The return number used in the traditional accounting ROE ratio is the earnings number from the income statement. But the return number in clean surplus is not the earnings number.
The income statement (see the following section) shows money in, money out, and the amount left over.
Note: I understand the term “net income” may be used differently in the accounting profession than we are using it here. But to keep everyone on the same page, let's use it this way: Our net income is earnings before non-recurring items such as extraordinary items and future liabilities according to the American Institute of CPAs (AICPA) position.
I mentioned that the income statement shows money in and money out. Well, up to a point:
Here's what we have: Money in, which is revenues and/or sales, minus money out, which is all recurring (operating) expenses. The amount left over is called “net income.”
By the way, net income is the return portion of Clean Surplus ROE, and is figured the same among all companies. However, net income is not the return portion of traditional accounting ROE. Please read on.
If this were all there was to it, we would use the net income as the return portion in the ROE ratio to compare one company to another because it is simply money in, money out, and thus, profit (net ...