The fundamental accounting equation is extended to incorporate new components like owner’s capital, common shares, and net assets. This is known as the expanded accounting equation. A more thorough view of a company’s financial situation is provided by the enlarged accounting equation, which is essential.
The expanded accounting equation is:
Asset = Liabilities + Owner’s Equity
For example, if a company has $1,000 in asset and $500 in liabilities, then the owner’s equity would be $500. It is also helpful in figuring out different ratios, like debt-to-equity ratio. The expanded accounting equation can be used to calculate the following ratios: Debt-to-equity ratio: It is used to determine a organization’s financial leverage. It is computed by dividing the total liabilities of an organization by the entire equity. An elevated debt-to-equity ratio means that organization is highly leveraged and may be at risk of financial distress. Asset-to-equity ratio: Retained earnings-to-equity ratio: This ratio is used to measure organization’s profitability. It is computed by dividing a organization’s retained earnings by its total equity. A high ratio indicates that organization is profitable and is able to reinvest its earnings to generate growth. The expanded accounting equation is a valuable tool for financial analysis. By understanding the expanded accounting equation, you will be able to better understand a company’s financial position and performance.