Economic Concepts of Income and Value Summary

Conventional accounting concepts of income and value possess a limited usefulness for decision making, because of the limitations inherent in the conventions of historical cost and realization which govern the measurement of accounting income. Under conditions of inflation, conservative asset values on the balance sheet contrast with over-optimistic income measurement in the income statement. Changes in value are not reported as they occur. Changing money values also undermine the stability of the unit of measurement in accounting.

Under conditions of certainty, economic income provides an ideal concept for financial reporting purposes. The value of the firm's future net receipts may be capitalized, thereby providing the investor with a basis for decision making.

The presence of uncertainty, which is the general rule, precludes the use of economic income because of its essentially subjective nature. Future cash-flows and discount rates cannot be estimated with certainty. For this reason, the accountant does not attempt to value the firm. Instead, financial reports are concerned with past performance, and the investor is required to make his own valuations from the information made available to him.

Despite these practical limitations, the importance of economic concepts of income and value lies in the emphasis they place on the importance of value and value changes rather than on historic costs. Moreover, they stress the limitations of accounting conventions such as the realization convention for financial reporting purposes, and emphasize the importance of the concept of capital maintenance to income measurement.

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Read on: Estimation of Ex-post Income

In the foregoing example, the income for the year 19X0 has been calculated on the basis that the expected future net receipts at the end of the year 19X0 remained the same as those at the beginning of the year. Under such conditions, ex-ante and ex-post income would be the same.

If, however, the present value of expected future net receipts at the end of the year 19X0 are different from the present value of those expected receipts at the beginning of the year, we may say that the ex-post income is different from the ex-ante income. The ex-ante income refers, therefore, to the estimated... see: Estimation of Ex-post Income