Financial Accounting Notes
Measurement of Business Income
Unit –
2: Business Income
Part A:
Measurement of Business Income
Measuring of Business Income
Business is an economic activity, which
is related with continuous and regular production and distribution of goods and
services with a view to earn profit. In accounting, the term income refers to
business income. Business income can be
defined as excess of revenue over expenses. Revenue means inflow of assets from
business operations which result in an increase in the owner’s equity. The
terms ‘expense’ refers to the amount incurred in the process of earning
revenue. If revenue exceeds expenses, it would represent income or profit. If
expenses exceed revenue, it would represent loss. Thus, Net Income
(Profit/Loss) = Total Revenue-Total Expenses.
Features
of Business income
Following are the main features of business
income:
a) Business
income is based on the transactions (both external and internal) actually
entered into the business enterprise.
b) Business
income always pertains to a given accounting period.
c) Business
income is based on the recognition and measurement of revenues.
d) Business
income requires the measurement of all business expenses in terms of historical
cost.
e) Business
income is based on the principle of matching realized revenues of the period
with corresponding relevant costs.
f) Business
income is the excess of the net worth of the business enterprise at the end of
accounting period.
Procedure for Measurement of Business income
a) First of
all, accounting year i.e., period of 12 months for which income is to be
calculated selected.
b) After
selection of the accounting year, revenue pertaining to it is identified. Realisation
concept is followed in the identification of revenue.
c) Then,
expenses incurred to earn the revenue are identified. Only expenses relating to
the relevant accounting year is to be taken into consideration.
d)
Excess of revenues over expenses represents
profits and excess of expenses over revenues represent loss.
Methods of Measuring Business Income
Following
are the methods of measuring business income:
a)
Net worth
method: As per
this method, the net worth i.e. Capital of a business enterprise at the end of
the accounting period is compared with the same at the beginning of the
accounting period. If capital at the end of the year is more than the opening
capital, there is a profit for the business enterprise or if capital in the
beginning is more than the closing capital, there will be a loss.
b)
Matching
Principle. Under this method, income of a business enterprise is determined
by matching revenues and expenses pertaining to a given accounting period. This
method is based on the income statement. For matching costs with revenues,
first revenues are recognized and then costs are incurred for generating those
revenues is recognized.
Objectives of Measurement of Business Income
a)
To measure of Managerial Efficiency.
b)
To measure the Creditworthiness or short term
liquidity.
c)
To provide base for calculation of tax.
d)
To help in taking investments decisions.
e)
To assist in taking dividend decision.
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