Financial Accounting Theory and Analysis: Text and Cases, 11th Edition

The primary objective of financial accounting is to provide information useful to investors in making predictions about enterprise performance. The emergence of income reporting as the primary source for investor decision making has been well documented, and income reporting aids economic society in a variety of ways.¹ For example, the Study Group on Business Income documented the need for the income concept in society, and Alexander discussed the following uses of income in this work:

1. As the basis of one of the principal forms of taxation
2. In public reports as a measure of the success of a corporation's operations
3. As a criterion for determining the availability of dividends
4. By rate-regulating authorities for investigating whether those rates are fair and reasonable
5. As a guide to trustees charged with distributing income to a life tenant while preserving the principal for a remainderman
6. As a guide to management of an enterprise in the conduct of its affairs²

Income determination is also important because a company's value is related to its current and future earnings. Since the 1970s, the relationship of accounting information to the value of the enterprise has been of interest to accounting researchers. In Chapter 4, the efficient markets hypothesis (EMH) was introduced. EMH holds that a company's stock price reflects market consensus expectations about a company's future earnings ...