expanded accouting equation

CFA Level I FRA
#1

we can conclude from the equation, the relationshio between asstes and expenses and revnues :

assets = liabilities + contributed capital+ beginning retained earnings + revenue - expenses - dividends. (1)

the eqution makes sens for me when it’s explaining how we get Owners equity. but when it’s about asstes, the developed form (1), it means that a deacrase in assets “can” result from an increase in expenses or a decrease in revenus!!! it’s not my assumption, that was the answer for a question.

let’s forget about the equation, I can’t see how it can happen in practice ? if asset decrease, meaning u sold some, it’s a revenue ( uncurrent revenue), and less depreaciation, so less expenses … where am I geting it wrong ??

#2

If you pay your employees twice as much, your cash decreases.

#3

When your expenses go up, your cash (or other assets) goes down.

When your revenue goes down, your cash (or other assets) goes down.

Is there any other way to see it?

#4

I found this book as a gift of God: The Accounting Game: Basic Accounting Fresh from the Lemonade Stand. http://www.amazon.com/The-Accounting-Game-Basic-Lemonade/dp/1402211864

It made me understand how accounting works without snobbery and terms overload. Great starting point for beginners.

#5

Since you mention depreciation, I believe you are referring to the selling of fixed assets like Property, Plant and Equipment (PPE) in your example.

Note: 1) If you sell the PPE at exactly Net Book Value (Cost - Accumulated Depreciation) :

=> ‘No Loss/Gain’ for the accounting period the sale was made

  1. If you sell the PPE at above Net Book Value(NBV):

=> Realise a ‘Gain’ for the accounting period the sale was made

  1. If you sell the PPE at below Net Book Value (NBV) :

=> Realise a ‘Loss’ for the accounting period the sale was made.

Let’s say you managed to sell some PPE with a NBV of $800 for $900.

=> Cash(Asset) goes up $900 (selling price); PPE (Asset) goes down by $800 (NBV); And you realise a “Gain” of $100 which increases Equity (because Revenue increases, albeit by an activity that isn’t part of your core-business)

A ( +900 cash - 800 PPE ) = L + E ( +100 Rev/Gain ) = > still in balance

Also, hopefully you see that Profit and Cashflow are not equivalent. Simplistically assuming no other transactions occured, Cashflow here is $900 (selling price) and Profit is $100.

In the long form of the basic accounting equation that you present view Revenue - Expenses as = Profit

Profit increases Retained Earnings => which increases Equity => Which balances the increase in Assets

Say you sold for only $700. Then Assets up: +700 (cash); Assets down: -800 (PPE); Net overall change in Assets -100; and you have -100 (loss on sale of PPE) which reduces Retained Earnings => which reduces Equity.

A ( +700 cash - 800 PPE ) = L + E ( -100 Exp/Loss ) = > still in balance

#6

I’m very very grateful guys for your help … I felt it was a damn stupid question when I get through curriculum and shweser all over :frowning: . I’m sorry, I studied accounting and financial analysis in frensh style that has nothing with US format, everything is upside down :frowning: I’m feeling really confused trying all the time to compare between them… in french assets most of the time refer to non current assets, didn’t see at first that it could affect other elements as well.

@Lampossible, thx so much for the example, it really helps . @go-getter thx for the book, it looks great :wink: