Expanded accounting equation with example transactions in this post we extend the accounting equation to account for revenues expenses and withdrawals.
What is the Expanded accounting equation?
Let’s define what these are a company that earns revenue when it provides services to its customers. When revenue gained owner’s equity increased; thus, revenue is a subset of the owner’s equity when revenue performed, assets also increased.
Assets can increase as either a form of cash if you collect the money from the customer or a form of accounts receivable accounts for the money that you have not yet received as maybe the customer promises to pay you in the future.
Again revenue earned transactions recorded an increase in revenue and an increase in assets, either cash or accounts receivable. Expenses are the costs a company incurs while aiming to produce a revenue.
Expenses are also a subset of owner’s equity when expenses incurred; they decrease owner’s equity. Also, when expenses incurred, they will either reduce cash if paying with cash or increase the liability account of accounts payable if you’re going to pay in the future.
Withdrawals are also a subset of owner’s equity and account for if the owner of the company wants to attract Ash or other assets from the business and use them for personal use. Withdrawals decrease owner’s equity.
Let’s look at three new accounts How they relate to their own equity
The capital account is for the personal investment the owner makes into the business; this increases equity.
Revenues increase equity and account for services performed for customers, expenses decrease equity and are incurred by the business while trying to make revenue, withdrawals reduce equity as they account for assets the owner takes back out of business for personal use.
Let’s say, For Example
I had $10000 in capital $5000 in revenue $3000 in expenses and $1000 in owner withdrawals, how much equity would I have.
Well, I would take $10000 plus $5000 minus $3000 and minus $1000 to get a total equity balance of $11000 to know it is essential to understand there are also two types of accounting systems.
A cash basis and accrual basis a cash basis accounts for revenues when cash is received, and expenses recorded when cash paid, the accrual basis accounts for revenue when the services performed, or earn whether the customer provided you cash or not.
And our examples we will be using the accrual basis which is most common in organizations an account for revenue and expenses as they are earned or purchased, and we accrue for uncollected money from customers and accounts receivable and unpaid expenses or purchases using accounts payable.
Let’s look at some transactions and their impact on the accounting equation.
We will start with balances based with $3000 in cash $16500 in equipment $4500 in liabilities and $15000 in capital or equity
Notice how the equation calculates to make the accounting equation balance where asset accounts added together to get total assets then add liabilities to capital ad revenue subtract expenses and subtract withdrawals to get total liabilities and owner’s equity.
Transaction one of the expanded accounting equation
I provide services for cash of $7000 let’s analyze this because we are collecting cash we will increase the cash account by $7000 because we are providing services we increase the revenue account by $7000.
We then determine our new totals thus now we have $10000 in cash we carry down our balance of $16500 for equipment $4500 of accounts payable $15000 of capital and then our revenue total of $7000. we also do a quick check to verify the accounting equation balances
Here assets total $26500 in liabilities and owner’s equity also totals $26500; thus, the accounting equation balances.
We provide services on account for $2000, so let’s analyze this I provided services on the account, so I did not receive cash so what accounts are impacted, well-provided services tell me I need to increase revenue by $2000, on account tells me I didn’t yet collect cash from the customer.
But cash or an asset is owed to me. Thus I would put that value into accounts receivable remember when you owed money, it is an asset. It goes to accounts receivable when you owe a creditor or someone else money it is a liability and goes into accounts payable.
Let’s add our totals I still have $10000 in cash I now have $2000 in accounts receivable 16500 remains equipment $4500 remains and accounts payable $15000 remains in the capital in my new revenue total is $9000.
Again you should check your accounting equation that it balances and it does with assets having $28500 and liabilities and equity having $28500 as well.
Your customer from the last transaction came to you and paid half of what they owed, which is a $1000. So let’s analyze that. The customer paid you, so you received cash; thus I know I’m going to increase my cash for a $1000.
For what other account do I need to impact it would not be revenue as I did not perform services again nor would I want to account for the same revenue twice but instead it would be reducing the amount they owe me thus reducing accounts receivable.
So I will make a $1000 reduction to the accounts receivable balance; thus, I am just doing a shift in assets.
Again I will compute my balances and confirm the accounting equation still balances.
Moving on to transaction four
The company pays $3000 for salaries. I pay salaries which are going to reduce cash by $3000 salaries is an expense.
So I’m going to increase the value of my expenses by $3000 this may be confusing but remember owner’s equity decreases as expenses increase. So we will retort all our accounts and notice how the accounting equation is still balanced.
Assets I have $25500 then I take $4500 of liabilities and add $15000 of capital add $9000 in revenue and subtract $3,000 of expenses to get the total of $25500 of liabilities and owner’s equity
The company pays rent expense of $500 so again if we analyze it we pay rent and are going to reduce cash by $500 rent is an expense so I will increase the total amount of expenses the company incurred thus now my cash account balances to $7500 and expenses increase to$3500.
Again as a check, we balance the accounting equation total assets equal $25000, and if we take the liabilities of $4500 and we add capital of $15000 and add revenue of $9000 subtract expenses of $3,500 will get $25000 thus the accounting equation balances.
We incurred advertising expenses of $1500 which will be paid next month, so I incurred an expense thus I’m going to increase the number of expenses I have $1500 now I didn’t pay with cash, but instead I’m going to pay for the expense in the future.
So what does that mean it means I have a liability thus, I would increase the liability of accounts payable by $1500.
Next, I would recheck my accounting equation to ensure it still balances which it does with $25000 in assets and $25000 in liabilities and equity. nope when I do decide to pay for this later, I would reduce cash and reduce accounts payable at the time of pain
Final transaction of expanded accounting equation
Let’s say I would true $100 for personal use if you remember from earlier in the post when I take money for personal use I would categorize that as owners withdraw thus if we go to our equation, I reduce cash by $100, and I add $100 to my withdrawal account.
A re total my accounts and balance the accounting equation here I have a total of $24900 in assets, then I have liabilities of$16000 plus capital of $15000 plus revenues of $9000 then subtract expenses of $5000 and subtract withdrawals of a $100 to confirm my total liabilities and equity equals $24900 this concludes
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