What is the Expanded Accounting Equation?
The expanded accounting equation is an extension of the accounting equation. It is formed by expanding the equity section of the accounting equation as shown below.
|2. Assets||=||Liabilities||+||Capital||+||Retained earnings|
In the expanded accounting equation formula equity is made up from the capital injected by the owner and the retained earnings of the business.
The retained earnings is the accumulated retained profits of the business which can be further split down into revenue less expenses less drawings. The drawings represents cash taken out of the business by way of salary, in a corporation this would be represented by dividends paid to the equity holders.
Rearranging the expanded version of the accounting equation gives the following equation, which can be used as a reference point to determine the use of debits and credits in double entry bookkeeping.
The expanded accounting equation effectively shows that retained earnings is the link between the balance sheet and the income statement.
Additional information can be found in our expanded accounting equation tutorial
For further information see the Wikipedia accounting equation definition.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.