Study: Expanded Accounting Equation: Computing Ending Balances
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Slide 1: Welcome to Introduction to Accounting Preparing for a User’s Perspective.
The Expanded Accounting Equation: Computing Ending Balances
Slide 2: We’ve already gone through the accounting equation, that’s the basic accounting equation, known as the balance sheet equation.
And we showed how to solve for the unknown. You should already be fully familiar with this. You should feel like you totally have that nailed down.
What we are going to do now, is we are going to break this out [Owners Equity] into its two sources of equity. You can either contribute equity or the company can earn equity and the owners can choose to keep that equity in the business. It is called “Retained Earnings Links to an external site.”.
Slide 3: So, let’s get into it.
The “expanded accounting equation”, all we mean by “expanded” is we are going to take equity and expand it into its two components pieces.
1) Contributed capital Links to an external site.. It is the contributed capital. That’s the equity that the owners have given directly to the business by contributing it.
2) Retained earnings. And then we have retained earnings. These are all the profits that the company has made that have not been paid out to the owners in the form of a dividend. It is the earnings they [the owners] have retained, the profit they have retained [in the business].
So, the expanded accounting equation is simply saying “Expand the equity into the contributed equity and the earned equity.”
Now with that in mind, we are going to do some problems, just like last time, we are going to do three problems, but this time, instead of just giving you the total equity, I’m only going to give you one piece of this equity and have you solve for the unknown.
Question 1: Assets are $50, Liabilities are $20, Contributed Capital is $5. What is Retained Earnings?
OK? So, assets. Assets are $50. Liabilities are $20, and we have only given you the contributed capital portion [$5] and the retained earnings portion is not yet known.
In order to get retained earnings on this one side, by itself, we have got to deduct contributed capital and liabilities from both sides.
If you do that, $50 - $25 = $25. Zero. Zero. Therefore, retained earnings must be $25. There is your answer. OK? That is an example of an accounting equation problem.
Slide 4: Let’s do another one.
Question 2: Assets are $90, Contributed Capital is $10, Retained Earnings is $40. What are Liabilities?
In this one, we’ve been given assets of $90, contributed capital of $10, we’ve been given the retained earnings of $40, so the total equity [contributed capital $10 + retained earnings $40] is $50.
With that in mind, we are going to go ahead and deduct the $10 and $40 from both sides. So this winds up being zero, but we’ve got to do this same thing to this other side, [minus] $10, minus $40. Then we take all of our assets and deduct what belongs to the owners, which is $50 worth of equity and we get $40, therefore, liabilities must be $40.
Slide 5: You are doing great, move on.
Question 3: Assets are $70, Liabilities are $10, Retained Earnings are $15. What is Contributed Capital?
In this case, we have been given assets of $70. Liabilities are $10. We’ve been given the retained earnings this time, but we don’t know how much the owners have contributed. The bottom line is, this [Liabilities $10 + Contributed Capital ? + Retained Earnings $15] must add up to $70 in order to keep this balance sheet equation in balance.
We are going to go ahead and get contributed capital by itself, so deduct $10 from both sides. Deduct $15 from both sides. What we get is $70 minus $25, and you get $45. $45.
Now one last thing you should do, once you feel that you have got the right answer, is put it back into the original equation. $10 [Liabilities] + $45 [Contributed Capital], that’s $55 [+ Retained Earnings $15] that’s $65, $70.
So, you’ve proven it out and you know that Contributed Capital is $45. So, in this case, the owners have contributed much more to the business than has been borrowed. This company has not had a lot of leverage. It’s not using liabilities to leverage Links to an external site. the resources [contributed by] the owners.
Slide 6: So that was the expanded accounting equation computing ending balances. We will now take this up another notch.