Q:

# What is the expanded accounting equation?

A:

The expanded accounting equation is Assets = Liabilities + (Owner's Capital + Revenues - Expenses - Owner's Draws) for a sole proprietorship or Assets = Liabilities + (Paid-in Capital + Revenues - Expenses - Dividends - Treasury Stock) for a corporation. The equation expands the owner's or stockholders' equity component of the basic accounting formula, which is Assets = Liabilities + Owner's or Stockholders' Equity.

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The basic accounting formula is the foundation of double-entry accounting and provides a summary of the balance sheet. The basic formula shows what a company owns, or its assets, and indicates whether the company borrowed money or used owners' investments to buy these assets.

The expanded accounting equation clarifies the effects net income have on equity and discretely shows the impacts of transactions with owners, including owners' draws, dividends and changes in ownership interests. In the expanded equation, revenues increase equity, and expenses and draws or dividends decrease equity. The expanded equation indicates the relationship between the balance sheet and income statement by breaking down the equity component into revenue and expenses, the two key elements of the income statement. The income statement indicates whether a business operates at a profit, meaning revenues exceed expenses, or a loss, meaning expenses exceed revenues.

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