You are on page 1of 4

A comparison of

accounting and economic


concepts of business
income
Accounting theory& Practice Assignment

M.com 3rd semester


Roll no. 37

Accounting income & economic


income
The determination of annual business income is, for accountants, a major
area of research, study and discussion. Economists, too, are intrigued with
this determination. However, the concept of income held by two groups,
broadly, is radically different, as will be evident from ensuing exposition.
Accountants and economists have been unable to come to terms in
developing a uniform concept of income. Indeed, there exist within each
profession many different concepts of income. Both professions have agreed
that income determination is one of their most important concerns.
But, both the disciplines have different objectives in their conceptual
approach to it.
The economist is concerned primarily with the income of persons, of groups
of persons and of society as a whole. The accountant, on the other hand, is
concerned principally with income as it arises in transactions of business
enterprises.
The economists approach to income is therefore much broader than that of
the accountant; but the domain of the accountant is also covered by the
economist. Despite the common interest, each discipline views business
income from a different vantage point, and consequently sees it in a different
light.

ECONOMIC CONCEPT
In economics, income is defined as the amount an individual could consume
during a period and remain as well off at the end of the period as he or she
was at the beginning of the period. To the economist, therefore, income
includes both the wealth that flows to the individual and changes in the
value of the individuals store of wealth. Or, more simply, income equals
consumption plus the change in wealth.
Under the economists definition, unrealized gains, as well as gifts and
inheritances, are income. Furthermore, the economist adjusts for inflation in
measuring income.

ACCOUNTING CONCEPT
In accounting, income is measured by a transaction approach. Accountants
usually measure income when it is realized in a transaction. Values measured
by transactions are relatively objective as accountants recognize (i.e., report)
income, expenses, gains, and losses that have been realized as a result of a
completed transaction. Accountants believe that the economic concept of
income is too subjective to be used as a basis for financial reporting and,

therefore, have traditionally used historical costs in measuring income


instead of using unconfirmed estimates of changes in market value. In
accounting, the meaning of the term realization is critical to the income
measurement process. Realization generally results upon the occurrence of
two events: (1) a change in the form or substance of a taxpayers property
and (2) a transaction with a second party. Conversely, the mere increase in
value of property owned by a taxpayer will not result in the realization of
income because there has been no change in the form of the property and
no transaction with a second party.
Consequently, we see that both the economist and the accountant agree
that income is an increase in net worth, but each has a different concept of
net worth; and therein lies the major difference between the concepts of
business income by the accountant and the economist.
The accountant determines net worth on an historical cost basis by the
formula of assets libilities= net wort; whereas the economists
determination is current value of tangible assets+ discounted value
of future net receipts liabilities. The following oversimplifies example
will serve to illustrate the accounting as well as the economic method of
computing net worth and consequently the determination of income.
Example:
Imagine Ralph earns $50,000 dollars per year salary, after tax, and has
$10,000 dollars invested in the stock market. At the end of the year, his
stock market investment is worth $15,000.
Because Ralph has not yet sold his stock and collected the profits, the
increase in value of the investment is considered unrealized. It is a paper
profit. At the end of the year Ralph has a realized income of $50,000 from his
salary. His total realized income is $50,000. He has unrealized profits of
$5,000 dollars. His combined realized and unrealized incomes equal $55,000.
In this example, Ralphs accounting income would be $50,000 and his
economic income would be $55,000. According to accounting income, the
increased value of the stock investments do not count as actual income
because the investor has not actually sold the stock, completed the
transaction, and collected the profits.
According to economic income, the increased value of the stock investments
to count as actual income because the real value of the assets has gone up.
The assets are worth more now than they were at the beginning of the year.
In this sense, Ralph has earned the full $55,000 income.

Conclusion
The economist and the accountant have different objectives in the
determination of income, as well as different concepts of income.

The accountant measures income independently, and the balance sheet, in


effect, is the residue of prepaid and deferred items. The economist, on the
other hand, uses successive balance sheets as real value determinants and
the annual increases or decreases represent real economic income. The
accountant, on the whole, is interested in what is or what has been, whereas
the economist in interested in what might be. Income of an enterprise from
the accountants point of view must be realized and objectively quantified.
But the economists point of view is that income can accrue only after proper
provision has been made to keep capital intact. The underlying assumption
on which the economic concepts of income are based bear heavily on
subjective judgments while the accounting assumptions are objective in
nature. Nevertheless, there is a great deal of inter-relationship of the
framework of the two disciplines. Many of the basic concepts of economics
are, in fact, derived from accounting practices and many accounting
practices have been devised in an attempt to answer what are essentially
economic questions.
Notwithstanding whatever degree of inter-relationship there is between the
development of the theories of accounting and economics, there remain
some differences in the conceptual view of business income between the two
disciplines.