When a company first starts the analysis process, it will make a
list of all the accounts used in day-to-day transactions. For
example, a company may have accounts such as cash, accounts
receivable, supplies, accounts payable, unearned revenues, common
stock, dividends, revenues, and expenses. Each company will make a
list that works for its business type, and the transactions it
expects to engage in. The accounts may receive numbers using the
system presented in
Table 3.2. The expanded accounting equation also demonstrates the relationship between the balance sheet and the income statement by seeing how revenues and expenses flow through into the equity of the company.
Expenses refer to the costs and expenses the company incurred to generate its revenues. In this case the 2 accounts lie on the opposite sides of the accounting equation. The business has paid $250 cash (asset) to repay some of the loan (liability) resulting in both the cash and loan liability reducing by $250. $10,000 of cash (asset) will be received from the bank but the business must also record an equal amount representing the fact that the loan (liability) will eventually need to be repaid. Essentially, Accounting is all about tracking the changes to the Owner’s Equity. Some equity comes from investments into the business by the owner.
- The long accounting equation, on the other hand, is a form of the basic accounting equation that recognizes more components of the stakeholder’s equity in an organization.
- Stockholder’s equity refers to the owner’s
(stockholders) investments in the business and earnings. - There is a hybrid owner’s investment labeled as
preferred stock that is a combination of debt and equity (a concept
covered in more advanced accounting courses). - These retained earnings are what the company holds onto at the end
of a period to reinvest in the business, after any distributions to
ownership occur. - For another example, consider the balance sheet for Apple, Inc., as published in the company’s quarterly report on July 28, 2021.
- When a company first starts the analysis process, it will make a list of all the accounts used in day-to-day transactions.
Cash includes paper currency as well as coins, cheques, bank accounts, PayPal accounts. Anything that can be quickly liquidated into cash is considered cash. Cash activities are a large part of any business, and the flow of cash in and out of the business is reported on the statement of cash flows. For accounting purposes, any form of cryptocurrency is considered an asset in the same way as a Renaissance painting.
2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions
Assets are
represented on the balance sheet financial statement. Some common
examples of assets are cash, accounts receivable, inventory,
supplies, prepaid expenses, notes receivable, equipment, buildings,
machinery, and land. Assets are resources a company owns that have an economic value.
The expanded accounting equation goes hand in hand with the balance sheet; hence, it is why the fundamental accounting equation is also called the balance sheet equation. Any changes to the expanded accounting equation will result in the same change within the balance sheet. When using the Expanded Accounting Equation, include all elements of the owner’s equity or stockholder’s equity, including gains, losses, and other accumulated comprehensive income, if applicable. All users of accounting information can benefit from the long accounting equation as it offers greater visibility of the various elements of stockholder equity.
Since the business has not yet provided the product or service, it cannot recognise the customer’s payment as revenue, according to the revenue recognition principle. The business owing the product or service creates the liability to the customer. Unearned revenue represents a customer’s
advanced payment for a product or service that has yet to be
provided by the company. Since the company has not yet provided the
product or service, it cannot recognize the customer’s payment as
revenue, according to the revenue recognition principle. The company owing the product
or service creates the liability to the customer.
The balance sheet is the financial statement that uses the expanded accounting equation, also known as the balance sheet equation. The concept of the expanded accounting equation does not extend to the asset and liability sides of the accounting equation, since those elements are not directly altered by changes in the income statement. Thus, tips for taxpayers who make money from a hobby there is no need to show additional detail for the asset or liability sides of the accounting equation. Shareholders’ equity refers to the owners’ (shareholders) investments in the business and earnings. We begin with the left side of the equation, the assets, and work toward the right side of the equation to liabilities and equity.
Advantages of the Expanded Accounting Equation
Each of these categories, in
turn, includes many individual accounts, all of which a company
maintains in its general ledger. Like the basic accounting equation, the expanded accounting equation shows the relationships among the accounting elements. In the expanded version, the “capital” portion is broken down into several components.
The Expanded Accounting Equation is a more detailed version of the Basic Accounting Equation that adds details about changes in owner’s equity due to day-to-day transactions in the business. It provides additional details of how an owner’s equity in the business changes over a period of time, and from which areas of the transactions of a business. Unearned revenue represents a customer’s advanced payment for a product or service that has yet to be provided by the business.
Example 6: Pay back a loan
Equipment examples include desks, chairs, and computers; anything that has a long-term value to the business that is used in the office. Equipment is considered a long-term asset, meaning you can use it for more than one accounting period (a year for example). Equipment will lose value over time, in a process called depreciation. You will learn more about this topic in Chapter 3, and Accounting, Business and Society. Buildings, machinery, and land are all considered long-term
assets.
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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. The purpose of this article is to consider the fundamentals of the accounting equation and to demonstrate how it works when applied to various transactions. The owner’s investments in the business typically come in the
form of common stock and are called contributed
capital. There is a hybrid owner’s investment labeled as
preferred stock that is a combination of debt and equity (a concept
covered in more advanced accounting courses).
At the point they are used, they no longer have an economic value to the organization, and their cost is now an expense to the business. As was previously stated, double-entry accounting supports the expanded accounting equation. Double-entry accounting is a fundamental concept that backs most modern-day accounting and bookkeeping tasks. By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn. Let’s look at an example of the “expanded” accounting equation so we can better understand the concept.
Equipment will lose value over time, in a process called
depreciation. You will learn more
about this topic in
The Adjustment Process. The accounts are presented in the chart of
accounts in the order in which they appear on the financial
statements, beginning with the balance sheet accounts and then the
income statement accounts. Additional numbers starting with six and
continuing might be used in large merchandising and manufacturing
companies.