Income Concepts

INCOME CONCEPTS
The Purpose of Income Reporting
Income is used…
1 As the basis of one of the principal forms of taxation.
2 In public reports as a measure of the success of a corporation’s operations.
3 As a criterion for the determination of the availability of dividends.
4 By rate-regulating authorities for investigating whether those rates are fair and reasonable.
5 As a guide to trustees charged with distributing income to a life tenant while preserving the principal for a remainder man.
6 As a guide to management of an enterprise in the conduct of its affairs.
Importance of Income Reporting
 The EMH and stock prices
 Economic Vs. Accounting Income
 Related sciences
 concerned with the activities of business firms
 use similar variables
 differences over the timing and measurement of income
 Relative importance of income statement (accounting) and balance sheet (economics)
What is the Nature of Income?
 Three possibilities
 Psychic
 Satisfaction of human wants
 Real
 Increase in economic wealth
 Money
 Increases in monetary value
 The concept of well-offness or capital maintenance
 Problems
 Because of the difficulties in measuring real income - Accountants have adopted a transactions approach to income recognition
Capital Maintenance Concepts Financial capital maintenance - money amount -transactions based VS Physical capital maintenance - productive capacity
Difference is in the treatment of holding gains
Current Value Accounting
 The concept of physical capital maintenance requires assets and liabilities to be stated at their current values
 Approaches:
1 Entry price or replacement cost
1 Exit value or selling price
1 Discounted present value
Income Recognition
 Criticisms of the transactions approach
 Possible alternatives
– Edwards and Bell
1 Current operating profit
1 Realizable cost savings
1 Realized cost savings
1 Realized