The Basic and Expanded Accounting Equation
01. The Foundation
Assets = Liabilities + Stockholders’ Equity
The basic accounting equation serves as the foundation for all financial recording and reporting.
02. Equity Breakdown
Assets = Liabilities + Common Stock + Retained Earnings
Stockholders’ Equity is divided into Common Stock (shareholder shares) and Retained Earnings (profits kept in the company).
03. Earnings Detail
Assets = Liab. + Stock + Net Income – Dividends
Retained Earnings shows money kept versus money paid out as Dividends to stockholders.
04. Net Income Formula
Net Income = Revenues – Expenses
Defines profit or loss. If Revenues > Expenses, you have a Net Profit; otherwise, a Net Loss.
05. The Expanded Accounting Equation
Assets = Liabilities + Common Stock + Revenues – Expenses – Dividends
The final expanded equation integrates all broken-down accounts. Revenues and expenses impact Net Income on the Income Statement, while the combined figures prepare the company for the Balance Sheet review.
The first financial statement is the income statement. As previously mentioned, the income statement is composed of the revenues and expenses accounts. There can be a basic income statement or a multi-step income statement. The basic income statement will simply be composed of revenues and then expenses listed in alphabetical order. Then the total from the expenses will be subtracted from the revenues to find net income/net loss. The multi-step income statement does the same except it distinguishes operating revenues from non-operating revenues, and operating expenses from non-operating expenses. Here is how a single step and multiple income statement would look:
Income Statement
Single-Step Statement
For the Year Ended December 31, 2026
Johnson Company
Revenues
Income Statement
Total Revenues
Gain on Sale of PPE
Expenses
Sales Revenue
Advertising Expense
$220
$20
200
Cost of Goods Sold
Income Tax Expense
Loss on Sale of PPE
$12
Total Expenses
Wages Expense
108
10
Net Income
$70
$150
10
10
Multi-Step Statement
Johnson Company
Income Statement
Multi-Step Statement
For the Year Ended December 31, 2026
Johnson Company
Income Statement
Sales Revenue
Cost of Goods Sold
Gross Margin
(108)
$200
Operating Expenses
$92
Advertising Expense
Total Operating Expenses
Wages Expense
12
10
Operating Revenue
Other Revenues and Gains
$70
22
Other Expenses and Losses
Gain on Sale of PPE
20
Income before Income Taxes
Loss on Sale of PPE
Income Tax Expense
(10)
Net Income
$70
(10)
$80
*The point in this document is to find the net income that will be used in the statement of retained earnings and additionally to highlight certain accounts and figures if necessary for the decision makers in management. Next, to review the Statement of Retained Earnings.
Statement of Retained Earnings
The second financial statement is the statement of retained earnings, this is the quickest financial statement to put together. It is short, sweet, and to the point. Here is how a statement of retained earnings would look:
Statement of Earnings
Statement of Retained Earnings
Johnson Company
For the Year Ended December 31, 2026
Beginning Retained Earnings (October 1, 2026)
Net Income
$180
Dividends
Ending Retained Earnings (December 31, 2026)
$225
(25)
70
*The point of this document is to find the ending retained earnings which is carried into the balance sheet and additionally to highlight certain accounts and figures if necessary for the decision makers in management. Next, to review the balance sheet.
The balance sheet is the third and final financial statement. This statement can be a basic balance sheet or a classified balance sheet. The difference between the two is that the basic balance sheet keeps all the assets and liabilities together while the classified balance sheet keeps the current and noncurrent assets separate. This classification allows for a clearer understanding of what the company has and owes in the short term versus the long term.
Balance Sheet
Basic Balance Sheet
December 31, 2026
Johnson Company
Balance Sheet
Assets
Cash
Equipment
$100
Total Assets
Liabilities and Equity
$450
350
Total Liabilities
Total Liabilities and Equity
$450
Total Stockholders’ Equity
$150
300
Classified Balance Sheet
December 31, 2026
Johnson Company
Balance Sheet
Current Assets
Non-Current Assets
Cash
$100
Total Assets
Equipment
Total Liabilities and Equity
$450
$450
350
Mastering these foundational financial statements is essential for any aspiring accountant. These concepts form the bedrock of accounting education and professional practice, ensuring you can accurately interpret the financial story of any organization.