by Accounting income is an income resulting from business transactions arising from the cash-to-cash cycle of business operations. It is derived from a periodic matching of revenue (sales) with associated costs. Accounting income is an expost measure that is, measured ‘after the event.’
The accounting income recognises income only when they have been realised. On the other hand, the economic income, because it is based on valuations of all anticipated future benefits, recognises these flows well before they are realised. This means that, at the point of original investment, economic capital will exceed accounting capital by an amount equivalent to the difference between the present value of all the anticipated benefit flows and the value of those resources transacted and accounted for at that time.
The difference represents an unrealized gain which will, over time, be recognised and accounted for in computing income as the previously anticipated benefit flows are realised.
Accounting income and economic income basically differ in terms of the measurement used.
As Boulding observes:
“Accountants measure capital in terms of actualities, as the primary by-product of the accounting income measurement process; and that economist in terms of potentialities, in order to measure economic income.”
The accountant uses market prices (either past or current) in measuring income based upon recorded transactions which may be verified. Current values, if used in accounting income, utilise the historic cost transactions base before updating the data concerned into contemporary value terms.
The economist, on the other hand, uses predictions of future flows stemming from the resources which have the subject of past transactions. The accountant basically adopts a totally backward-looking or expost approach, and consequently ignores potential capital value changes.
The economist, on the other hand, is forward looking in his model and bases his capital value on future events. Under accounting income, the accountant aims to achieve objectivity maximization while measuring income for reporting purposes. The economist is free of such a constraint and is quite content in his model which may have large-scale subjectivity.
As a result, the two income concepts appear to be poles apart in concept and measurement certainly the accountant would find the economic model almost impossible to put into practice in financial reporting, despite its great theoretical qualities. On the other hand, the economist would not find the accounting model relevant as a guide to prudent personal conduct.
Conventional accounting income possess a limited utility for decision-making purposes because of the historical cost and realisation principle which govern the measurement of accounting income. Changes in value are not reported as they occur. Economic concept of income places emphasis on value and value changes rather than historical costs. Economic income stresses the limitations of accounting income for financial reporting and decision-making purposes.
Similarities:
- Both involve measurement and valuation procedures.
- Both use the transactions for income measurement.
- Capital is an essential ingredient in income determination.
- In a world of certainty and with perfect knowledge, accounting income and economic income as measures of better-offness would be readily determinable and would be identical. With such knowledge, earnings for a period would be the change in the present value of the future cash flows, discounted at an appropriate rate for the cost of money.
- Under current cost accounting, the reported income equals economic income in a perfectly competitive market system. During periods of temporary disequilibrium and imperfect market conditions, current cost income may or may not approximate economic income.
