What is the Expanded Accounting Equation?
How do you calculate it?
What are the essential elements you should know!
In this article, I will break down the notion of Expanded Accounting Equation so you know all there is to know about it!
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Let me explain to you what the expanded accounting equation is and why it’s important!
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Table of Contents
What Is The Expanded Accounting Equation
The expanded accounting equation is formulated as assets are equal to liabilities, plus contributed capital, plus beginning retained earnings, plus revenues, minus expenses, and minus dividends.
The fundamental accounting equation (or basic accounting equation) can be written as:
Assets = Liabilities + Owners’ Equity
By taking the basic accounting equation and dividing the Owners’ Equity into Revenues, expenses, contributed capital, dividends, and retained earnings at the beginning of the period, we can get an expanded version of the accounting equation.
The main objective in calculating the expanded accounting equation is to get a better understanding of a company’s stockholders’ equity.
The accounting expanded equation splits the shareholders’ equity into five parts:
- Contributed capital
- Beginning retained earnings
Contributed capital and dividends show how much money has been injected by shareholders into the business and how much the business has paid out to shareholders.
Revenue and expenses (or net income) provide the impact of the company’s operating revenue and expenses on the stockholder equity.
The beginning retained earnings is a measure of the stockholders’ equity at the beginning of the calculation period so the impact of contributed capital, dividends, revenue, and expenses can be measured.
Expanded Accounting Equation Formula
The expanded accounting formula can be written as follows:
Assets = L + CC + BRE + REV – EXP – DIV
- L = Liabilities
- CC = Contributed Capital
- BRE = Beginning Retained Earnings
- REV = Revenue
- EXP = Expenses
- DIV = Dividends
Contributed capital, also known as the paid-in capital, refers to the capital provided by the shareholder to the company.
Beginning retained earnings refers to the earnings that have been kept by the company at the beginning of the accounting period compared to the previous period.
Revenue refers to the amount of money the company generated in operating its business.
Expenses refer to the costs and expenses the company incurred to generate its revenues.
Dividends refer to the amount of money paid out by the company to its shareholders.
You can alternatively write the expanded accounting equation as follows:
Assets – Liabilities = Share Capital + Retained Earnings
The expanded accounting equation in a partnership can be written as:
Assets = Liabilities + Owner’s Capital Contribution – Owner’s Capital Withdrawals + Revenues – Expenses
Expanded Accounting Equation vs Basic Accounting Equation
Essentially, the expanded accounting equation is derived from the basic accounting equation.
The basic account equation is written as Assets = Liabilities + Owner’s Equity.
The expanded accounting equation takes the basic accounting equation and expands the Owner’s Equity element into its various components, namely:
- Contributed capital
- Beginning retained earnings
This division of the owners’ equity allows financial analysts and investors get a basic understanding of how the company transacted with its owners (contributed capital and dividends) along with the impact of its net income (revenue and expenses) on the stockholders’ equity on the balance sheet.
Expanded Accounting Equation Example
Let’s look at an example of the “expanded” accounting equation so we can better understand the concept.
Imagine that a company has the following financial variables:
- Assets = $10,000,000
- Liabilities = $6,000,000
- Owners’ Equity = $4,000,000
- The company issues 100,000 shares for $20 per share getting $2,000,000
- The company pays $500,000 in dividends
- Has revenues of $15,000,000
- Has expenses of $13,000,000
- Has a beginning retained earnings of $500,000
Now, if we plug in these figures into the expanded accounting equation formula, we’ll get the following:
Assets = Liabilities + Contributed Capital – Dividends + Revenues – Expenses + Beginning Retained Earnings
$10,000,000 = $6,000,000 + $2,000,000 – $500,000 + $15,000,000 – $13,000,000 + $500,000
As you can see with this example, the basic accounting equation remains balanced although we’ve split the stockholders’ equity into its components.
The Expanded Accounting Equation Takeaways
So there you have it folks!
What does the expanded accounting equation mean?
The expanded accounting equation is defined as assets being equal to liabilities plus the contributed capital, retained earnings at the beginning of the period, revenues, and less expenses and dividends.
Using the expanded accounting equation, you can drill into the specific components of the stockholders’ equity by assessing elements such as retained earnings, dividends, and net income (transactions related to the stockholders and the company’s net income).
The accounting equation expanded allows analysts and investors better understand how the company makes use of its profits and stockholders’ equity (to reinvest in the business, increase retained earnings, or pay dividends).
I hope I was able to explain to you what the expanded accounting equation means, give you good examples, show you how it is calculated, and why it’s important.
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Overview of The Expanded Accounting Equation Meaning
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