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 stock. 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 dividends from the revenue
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:
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 accounting point of view because it provides a picture of the financial well-being of the organization. The accounting equation 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 equity, 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 flows 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 statement. 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 policies 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 organization.
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