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.
- Total assets and total liabilities are also accounted for.
The Formula for the Expanded Accounting Equation Is
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."
Real-World Example of the Expanded Accounting Equation
- 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.