What Is the Expanded Accounting Equation?
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.
- The expanded accounting equation is the same as the common accounting equation but decomposes equity into component parts.
- The components of equity include contributed capital, retained earnings, and revenue minus dividends.
- It also accounts for total assets and total liabilities.
- Some terminology may vary among different companies, depending on how they organize their balance sheets.
The Formula for the Expanded Accounting Equation
The expanded version of the accounting equation details the equity role in the basic accounting equation. The common form of the accounting equation is:
Assets=Liabilities+Owner’s Equitywhere:Liabilities=All current and long-term debtsand obligationsOwner’s Equity=Assets available to shareholdersafter all liabilities
The expanded accounting equation decomposes equity into component parts:
Assets=Liabilities+CC+BRE+R−E−Dwhere:CC=Contributed Capital, capital provided bythe original stockholders (also known as Paid-In Capital)BRE=Beginning Retained Earnings, earnings notdistributed to stockholders from the previous periodR=Revenue, what’s generated from the ongoingoperation of the companyE=Expenses, costs incurred to run operations ofthe businessD=Dividends, earnings distributed to the stockholdersof the company
How the Expanded Accounting Equation Works
Sometimes, analysts want to better understand the composition of a company's shareholders' equity. Besides assets and liabilities, which are part of the general accounting equation, stockholders' equity is expanded into the following elements:
- Contributed capital: This is the capital provided by the original stockholders (also known as paid-in capital).
- Beginning retained earnings: Retained earnings are the earnings not distributed to the stockholders from the previous period.
- Revenue: This is what's generated from the ongoing operation of the company.
- Expenses: These are costs incurred to run operations of the business.
- Dividends: These 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 (NI) on 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."
Revenues and expenses are often reported on the balance sheet as "net income."
Real-World Examples of the Expanded Accounting Equation
Let's look at an actual historical example. Below is a portion of Exxon Mobil Corporation's (XOM) balance sheet as of September 30, 2018.
- Total assets were $354,628 (highlighted in green).
- Total liabilities were $157,797 (1st highlighted red area).
- Total equity was $196,831 (2nd highlighted red area).
The accounting equation whereby Assets = Liabilities + Shareholders' equity is calculated as follows:
- Accounting equation = $157,797 (total liabilities) + $196,831 (equity) equal $354,628, which equals the total assets for the period.
We could also use the expanded accounting equation to see the effect of reinvested earnings ($419,155), other comprehensive income ($18,370), and treasury stock ($225,674). We could also look to XOM's income statement to identify the amount of revenues and dividends the company earned and paid out.
For another example, consider the balance sheet for Apple, Inc., as published in the company's quarterly report on July 28, 2021.
For the quarter that ended on June 26, 2021, the company reported the following balances (in USD millions):
- Total Assets: $329,840.
- Total Liabilities: $265,560.
- Total Shareholder's Equity: $64,280.
The components of Shareholder's equity are further divided on the consolidated financial statement (in millions):
- Common stock and additional paid-in capital: $54,989
- Beginning retained earnings: $15,261.
- Net income (revenue minus expenses): $21,744
- Dividends and Dividend equivalents: $3,713
- Share repurchases: $22,500. (treated as a dividend in the expanded equation, since these funds are effectively used to benefit shareholders).
- Common stock withheld related to net share settlement of equity awards: $1,559.
- Accumulated other comprehensive income: $58.
Substituting for the appropriate terms of the expanded accounting equation, these figures add up to the total declared assets for Apple, Inc., which are worth $329,840 million U.S. dollars.
What Is the Expanded Accounting Equation?
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. The expanded equation is used to compare a company's assets with greater granularity than provided by the basic equation.
What Is the Basic Accounting Equation?
The basic accounting equation is used to calculate how much a company is worth, based on the amount of money that has already been invested and the cost of any obligations. The formula for the basic accounting equation is as follows:
- Assets = Liabilities + Owner’s Equity
When Should I Use the Basic Accounting Equation?
The basic accounting equation is used to provide a simple calculation of a company's value, based on a comparison of equity and liabilities. For a more specific breakdown of the components of equity, use the expanded equation instead.