Economists refer to income as a measure of “better-offness.” Thus, economic income represents an increase in command over goods and services. Such notions of income capture operating successes, as well as good fortune from holding assets that may increase in value. In contrast, accounting income tends to focus on the effects of transactions and events that are evidenced by exchange transactions. For example, land is recorded at its purchase price.
In recent years, however, accounting rules around the globe have increasingly reflected greater acceptance of fair value measurements for selected financial statement elements. Whether and when accounting should measure changes in value has long been a source of debate. This debate is ongoing, and rules that establish measurement principles will continually evolve.
Generalizing: (a) accounting measurements tend to be based on historical cost determined by reference to an exchange transaction with another party (e.g., a purchase) and (b) income is “revenues” minus “expenses” as determined by reference to those transactions. More specifically:
- Revenues — Inflows and enhancements from delivery of goods and services that constitute central ongoing operations
- Expenses — Outflows and obligations arising from the production of goods and services that constitute central ongoing operations
- Gains/Losses — Like revenues/expenses, but from peripheral transactions or events
Thus, it may be more precisely said that income is equal to Revenues + Gains – Expenses – Losses. Be aware that in some countries revenues is an all-inclusive term, including both revenues and gains.
Although accounting income will typically focus on recording transactions and events that are exchange based, some items must be recorded even though there is not an identifiable exchange between the company and some external party. What types of nonexchange events logically should be recorded to prepare correct financial statements? How about the loss of an uninsured building from fire or storm? Clearly, the asset is gone, so it logically should be removed from the accounting records. This would be recorded as an immediate loss. Even more challenging may be to consider the journal entry: debit a loss (losses are increased with debits since they are like expenses), and credit the asset account (the asset is gone and is reduced with a credit).
Need help preparing for an exam?
Check out ExamCram the exam preparation tool!
|Did you learn?|
|Distinguish between the economic and accounting concepts of income.|
|Why do accountants use the transactions approach to compute net income?|
|Distinguish between exchange transactions and nonexchange events.|