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Expanded Accounting Equation Explanation and Examples

Rearrangement in such a way can be useful when looking at bankruptcy. The equation layout can help shareholders to see more easily how they will be compensated. For another example, consider the balance sheet for Apple, Inc., as published in the company’s quarterly report on July 28, 2021.

  • The balance sheet is the financial statement that uses the expanded accounting equation, also known as the balance sheet equation.
  • Machinery is usually specific to a manufacturing company
    that has a factory producing goods.
  • When a company first starts the analysis process, it will make a list of all the accounts used in day-to-day transactions.
  • If you find it difficult, you may refer back to the explanation in the previous lesson.
  • The expanded accounting equation breaks down the equity portion of the accounting equation into more detail.

The expanded accounting equation makes it easier to see how shareholders’ equity in a company changes between periods. The expanded accounting equation is a more detailed version of the common accounting equation. It provides greater detail on the different sections of shareholders’ equity, allowing companies to see how their profits are used. A notes payable is similar to accounts payable in that the company owes money and has not yet paid.

Reviewing and Analyzing Transactions

See the article “The
contentious debit—seriously” on continuous debt for further
discussion of this practice. Examples of supplies (office supplies) include pens, paper, and
pencils. At the point they are used, they no longer have an economic
value to the organization, and their cost is now an expense to the
business. The equation quantifies how a company utilizes its profits, whether reinvesting in the business, increasing its retained earnings, or paying dividends. The various economic events that alter shareholders’ equity represent the profits and losses that appear in the shareholders’ equity section of the balance sheet. The Financial Accounting Standards Board had a policy that allowed companies to reduce their tax liability from share-based compensation deductions.

  • Each company will make a list that works for its business type, and the transactions it expects to engage in.
  • The cost of this sale will be the cost of the 10 units of inventory sold which is $250 (10 units x $25).
  • The income statement would see an increase to revenues, changing net income (loss).
  • The fundamental accounting equation is debatably the foundation of all accounting, specifically the double-entry accounting system and the balance sheet.

When dividends are issued, cash is disbursed to shareholders reducing assets while the dividends reduce equity. This transaction decreases assets when the cash is distributed and increases assets when the new equipment is received. Let’s take a look at a few example business transactions for a corporation to see how they affect its expanded equation. For example, a company uses $400 worth of utilities in May but
is not billed for the usage, or asked to pay for the usage, until

What is the expanded accounting equation?

If the answer is yes, the company will then analyze the information for how it affects the financial statements. For example, if a company receives a cash payment from a customer, the company needs to know how to record the cash payment in a meaningful way to keep its financial statements up to date. The accounting equation, whether in its basic form or its expanded version, shows the relationship between the left side (assets) and the right side (liabilities plus capital).

Exercises 3: Paying expenses with cash

Some equity comes from investments into the business by the owner. And then, reductions to Equity come from withdrawals and expenses. Therefore cash (asset) will reduce by $60 to pay the interest (expense) of $60. $10,000 of cash (asset) will be received from the bank but the business must also record an equal amount representing the fact that the loan (liability) will eventually need to be repaid. The cash (asset) of the business will increase by $5,000 as will the amount representing the investment from Anushka as the owner of the business (capital).

2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions

Net income (loss) is computed into retained earnings on the statement of retained earnings. This change to retained earnings is shown on the balance sheet under stockholder’s equity. In a corporation, capital represents the stockholders’ equity.

Changes to assets, specifically cash, will increase assets on the balance sheet and increase cash on the statement of cash flows. Changes to stockholder’s equity, specifically common stock, will increase stockholder’s equity on the balance sheet. When a company first starts the analysis process, it will make a list of all the accounts used in day-to-day transactions. For example, a company may have accounts such as cash, accounts receivable, supplies, accounts payable, unearned revenues, common stock, dividends, revenues, and expenses. Each company will make a list that works for its business type, and the transactions it expects to engage in.

Expanding the accounting equation

The owner’s investments in the business typically come in the form of common stock and are called contributed capital. There is a hybrid owner’s investment labeled as preferred stock that is a combination of debt and equity (a concept covered in more advanced accounting courses). The company will issue shares of common stock to represent stockholder ownership. You will learn more about common stock in Corporation Accounting. The expanded accounting equation breaks down shareholder’s equity (otherwise known as owners’ equity) into more depth than the fundamental accounting equation.