Expanded Accounting Equation: Definition, Formula, How It Works

expanded equation

Machinery and buildings are often called PPE – Property Plant and Equipment. 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.

It is used in Double-Entry Accounting to record transactions for either a sole proprietorship or for a company with stockholders. Although the accounting equation appears to be only a balance sheet equation, the financial statements are interrelated. Net income from the income statement is included in the Equity account called retained earnings on the balance sheet. The expanded accounting equation is a form of the basic accounting equation that includes the distinct components of owner’s equity, such as dividends, shareholder capital, revenue, and expenses.

Real-World Examples of the Expanded Accounting Equation

Equipment examples include desks, chairs, and computers; anything that has a long-term value to the business that is used in the office. Equipment is considered a long-term asset, meaning you can use it for more than one accounting period (a year for example). Equipment will lose value over time, in a process called depreciation. You will learn more about this topic in Chapter 3, and Accounting, Business and Society. We begin with the left side of the equation, the assets, and work toward the right side of the equation to liabilities and equity.

  • Machinery and buildings are often called PPE – Property Plant and Equipment.
  • Notes receivable is similar to accounts receivable in that it is money owed to the business by a customer or other entity.
  • These retained earnings are what the business holds onto at the end of a period to reinvest in the business, after any distributions to ownership occur.
  • As each month passes, the business will adjust its records to reflect the cost of one month of insurance usage.
  • Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.

Any changes to the expanded accounting equation will result in the same change within the balance sheet. Looking at the two equations above, it can be observed that the owner’s equity section in the basic equation has been split into contributed capital, beginning retained earnings, revenue, expenses and dividends. Shareholders’ equity refers to the owners’ (shareholders) investments in the business and earnings. These two components are contributed capital and retained earnings.

Equity and the expanded accounting equation

Unearned revenue represents a customer’s advanced payment for a product or service that has yet to be provided by the business. Since the business has not yet provided the product or service, it cannot recognise the customer’s payment as revenue, according to the revenue recognition principle. The business owing the product or service creates the liability to the customer.

expanded equation

The expanded accounting equation differs from company to company based on the size and the economic structure of the business. The accounting equation is formalized in different methods for different setups. The fundamental accounting equation is debatably the foundation of all accounting, specifically the double-entry accounting system and the balance sheet. Double-entry accounting is the concept that every transaction will affect both sides of the accounting equation equally, and the equation will stay balanced at all times.

The Expanded Accounting Equation for a Sole Proprietorship

The expanded accounting equation breaks down the equity portion of the accounting equation into more detail. This expansion of the equity section allows a business to see the impact to equity from changes to revenues and expenses, and to owner investments and payouts. It is important to have more detail in this equity category to understand the effect on financial statements from period to period. For example, an increase to revenue can increase net income on the income statement, increase retained earnings on the statement of retained earnings, and change the distribution of shareholder’s equity on the balance sheet. This may be difficult to understand where these changes have occurred without revenue recognised individually in this expanded equation. The expanded accounting equation can allow analysts to better look into the company’s break-down of shareholder’s equity.

expanded equation

You will learn about other assets as you progress through the book. Let’s now take a look at the right side of the accounting equation. Notes receivable is similar to accounts receivable in that it is money owed to the business by a customer or other entity.