The Expanded Accounting Equation Explained

What is the expanded accounting equation?

The expanded accounting equation is an expansion of the accounting equation, showing the different units of shareholder’s equity (one of the components of the basic accounting equation) in greater detail.

The accounting equation briefly explained[1]

Typically, the balance sheet of a business comprises three core components: assets, liabilities, and shareholder’s equity, otherwise called owners’ equity.

• Assets

Assets are resources a business owns that hold a future benefit for the business. Assets include current assets (such as cash, accounts receivable, and marketable securities) and non-current assets (for example, property, plant, and equipment (PP&E), and vehicles). Non-current assets, also referred to as long-term assets, usually have a life that exceeds one year.

• Liabilities

Liabilities, also called obligations, refer to money that a business owes to lenders, such as banks and other financial institutions, and creditors, as a result of previous transactions. Liabilities are classified into current liabilities, such as accounts payable, taxes owed, short-term loans, and long-term liabilities like bank overdrafts and long-term loans.

Long-term liabilities are due after a year or more.

• Shareholder’s equity (owners’ equity)

Shareholder’s equity refers to the rights of the owners (shareholders) of a company to the remaining assets after all liabilities have been deducted.

The expanding accounting equation is a more detailed analysis of the subcomponents of this particular component on the balance sheet.

The accounting equation illustrates the relationship between the three components of the balance sheet, ensuring that the employment and uses of all the assets are in balance with all the sources (debt and owners’ equity) that made the acquiring of all the assets possible.

This equation is the basis of all accounting, especially the double-entry accounting system which is the concept that every financial transaction has equal and opposite outcomes in at least two different accounts in the accounting system of a business.

The following names are also used to refer to the accounting equation: the balance sheet equation, the basic accounting equation, the common accounting equation, or the fundamental accounting equation.

The formula for the fundamental accounting equation

The basic form for the accounting equation is:

Assets = Liabilities + Shareholder’s equity

As mentioned, the equation must always be in balance.

Rearranging the accounting equation

The common accounting equation can be rearranged to look like this:

• Shareholder’s equity = Assets – Liabilities

This formula illustrates the relationship between shareholder’s equity and liabilities (debt or obligations) more clearly. It indicates what amount is available for shareholders after liabilities have been deducted from assets.

This equation is important because lenders and other creditors have a legal right to first claim from a company’s assets.

• Liabilities = Assets – Shareholder’s equity

The formula can be rearranged in this form if the total amount of liabilities has to be calculated. For example, let us say a company has assets of R5 million and shareholder’s equity of R2.5 million. To determine the company’s liabilities, the equity is subtracted from assets, to give a result of R2.5 million.

The expanded accounting equation of businesses explained

The expanded accounting equation is described in different terms on accounting websites. For instance:

Investopedia

• ‘The expanded accounting equation … illustrates in greater detail the different components of stockholders’ equity in a company.’
• ‘The expanded accounting equation … decomposes equity into component parts.’

Corporate Finance Institute

• ‘The expanded accounting equation breaks down shareholder’s equity … into more depth than the fundamental accounting equation.’

The Business Professor

• ‘The expanded accounting equation shows the various units of stockholder equity in greater detail.’

Udemy

• ‘The expanded accounting equation looks to delve more deeply into the equity part of this equation, but both the assets and liabilities parts stay the same.’

Although differently described, the essential part of the expanded accounting equation Is that the subcomponents of shareholder’s equity are described in a comprehensive way.

Contrarily to the common accounting equation, which only focuses on the core components of the balance sheet, the expanded equation also makes use of figures obtained from the income state of a business. This provides for a more detailed picture of the transactions with regard to the owners of a business.

The expanded accounting equation applied to different types of business formats

There are basically three different types of business formats that may use this equation, each with a different composition of ownership. This implies that the expanded accounting equation needs to be adjusted in accordance with the specific type of ownership.

The three types of business formats are corporation, sole proprietorship, and partnership.

The expanded accounting equation applied to corporations

A corporation is a legal entity that exists and operates separately from its owners, referred to as shareholders or stockholders.

It is one of the best-known business forms and is commonly called a company (publicly traded or private).

In South Africa, the Companies Act (Act 71 of 2008), defines a company as a juristic person which ‘has all of the legal powers and capacity of an individual’ (section 19 (1)). Put differently, a juristic person is recognised as a legal person with legal rights and responsibilities. In contrast, an individual is referred to as a natural person.

The standard formula of the expanded accounting equation of a corporation looks as follows:

Assets = Liabilities + CC + BRE + R – E – D

Where:

• CC = Contributed Capital, also called Paid-in capital, which is the capital provided by the original shareholders.
• BRE = Beginning Retained Earnings is the carryover retained earnings that were not distributed to the shareholders during the previous financial period.
• R = Revenue refers to the income generated from the sales and ongoing operations of the company.
• E = Expenses are the costs incurred to run the daily operations of the company.
• D = Dividends are the earnings distributed to the company’s shareholders.

