What is the Expanded Accounting Equation for a Single Proprietorship?
In a single proprietorship, the owner’s assets, liabilities and personal expenses should be separate and distinct from that of his or her business. Hence, the reader of the Balance Sheet report will have a ready reference about the composition of the Owner’s Capital account if the expanded accounting equation is used.
Whereas the fundamental accounting equation for a single proprietorship is:
Asset= Liabilities + Capital
The expanded accounting equation for a single proprietorship would be:
Assets= Liabilities + Owner’s Capital + Revenues – Expenses – Capital Drawing
As an aid to understanding this expanded accounting equation, the components of the equation are explained as follows:
Assets- This is the value of the business’s available resources. In a sole proprietorship, examples of accounts included under this component are cash, accounts receivables, inventory on hand, prepaid expenses, office equipment and machinery, and all other resources used as tools for carrying out the business operations.
Liability- This is the value of the amount borrowed by the business proprietor from other sources; the proceeds or benefits of which, were used to sustain the business operations. Examples of accounts included under this component are accounts payable, notes payable, and accrued expenses payable.
Capital- Initially, this represents the amount of money invested by the proprietor to put up his business. This account increases as the company realizes annual net profits or additional funds are infused as capital. Net losses and capital drawings will decrease this account.
Revenues- The revenue presented in this expanded accounting equation will be at the gross amount of all sales realized during the year whether cash (COD) or on credit. In the general ledger, this is a temporary account and may have additional descriptions such as Sales Revenues, Service Revenues, or Interest Revenues. As a temporary account it will be transferred to the Profit and Loss Summary at year-end closing. As of year end, all revenue accounts will have zero balances.
Expenses- This represents the total expenses incurred by the business related to business operations. All expenses incurred will be based on the accounting period in which the expense is related to and not on the date the expense was paid. This is also a temporary account and will likewise be transferred to the Profit and Loss Summary in order to zero out the balance as of year-end.
Capital Drawing- Any personal expenses incurred by the owner using the business’s cash fund and in no way related to business operations will be classified under this account. This is also a temporary account which will be transferred to the Owner's Capital account at year end in order to zero out its balance.