ACCOUNTING

INCOME

INTRODUCTION
1.What is Income and what is the characteristics of accounting
Income
2.What is the difference between earning and comprehensive
income?
3.Describe the elements that make up comprehensive income
4.What is equity
5.Explain the elements forming Equity
 DEFINITION
• Asset is a present economic resource controlled by the
entity as a result of past events
• Liability is a present obligation of the entity to transfer
an economic resource as a result of past events
• Revenue is the gross inflow of economic benefits (cash,
receivables, other assets) arising from the ordinary
operating activities of an entity (such as sales of goods,
sales of services, interest, royalties, and dividends)
• Expenses are decreases in economic benefits during
the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that
result in decreases in equity, other than those relating to
distributions to equity participants

What is Income?
• Conceptually, Income is defined from syntactical
approach
• Income = Residual of revenue after deduction of expenses
• Why, syntactical approach?
• Income does not stand alone
• It depends on revenue and expense
• No revenue, no expense = no income
 WHAT IS INCOME?
• REGULATORY ASPECT: Income is defined
semantically as follow (IASB) :
• OLD VERSION:
• Income is increases in economic benefits during
the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity, other than those
relating to contributions from equity participants
• NEW VERSION (2018):
• Increases in assets or decreases in liabilities that
result in increases in equity, other than those relating
to contributions from holders of equity claims

ACCOUNTING INCOME
• Accounting income is operationally defined as
(Belkaoui):
the difference between the realized revenues arising
from the transactions of the period and the
corresponding expenses
 ACCOUNTING ECONOMIC INCOME BUSINESS INCOME
INCOME
the enjoyment of psychic income, • Business income
accounting income as real income and money income: differs from
the difference
• psychic income = the actual accounting income in
between the realized
personal consumption of goods and two ways:
revenues arising services that produce a psychic
from the transactions 1.business income is
enjoyment and satisfaction of wants
of the period and the (approximated by real income) based on
corresponding replacement-cost
• real income = an expression of the valuation
historical costs events that give rise to psychic
enjoyment (measured by the cost of 2.business income
living) recognises only the
• money income = all the money gains accrued
received and intended for use in during the period
consumption to meet the cost of
living

Characteristics of accounting income

1. Based on the actual transactions
• Primarily revenues arising from the sales of goods or services minus
the costs necessary to achieve these sales)
2. Based on the revenue principle
• requires the definition, measurement, and recognition of revenues
3. Requires the measurement of expenses
• constituting a strict adherence to the cost principle
4. Based on matching principles
5. Based on the period postulate
• refers to the financial performance of the firm during a given period
 Advantages of accounting income
1. Has survived the test of time
2. Measured and reported objectively (verifiable)
• based on actual, factual transactions,
3. Meets the criterion of reliability
• Rely on the realization principle for the recognition of
revenue
4. Useful for control purposes, especially in reporting on
stewardship

Disadvantages of accounting income Overcome by the use of Fair Value

1. Its relevance in decision making is questionable

2. Predicated on the assumption of a stable monetary unit,
• Fails to recognize increases in the values of assets and liabilities
Measurement

held in a given period

3. May provide misleading impression of an entity’s earnings,
financial strength and performance (assume the monetary
unit is stable)
4. Allows entities to ‘manage’ results
5. Makes comparability difficult
• reliance on the historical-cost principle, different methods of
computing ‘cost’ and cost allocation
COMPONENT OF INCOME
• What is the component of income?
• What should be recognized as Income?
• It depends on the concept of Income
• EARNINGS VS COMPREHENSIVE INCOME

EARNING
• Current period income from company's regular business
activities and operations
• Changes in equity controllable by management during current
period
• IASB call earning as Profit and Loss = "the total of income
less expenses, excluding the components of other
comprehensive income"
• Do not include cumulative effect of accounting changes
EARNING
• Profit and Loss (Earning) consist of:
• Revenue
• Gains and losses from the derecognition of financial assets
measured at amortized cost
• Finance costs
• Share of the profit or loss of associates and joint ventures
accounted for using the equity method
• Certain gains or losses associated with the reclassification of
financial assets
• Tax expense
• A single amount for the total of discontinued items

Comprehensive Income
• Comprehensive Income (FASB) or Other
Comprehensive Income (IASB)
• items of income and expense (including reclassification
adjustments) that are not recognized in profit or loss as
required or permitted by other IFRSs
• CI =
• the items do not stem from the company's regular business
activities and operations
• All changes in equity except those resulting from investments
by owners and distributions to owners.
• Cumulative Effect of Accounting Changes
 Comprehensive Income