This equation allows analysts, accountants, and shareholders to see individually:

• the effect net income (NI) (increased by revenues and decreased by expenses) has on owners’ equity from financial period to financial period, and
• the effect of transactions with owners (shareholders), such as contributed capital and dividends.

Noteworthy, some analysts use a slightly different expanded accounting equation such as:

Assets = Liabilities + (Common Stock – Dividends + Paid-in Capital – Treasury Stock + Revenue – Expenses)

Where:

• Common stock, also called ordinary shares, are shares held by ordinary shareholders who are entitled to receive dividends.
• Treasury shares, also known as treasury stock or reacquired stock, are previously outstanding shares that were bought back by the issuing company from shareholders.

Examples of the expanded accounting equation

Common example

The following figures are obtained from the 2025 financial statements of company Sunshine:

• Assets: R2 650 000
• Liabilities: R1 500 000
• Contributed Capital (CC): R1 000 000
• BRE: R500 000
• Revenue (R): R500 000
• Expenses (E): R300 000
• Dividends distributed (D): R50 000

The expanded accounting equation of company Sunshine will look as follows:

Assets = Liabilities + CC + BRE + R – E – D

R 2 650 000 = R1 500 000 + R1 000 000 + R500 000 + R500 000 – R300 000 – R50 000

Examples illustrating how the expanded accounting equation is affected by specific financial transactions

As mentioned, the double-entry accounting system requires that all financial transactions be recorded via journal entries with one or more accounts being debited and one or more accounts being credited.

The journal entries must be in balance which ensures that the accounting equation is in balance.

Example #1

Office furniture (R10 000) and new computers (R30 000) are purchased by the company Good Luck. The office furniture is paid upfront in cash and the computers are bought on credit.

The journal entries will look as follows:

1. Computers (Asset): R30 000
2. Accounts Payable (Liability): R30 000
3. Office furniture (Asset): R10 000
4. Cash (Asset): R10 000

The effect on the equation is as follows:

• Assets: + R30 000 + R10 000 – R10 000
• Liabilities: – R30 000

Example #2

Company Good Luck distributes dividends to the amount of R15 000 to shareholders from retained earnings and pays R20 000 to the supplier of the computers.

Journal entries

1. Retained earnings: R15 000
2. Dividends: R15 000
3. Accounts Payable (Liability): R20 000
4. Cash (Asset): R20 000

The equation will be affected as follows:

Assets: – R20 000

Liabilities: + R20 000

Retained earnings: – R15 000

Dividends: + R15 000

Rearranging the expanded accounting equation for corporations

The equation can be rearranged to satisfy certain needs. The equation can be rearranged to look as follows:

Assets – Liabilities = Shareholder’s equity (Balance sheet equation)

Assets – Liabilities = CC + BRE + R – E – D (Expanded equation)

Rearranging the equation in such a way allows shareholders to see how much they will receive when a company ceases to operate as a result of a specific reason, such as bankruptcy.

The expanded accounting equation applied to sole proprietorships

A sole proprietorship refers to a business (usually a small business) that is owned by a single person who takes responsibility to operate the business.

The sole owner supplies the capital owns all the assets, is responsible for all the liabilities of the business, and is allowed to draw money from the business for personal use – availability of funds permitting.

The expanded accounting equation of a sole proprietorship will look as follows:

Assets = Liabilities + (Owner’s Capital + Revenue – Expenses – Withdrawals)

Example:

Aubrey’s business started the 2025 financial year with the following fundamental accounting equation:

Assets = Liabilities + Owner’s equity

R750 000 = R350 000 + R400 000

The following figures were reported for the 2025 financial year:

• Assets acquired: R70 000
• Loans received: R50 000
• Revenue generated: R150 000
• Expenses incurred: R110 000
• Withdrawals: R0
• Cash paid to acquire assets: R20 000

At the end of the 2025 financial year the expanded accounting equation for Rudy’s sole proprietorship will look as follows:

Assets (R750 000 + R70 000 – R20 000 + R40 000¹) = Liabilities (R350 000 + R50 000) + Owner’s equity (R400 000) + Revenue (R150 000) – Expenses (R110 000) – Withdrawals (R0)

1 – R40 000 is the difference between revenue and expenses

Thus:

R840 000 = R400 000 + R400 000 + R150 000 – R110 000

The expanded accounting equation applied to partnerships

A partnership is a type of business that is owned by two or more people, who agree to contribute capital to the business and share responsibilities and expenses to run the business. Partners are also allowed to take funds (referred to as distributions) from the business as per agreement.

The expanded accounting equation for a partnership looks as follows:

Assets = Liabilities + (Partners’ Capital – Distributions + Revenue – Expenses)

The key benefit of the expanded accounting equation

The key benefit of the expanded accounting equation is that it provides a clearer picture of how the various subcomponents of owner’s equity change over a given period of time, allowing analysts and owners a better understanding of how profits are being used – as dividends (company), drawings (sole proprietorship), distributions (partnership), retained as cash, or reinvested into the business.

[1] For a more detailed explanation of the accounting equation, see the article, The Accounting Equation Explained for Dummies.’