MEASUREMENT OF BUSINESS INCOME- ALL YOU NEED TO KNOW
Business is an economic activity , which is related with continuous and regular production and distribution of goods andservices with a view to earn profit. In accounting, the term income refers to business income. Business income can bedefined as excess of revenue over expenses. Revenue means inflow of assets frombusiness operations which result in an increase in the owner’s equity. Theterms ‘expense’ refers to the amount incurred in the process of earningrevenue. If revenue exceeds expenses, it would represent income or profit. Ifexpenses exceed revenue, it would represent loss. Thus,
Net Income (Profit/Loss) = Total Revenue-Total Expenses.
Measurement of business income (or profit) is very important due to the following reasons:
(a) An important objective of most business enterprises is to earn profit.
(b) Income-tax is levied on the basis of income earned by the individuals and others from various sources including profits and gains from business and profession.
(c) Management takes various types of decisions such as dividend and transfer to reserves on the basis of income earned during the accounting period.
(d) Income is used as a basis for evaluating the performance of the enterprise.
Therefore, it is necessary to ascertain the correct amount of income (or profit) earned during the period. According to Accounting Standard-5, “all items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period unless an Accounting Standard requires or permits otherwise.” The word income is also used for aggregate of revenues and gains. But in this chapter, the word income is used in the sense of net profit earned by the enterprise.
Measurement of Business Income
There are following two factors which are helpful in the estimation of an income −
- Revenues− Sale of goods and rendering of services are the way to generate revenue. Therefore, it can be defined as consideration, recovered by the business for rendering services and goods to its customers.
- Expenses− An expense is an expired cost. We can say the cost that have been consumed in a process of producing revenue are the expired cost. Expenses tell us – how assets are decreased as a result of the services performed by a business
Measurement of Revenue
Measurement of the revenue is based on an accrual concept. Accounting period, in which revenue earned, is the period of revenue accrues. Therefore, a receipt of cash and revenue earned are the two different things. We can say that revenue is earned only when it is actually realized and not necessarily, when it is received.
Measurement of Expenses
- In case of delivery of goods to its customers is a direct identification with the revenue.
- Rent and office salaries are an indirect association with the revenue.
There are four types of events (given below) that need proper consideration about as an expense of a given period and expenditure and cash payment made in connection with those items −
- Expenditure, which are expenses of the current year.
- Some expenditure, which are made prior to this period and has become expense of the current year.
- Expenditure, which is made this year, becomes expense in the next accounting periods. For example, purchase of fixed assets and depreciation in next up-coming years.
- Expense of this year, which will be paid in next accounting years. For example, outstanding expenses.
Featuresof Business income
Following are the main features of businessincome:
- a) Businessincome is based on the transactions (both external and internal) actuallyentered into the business enterprise.
- b) Businessincome always pertains to a given accounting period.
- c) Businessincome is based on the recognition and measurement of revenues.
- d) Businessincome requires the measurement of all business expenses in terms of historicalcost.
- e) Businessincome is based on the principle of matching realized revenues of the periodwith corresponding relevant costs.
- f) Businessincome is the excess of the net worth of the business enterprise at the end of accounting period.
Objectives of Measurement of BusinessIncome
- a) To measure of Managerial Efficiency.
- b) To measure the Creditworthiness or short termliquidity.
- c) To provide base for calculation of tax.
- d) To help in taking investments decisions.
- e) To assist in taking dividend decision.