• Example of CI:
• Gains and losses from derivative instruments
• Unrealized gains and losses from debt securities
• Pension or other retirement plan gains and losses
• Foreign currency transactions
• Available-for-sale securities unrealized gains and
losses

TOTAL COMPREHENSIVE INCOME

• Total Comprehensive Income = "the change in equity during a
period resulting from transactions and other events, other
than those changes resulting from transactions with owners
in their capacity as owners"
+ Revenue 200 + Earnings 50

(-) Expenses 140 (-) Cummulative Effect of 20

Accounting changes
+ Changes in equities (non
+ Gains 10 owners’ transaction) 10
(-) Losses 20 = Comprehensive Income 40

= Earnings 50

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Transi 17

EQUITY
Equity defined
• Conceptually (Syntactic approach), Equity is defined
as:
• the residual interest in the assets of the entity
after deduction of its liabilities
• Why?

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Owners’ equity
Essential features
• Rights of the parties
• Economic substance of the arrangement

Definition of Equity depend on the adopted theory:

PROPRIETARY theory vs ENTITY theory
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Proprietary Theory
• Proprietary theory = the owner is the centre of
attention
• Focus of accounting: he owners’ interests
• From Proprietary Theory:
E = A – L
Equity defined as “the residual interest in the assets
of the entity after deduction of its liabilities”

Proprietary theory
• Proprietorship = net worth of owners =
capital
• The objective of accounting = determine
the net worth of the owners
• Profit = the increase in net worth
• includes operating profit
• includes changes in the values of assets

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Entity theory
• Entity theory focuses on the firm as the centre
of attention
• The company is viewed as a separate entity
with its own identity
• separation of owners and managers
• the entity is an operating unit
• accounting principles and procedures is not
formulated in terms of an ownership interest

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Entity theory
• The objective of accounting = stewardship or
accountability
• Entity is seen as being in business for itself
• interested in its own survival
• sees owners as outsiders
• reports to owners to meet legal requirements and
maintain good relationships with them

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 Entity theory
• Focuses on the assets
• Assets are resources controlled by the entity
• Liabilities are obligations of the entity
• Profit increases net assets and accrues to the entity
• The owners only have a residual claim on the net
assets of the entity

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Equity from Entity Theory

From Entity Theory (A = L + E):
Equity = liability
 Thus, Equity should be defined as
Equity = obligation of company to the Owners
 Similar to liability:
Liability = obligation of company to the creditors
Entity Theory: Equity vs Liability
• Liquidation Case:
• Creditors has first right to be paid
• Owners = after liability settlement finished
• Access to Asset, Meeting:
• Creditors = less access
• Owners = more access
• Deadline of Maturity:
• Liability has maturity date
• Equity = no maturity date

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 THE END

Concept of capital
• Influenced by legal prescriptions
• capital maintenance
• Financial capital
• invested money or invested purchasing power
• Physical capital
• the productive capacity of the entity
• Capital can be measured on either a nominal dollar or purchasing
power (‘real’) scale

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 Challenges for standard setters
• IASB has several projects which will affect the definition, recognition
and measurement of liabilities
• debt versus equity distinction
• extinguishing debt
• employee shares (share-based payment)

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 Capital maintenance
• The concept of capital maintenance implies that
income is recognised after capital has been
maintained or costs have been recovered
• Return on capital (income) is distinguished from
return of capital (cost recovery)
• SAC 4 identified two concepts of capital
maintenance: financial and physical

Financial and physical capital

maintenance
• Financial and physical capital maintenance can be in the
form of units of money or general purchasing power
• This gives rise to four concepts of capital maintenance:
1. money maintenance, being financial capital
measured in units of money
2. general purchasing-power money maintenance,
being financial capital measured in units of the same
purchasing power
 Financial and physical capital maintenance (cont’d)

3. productive-capacity maintenance, being physical

capital measured in units of money
4. general purchasing-power, productive-capacity
maintenance, being physical capital measured in
units of the same purchasing power

Holding gains and losses

• The valuation of assets and liabilities at current entry
prices gives rise to holding gains and losses as entry prices
change during a period of time when they are held or
owed by a firm
• Holding gains and losses may be divided into two
elements:
1. the realised holding gains and losses that correspond
to the items sold or to the liabilities discharged
2. the holding gains and losses that correspond to the
items still held or to the liabilities owed at the end of
the reporting period
The concept of business income
• Edwards and Bell have introduced the concept of
business income
• We have defined accounting income as the difference
between the realised revenues arising from the
transactions of the period and the corresponding
historical costs
• Business income differs from accounting income in two
ways:
1. business income is based on replacement-cost
valuation
2. business income recognises only the gains accrued
during the period