What is Expanded Accounting Equation?
Expanded Accounting Equation refers to the expanded version of basic accounting equation for the particular corporation / sole proprietor, giving detailed information pertaining to financial transactions of the corporation such as assets, liabilities, share capital, income, expenses, and withdrawals.
The Expanded Accounting equation is generally different for varying forms of businesses. The equation differs slightly in case of a proprietary concern, partnership firm, and corporation.
For a proprietary concern, the equation will be:
Assets = Owner’s Capital – Drawings + Liabilities + Income – Expenses
For a partnership firm, the equation will be:
Assets = Partner’s Capital – Distributions + Liabilities + Income – Expenses
For a corporation, the equation will be:
Assets = Stockholder Equity + Retained Earnings
Expanded Accounting Equation = Paid-up Capital – Treasury Stock (if any) + Liabilities + Income – Expenses – Dividends
- Stockholders Equity is the sum of the Paid-up capital of the organization reduced by Treasury stockTreasury StockTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. read more. Treasury stock means the amount of equity stock in which the organization had earlier issues but repurchased/reacquired subsequently.
- Retained Earnings are arrived at by reducing the expenses and dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more from the revenue.
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For eg:
Source: Expanded Accounting Equation (wallstreetmojo.com)
Example of Expanded Accounting Equation
Let us take the example of Foods & Drugs Inc. The Company was incorporated on 1 June 2019 with a paid-up capital consisting of 1000 shares having a value of $50. During the first quarter of its operations, the company has entered into the following transactions:
| Date | Transaction |
|---|---|
| 1-Jun | Capital introduced – $ 50,000 |
| 6-Jun | Paid $10,000 for purchase of furniture and computers. |
| 15-Jun | Paid $ 5,000 towards purchase of machinery and equipment. Paid $ 1,000 towards purchase of raw materials |
| 22-Jun | Incurred expenditure towards advertising and marketing amounting to $200 |
| 30-Jun | Paid salaries to its employees – $13,000 |
| 30-Jun | Paid Rent and telephone bills – $15,000 |
| 13-Jul | Earned revenue through sale of products worth $ $ 35,000 |
| 18-Jul | Made payments towards petty cash and bills for $ 1,500 |
| 31-Jul | Paid salaries to its employees – $13,000 |
| 31-Jul | Paid Rent and telephone bills – $13,500 |
| 05-Aug | Received $28,000 as an advance from suppliers for future orders |
| 26-Aug | Purchased raw materials costing $5,000 on credit |
| 31-Aug | Paid salaries to its employees – $13,000 |
| 31-Aug | Paid Rent and telephone bills – $17,000 |
| 31-Aug | Paid $1,000 as dividend |
| 31-Aug | Miscellaneous expenses paid $3,000 |
Solution
Below table provides the segregation of the aforementioned details under specific heads:
- Assets = Paid-up Capital – Treasury Stock (if any) + Liabilities + Income – Expenses – Dividends
- Assets = 50000 – 0 + 0 + 63000 – (-110200) – (-1000)
- = 1800
Relevance and Use
It is an important concept from the accountingConcept From The AccountingAccounting concepts are the principles, assumptions, and conditions that govern accounting's foundation. They ensure that the accounting is done in a way that the financial statements present a true and fair view.read more point of view because it provides a picture of the financial well-being of the organization. The accounting equationAccounting EquationAccounting Equation is the primary accounting principle stating that a business's total assets are equivalent to the sum of its liabilities & owner’s capital. This is also known as the Balance Sheet Equation & it forms the basis of the double-entry accounting system. read more not only includes information from the balance sheet but also provides information about the income-expenditure statement.
As seen in the example above, the net result of the expanded accounting equation is such that the assets of the corporation are equal to the net impact of stockholder equityStockholder EquityA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares.read more, liabilities and net earnings. A balanced equation also ensures the fact that the whole accounting process has been followed properly. It further helps strengthen the fact that all the debit and credit entries pertaining to all transactions entered during the period have been taken into consideration.
It basically shows the effect of each and every transaction taking place and how it affects the liabilities that the corporation may have. Further, it also elaborates on the detailed aspects of any increase in cash flows on account of revenue earned or any decrease in cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more on account of expenses incurred for running the operations.
The equation is used by organizations to understand a holistic and descriptive picture of the financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. It can be used for deep diving into the financial transactions of the organization thereby also in the detailed analysis of the financial statements.
Professionals use it to understand the effectiveness of the accounting policiesAccounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level.read more followed by the organization.
Conclusion
Expanded accounting equation not only provides a detailed view of the financial statements, but it also shows how effectively the accounting policies are in place. Further, from a professional point of view, it provides a glimpse of the financial well-being and net worth of the organizationNet Worth Of The OrganizationThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus.read more.
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