Summary the Nature of Income Measurement W. Beaver and J. Demski (1979)

Topics: Market failure, Uncertainty, Accrual Pages: 5 (1330 words) Published: December 19, 2012
The Nature of Income Measurement – W. Beaver and J. Demski (1979)

The Paper of Beaver and Demski generally has the purpose to explore the nature of income measurement. They define income measurement as a representation of preference ordering on production plans of the firm. Or: Taking the best one out of possible production plans from a firm. The easiest way to explore such a measure is by looking at it in a complete and perfect market surrounding, but the authors will have a look at four market situations: 1. Income measurement in: Certain world + perfect and complete markets 2. Income measurement in: Uncertain world + perfect and complete markets 3. Income measurement in: Uncertain world + imperfect and incomplete markets (realistic). 4. Reinterpretation of financial reporting ad a noisy communication process in the ligjt of potentially impossible fundamental measurement.

Income measurement in a certain world with perfect and complete markets The first setting the authors looked at, as already told, is the conventional, neoclassical setting. Here they look at a subjectively certain world with perfect and complete markets. This means that all goods and production factors are traded in organized markets. Moreover, everyone knows which production plan is best for the firm, and thus there will be a unanimous choice for the optimal production plan. This is possible because in a perfect market, we know that for everyone - more income is better.

- All prices are known by every agent.
- There are no transaction costs.
- The market is in equilibrium.
- the firm can instantaneously transform resources into goods. As a result, it is easy to maximize the income of a firm by choosing the best production plan. Measuring income in this setting is nothing more than the price of all goods produced less the price of all goods acquired.

Income measurement in an uncertain world with perfect and complete markets The second option is an uncertain world, still with perfect and complete markets. This will leave most of the arguments and outcomes equal to option 1. Uncertainty means that precise productive outcome is unknown at the time of production. Therefore Beaver&Demski introduce a state variable. This variable provides a basis for trading in consumption goods, contingent on which state actually obtains. The formula of option 1, now is depending on a state variable s. This means for example that qs now denotes the quantities of factors acquired if and only if state s obtains. So, suppose there are L possible states, than the production plan of a firm is an L dimensional list of input-output combinations. And with the assumption of complete and perfect markets, there is a market value of each possible production plan. So, there can still be an unambiguous market valuation of the firm’s production plan. Beaver&Demski conclude in short hat existence of uncertainty in and of itself creates no problems with or interest in, income measurement

However, such perfect markets are inconsistent with existing market structures, so they also look at incomplete markets.

Income measurement in an uncertain world with incomplete markets This option is the more realistic one.
Firms are still specifying production plans consisting of (state-contingent) inputs and outputs. The big difference is that some of the inputs and outputs cannot be traded in organized markets. For example, there may not be a market for certain research output. The big problem is that without the marketability of all of the factors and commodities it is possible to lose the unanimous ranking of alternative production plans. Because: some shareholders may prefer one above the other because of the non marketable commodities.

It is possible that, even in an incomplete market setting, unanimous agreement does exist. For example in a monopolistic setting where the owners agree but there doesn’t have to be agreement on...
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