EXPANSION OF ACCOUNTING EQUATION

For anyone trying to understand the perception of the expansion of accounting equation, it is pertinent to refer to the accounting equation. An accounting equation is a statement you encounter very frequently in every accounting session.

It is the fundamental equation in understanding the basics of principles of accounting. Simply put, it is the foundation of the accounting course.

 What is this accounting equation?

The accounting equation is ASSETS = LIABILITY + OWNERS EQUITY

It is also called the balance sheet equation and it basically represents the relationship between the assets, liability and owners of a business or company.

Assets: assets are economic resources that provides a future benefit for a business example cash, account receivable, notes receivable, inventory, prepaid expenses, land, buildings. Equipment, furniture, and fixtures.

Liabilities: liability is a debt. A payable is always a liability. The most common types include Accounts payable. Notes payable, accrued liabilities.

Owners’ equity: These are the owners claim to the assets of a corporation. They are also called stockholders equity. Some of them are common stock, retained earnings, dividends, revenue, expenses.

Accounting equation lays a foundation of double entry accounting and highlights the structure of the balance sheet.

Double entry accounting is a system where every transaction affects both sides of the accounting equation. For every change to an asset, there must be an equal change to the liability or shareholder’s equity account. That is why this foundation of what makes up an accounting equation must be kept in mind when entering journal entries.

Expansion of accounting equation

The expanded accounting equation breaks down owners’ equity which is also known as shareholders equity into more depth more than the fundamental accounting equation. It lets those analyzing or accountants see the components of shareholders equity and how it impacts the company. The equation for expanded accounting equation is:

Assets= liabilities+share capital+retained earnings

Which could also be broken down as

Assets= Liabilities + contributed capital+ beginning retained earnings+ revenue + Expenses + Dividends

Explanation of terms used.

1. Contributed capital comes from the capital provided by the original stockholders
2. Beginning retained earnings is the carryover retained earnings that were not distributed to stockholders during the previous period
3. Revenue comes from the sales and operations of the business.
4. Expenses are the costs associated with the running of the operation
5. Dividends are the earning that are distributed to the stockholders of the company.

Examples are journal entries

The journal process has 3 steps:

1. Specify each account affected by the transaction and classify each account by type (assets, liability, stockholders’ equity, revenue or expense)
2. 2. Determine whether each account is increased or decreased.
3. Record the transaction in the journal including a brief explanation. The debit side is entered on the left and the credit side is entered on the right.

The account that is debited is entered first. In accounting, a space is given before writing credits.

Balance sheet

The expanded accounting equation conforms with the balance sheet and that is why the accounting equation is also called the balance sheet equation. Any changes to the expanded accounting equation will result in the same change in the balance sheet.