Expanded Accounting Equation: Definition, Formula, How It Works

Unlike other long-term assets such as machinery, buildings, and equipment, land is not depreciated. The process to calculate the loss on land value could be very cumbersome, speculative, and unreliable; therefore, the treatment in accounting is for land to not be depreciated over time. The expanded accounting equation goes hand in hand with the balance sheet; hence, it is why the fundamental accounting equation is also called features of goodwill the balance sheet equation. Any changes to the expanded accounting equation will result in the same change within the balance sheet. Therefore, always consult with accounting and tax professionals for assistance with your specific circumstances. Unearned revenue represents a customer’s advanced payment for a product or service that has yet to be provided by the company.

29: Expanded Accounting Equation

— X hires an employee to start producing products with its new equipment. The cash disbursement reduces assets and the payroll expense is recorded as a reduction of equity. This transaction decreases assets when the cash is distributed and increases assets when the new equipment is received. Notice that all of the equations’ assets and liabilities remain the same—only the ownership accounts are changed. For a bit of challenge, study the examples above and try to determine what specific items were affected under each element and why they increased or decreased. If you find it difficult, you may refer back to the explanation in the previous lesson.

Expanded Accounting Equation: Definition, Formula, How It Works

Accounts shows all the changes made to assets, liabilities, and equity—the three main categories in the accounting equation. Each of these categories, in turn, includes many individual accounts, all of which a company maintains in its general ledger. A business can now use this equation to analyze transactions in more detail. But first, it may help to examine the many accounts that can fall under each of the main categories of Assets, Liabilities, and Equity, in terms of their relationship to the expanded accounting equation. We can begin this discussion by looking at the chart of accounts. Since corporations, partnerships, and sole proprietorships are different types of entities, they have different types of owners.

Expanded Accounting Equation for a Sole Proprietorship

Stockholder’s equity refers to the owner’s (stockholders) investments in the business and earnings. These two components are contributed capital and retained earnings. Accounts payable recognizes that the company owes money and has not paid. Remember, when a customer purchases something “on account” it means the customer has asked to be billed and will pay at a later date. Insurance, for example, is usually purchased for more than one month at a time (six months typically). The company does not use all six months of the insurance at once, it uses it one month at a time.

By decomposing equity into component parts, analysts can get a better idea of how profits are being used—as dividends, reinvested into the company, or retained as cash. 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. As you can see from all of these examples, the expanded equation always balances just like the basic equation. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

1. This means that the expenses exceeded the revenues for the period, thus decreasing retained earnings.
2. 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 June.
3. The increases (credits) to common stock and revenues increase equity; whereas the increases (debits) to dividends and expenses decrease equity.
4. See the article “The contentious debit—seriously” on continuous debt for further discussion of this practice.

How to use the Expanded Accounting Equation

This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax’s permission. 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. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.

Essentially, anything a company owes and has yet to pay within a period is considered a liability, such as salaries, utilities, and taxes. The accounts are presented in the chart of accounts in the order in which they appear on the financial statements, beginning with the balance sheet accounts and then the income statement accounts. Additional numbers starting with six and continuing might be used in large merchandising and manufacturing companies. The information in the chart of accounts is the foundation top 10 alternatives to xero of a well-organized accounting system. Like the basic accounting equation, the expanded accounting equation shows the relationships among the accounting elements. In the expanded version, the “capital” portion is broken down into several components.

Net income reported on the income statement flows into the statement of retained earnings. If a business has net income (earnings) for the period, then this will increase its retained earnings for the period. This means that revenues exceeded expenses for the period, thus increasing retained earnings. If a business has net loss for the period, this decreases retained earnings for the period. This means that the expenses exceeded the revenues for the period, thus decreasing retained earnings. The increases (credits) to common stock and revenues increase equity; whereas the increases (debits) to dividends and expenses  decrease equity.