The Expanded accounting equation plays a similar role in varieties of business like a partnership, sole-proprietorship, a public or private corporation. Each business has different laws, rules but similar methods to prepare and improve accounting records. Basically, the Fundamental accounting equation is used to arrange and manage the owner’s equity capital but there is another one that demonstrates the owner’s equity after all arrangements of business operations that is an advanced accounting equation.
What is the expanded accounting equation?(Meaning of Expanded Accounting Equation?
The Expanded Accounting Equation is a concept of distribution of owner’s equity into different forms so that accountants can show each transaction whether it is related to revenue, expenses, capital, retained earnings, income, loss, profit, and dividends in a particular place or heading which demonstrates the clear Balance Sheet and Income Statement.
In simple words, we can say that the latest plus advanced version of the accounting equation makes advanced business activities by breaking down shareholder’s equity into different results that show clarity for the analysts to judge the status of the company.
The breaking method of estimating an expanding accounting equation:
Assets = Liabilities + Contributed Capital + Beginning Retained Earnings + Revenue – Expense – Dividends
We can give you an example by which your generating queries can be solved to clear the concept of the expanded accounting equation.
Double-entry bookkeeping accounting system shows the effect of transactions on both sides to balance equality of assets and liabilities, the same as the expanded accounting equation shows the components of transactions related to the owner’s equity which affects the balance sheet and Income Statement of the company such as:
- Revenue and Expenses decide the profit and losses.
- Contribution capital increases the capital assets.
- Retained earnings are like savings for the next year that are taken out by deducting all expenses, liabilities, and dividends from total revenue.
- Adding stock increases the value of the assets but decreases the capital.
- Drawings decrease the company’s assets that are withdrawn by the shareholders for their personal use.
What represents the expanded accounting equation and who analyses the equation?
Expanded accounting equation represents the broken parts of the owner’s equity into different components and internal and external analysts represent this equation to know the liquidity and measure how much the company impact and owner’s equity affect with the advanced changes so they can be alert for the next financial year. It is mainly measured to analyze the changing period of owner’s equity during the year due to business elements.
While distributing the owner’s equity, there are some elements that are affected by the single change or single transaction:
Assets
Assets are a resource for the business which can be in the form of capital as well as stocks that include current as well as non-current assets. They are the important part of the business which affects the other activities that are the future and present collection for business by which business earns profit such as cash receivables, machinery, buildings.
Liabilities
Liabilities are financial obligations that need to be paid to the other individual or company that involves current as well as non-current liabilities. These are like a financial burden that is paid from the earned revenue by the business such as accounts payables that can be short-term debt as well as long-term debt.
Contribution capital
Contribution Capital (CC) is invested by the shareholders or owners as an investment capital that increases the value of capital assets of the business in the expectation of profit as a dividend.
It is a collection of different equity owners who distribute their capital based on their financial back and also get a dividend based on the percentage of invested capital and take out the dividends to the shareholders or owner’s equity to decrease the business capital assets.
Retained Earnings
Retained Earnings are saved out from total revenue earned by the business after deducting expenses, liabilities, and dividends. It is not distributed to the shareholders by the company due to not being a part of the owner’s income, it is a part of savings that is used for the next financial investment.
Revenue
Revenue is the profit which is earned by the business from the sales so it is counted as a profit as well as income that shows the business profitability chart. It comes from the business operation that is earned. Without getting revenue, you can’t maintain the flow of your business and won’t be able to pay the expenses as well as short-term and long-term debts.
Expense
Expenses are the financial costs that reduce the business capital and are paid out from the revenue. The Expense can be more or less, it depends on the way of business activities and the size of the business.
Dividends
Dividends are the profit and earnings for the shareholders or equity owners that are distributed among all the shareholders.
How expanded accounting equation effects
The expanded accounting equation affects the business losses and profits that can be possible during the year. The equation describes the correlation between the balance sheet and Income statement that shows how much expense is incurring and revenue is getting.
The effectiveness depends on business entities, each entity has a unique expanded accounting equation due to different laws and rules.
Rearrangement
- The process of rearrangement of expanded accounting equation depends on the elements of the owner equity such as:
- Liabilities need to be paid first before going to do other additional investing activities
- Dividends need to be paid to the shareholders due to their earning rights
- The cost or an expense are paid out from the total revenue earned by the sales of an assets
- Retained earnings need to be saved for future investment or count as business earnings that are shown in the balance sheet
- Owner’s capital is also known as members equity that is a crucial investment of every business entity.
Uses of Expanded Accounting Equation (EAE)
- Expanded Accounting Equation comes from the part of the accounting equation that shares the financial health of the business to analysts.
- The balance sheet and income statement are the main hands to describe the expanded accounting equation (EAE).
- To balance both sides, rearrangement is important with the help of Expanded Accounting Equation.
- Assets = Net shareholder equity + liabilities + Net earnings
- The Expanded accounting equation helps to view accurate results to the analysts, investors, stakeholders, and advisors.
- As we know that, EAE breaks down the owner’s equity into some components and each component affects by a single transaction such as:
- Cash flow increases, when revenue earn from the sales
- Cash flow decreases when expenses incurred from business activities
- The Analyst can understand better from each component so that they can think about future financial goals with accounting policies.
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