances, especially when looking at bankruptcy, the formula of the full accounting equation can be rearranged so shareholders can easily see how they will be compensated. The formula can be rearranged in the following ways:

  • Assets – Liabilities = Shareholder’s Equity
  • Assets – Liabilities = Share Capital + Retained Earnings
  • Assets – Liabilities = CC + BRE + R + E + D

In case of bankruptcy, the short and long-term debts, which are part of liabilities, are first in line for payment. The remaining liquidated assets will then be used to compensate parts of stockholders’ equity until no funds are left. 

The formula can be rearranged in any way that benefits its user the most. That said, the formula must always be balanced regardless of the order used. When you go by the golden rules of accounting, a balanced accounting equation is inevitable. 

Use of Expanded Accounting Equation

All users of accounting information can benefit from the long accounting equation as it offers greater visibility of the various elements of stockholder equity. It’s the same as the basic accounting equation, except that it divides equity into different components. 

By using the expanded accounting equation, accounting analysts can see:

  • The impact net income plus revenues, decreased by expenses, has on equity
  • The effect of transactions with owners (dividends, draws, purchasing, or selling of ownership)

The expanded accounting equation separates the economic events that caused an increase or decrease in the owner’s equity, allowing analysts to understand the company’s equity composition better. The effect of net income on stockholders’ equity is reflected in the difference in revenue and profit and expenses and losses. The contributed capital and dividends, on the other hand, show the effect of transactions with the stockholders. The equation showcases how a company’s stockholders’ equity changes over time or throughout the accounting cycle.

Expanded Accounting Equation Examples

Double-entry accounting is currently the most widely used accounting concept. This concept supports the expanded accounting equation. It involves recording transactions by debiting one or more accounts and simultaneously crediting one or more accounts. All transactions must include a corresponding and opposite record in two or more accounts. Here are some expanded accounting equation examples that show the equation is always in balance no matter how the formula is used. 

Example 1: A company purchases new printers that cost $3,000 and pays $1,500 in cash upfront, while the rest is paid on account. 

Dr: printers (asset) $3,000

Cr: cash (asset) $1,500

Cr: A/P (liability) $1,500

The formula for this example would be: 

$3,000 – $1,500 = $1500 + CC + BRE + R + E + D

Example 2: The company has paid $3,000 of retained earnings in dividends to stockholders.

Dr. Retained earnings of $3,000

Cr. Dividends $3,000

The formula for this example would be: 

Assets = Liabilities + CC + $3,000 + R + E + (–) $3,000

Example 3: The company has paid one of its suppliers $1,000 on the account. 

Dr. Supplies expense $1,000

Cr. Accounts payable $1,000

The formula for this example would be: 

Assets = $1,000 + CC + BRE + R + E + (–) $1,000 + D

Note: Dr. and Cr. are accounting abbreviations for debit and credit. 

Expanded Accounting Equation FAQs

What is the expanded accounting equation? 

The expanded accounting equation is defined as a form of the basic accounting equation that divides the stakeholder’s or owners’ equity into more components, including contributed capital, revenue, and dividends. It provides a more detailed view of the company’s worth and how it uses its profits.

What is the expanded accounting equation formula? 

The formula is as follows: Assets=Liabilities+Contributed capital+Beginning retained earnings+Revenue−Expenses−Dividends. 

Which financial statement uses the expanded accounting equation?

The balance sheet is the financial statement that uses the expanded accounting equation, also known as the balance sheet equation. 

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