Financial Accounting: In an Economic Context

SUMMARY OF KEY POINTS

Economic consequences associated with reporting net income.

Income is the most common measure of a company's performance. It has been related to stock prices, suggesting that equity investors use income in their decisions to buy and sell equity securities. It has been related to bond prices, indicating that debt investors use income in their decisions to buy and sell corporate bonds. Income is also used by credit-rating agencies to establish credit ratings. Various income measures are also found in contracts written among shareholders, creditors, and managers. Such contracts are normally designed either to protect the interests of creditors or to encourage managers to act in the interests of the shareholders.

Two different concepts of income: Matching and fair market value

The matching process measures income by first recognizing the revenues of a particular period and then subtracting from them the expenses necessary to generate the revenues. The fair market value concept measures income by comparing the fair market value of the firm's net assets at the end of a period to the fair market value of the net assets at the beginning of the period. For years the matching principle has provided the basis for income measurement, and it still does for both U.S. GAAP ...