DEFINITION of Expanded Accounting Equation
The expanded accounting equation is derived from the common accounting equation and illustrates in detail the different components of stockholders’ equity of a company. It expands the equity role in the basic accounting equation from:
Assets = Liabilities + Stockholders’ Equity
Assets = Liabilities + Contributed capital + Beginning retained earnings + Revenue - Expenses - Dividends
Where Stockholders’ Equity in the accounting equation is substituted by Contributed capital + Beginning retained earnings + Revenue - Expenses - Dividends in the expanded accounting equation.
BREAKING DOWN Expanded Accounting Equation
Besides assets and liabilities, which are part of the general accounting equation, stockholders' equity is expanded into the following elements:
- Contributed capital is the capital provided by the original stockholders (also known as Paid-In Capital).
- Beginning retained earnings are the earnings not distributed to the stockholders from the previous period.
- Revenue is what's generated from the ongoing operation of the company.
- Expenses are those costs incurred to run operations of the business.
- Dividends are subtracted since they are the earnings distributed to the stockholders of the company.
Contributed capital and dividends show the effect of transactions with the stockholders. The difference between the revenue and profit generated and expenses and losses incurred reflects the effect of net income for stockholders' equity. Overall, then, the expanded accounting equation is useful in identifying at a basic level how stockholders' equity in a firm changes from period to period.
Some terminology may vary depending on the type of entity structure. "Members' Capital" and "Owners' Capital" are commonly used for partnerships and sole proprietorships, respectively, while "distributions" and "withdrawals" are substitute nomenclature for "dividends."