Proceeds

Receipts are the receipt of natural or legal fruits in respect of the property. The right to receive income may also accrue to a non-owner by law or with the owner's consent. Income from production or operations, business income, and benefits received are all earnings.

Simply put, it is legal interest income. Economics classifies earnings into spiritual earnings, real earnings, and monetary earnings. We generally discuss the latter two, real and monetary, the most. Real gains are much broader in scope. 

All increases in material wealth are real gains (e.g., houses, land), while monetary gains are simply increased in the monetary value of assets.

The concept of gain in accounting is called accounting gain. According to the traditional view, accounting revenue is the difference between realized income and corresponding expenses from transactions during the enterprise period.

Yield is the rate of return on an investment and is generally expressed as an annual percentage. It is calculated based on the prevailing market price, par value, coupon rate, and time to maturity. For companies, the yield is the net profit as a percentage of the average capital employed.

The return on investment ratio reflects the profitability of the investment. 

When the ratio is significantly lower than the company's return on net assets, it indicates that its foreign investment is a failure and the structure of foreign investment and investment projects should be improved. 

When the ratio is much higher than the general corporate return on net assets, there is a suspicion of profit manipulation, and the reasonableness of each return should be further analyzed.

Economic Concepts

Historically, the concept of gain first appeared in economics. Earnings are explained as "that part of capital which is not eroded which can be consumed" by Adam Smith, the author of  Wealth of Nations, and regarded earnings as an increase in wealth. 

In 1890, Alfred Marshall introduced Adam Smith's "increase in wealth" view of earnings into the business in his Principles of Economics. He introduced the economic idea of earnings, distinguishing between real capital and value-added earnings.

At the beginning of the 20th century, the famous American economist Irving Fisher developed the theory of economic returns. In his book The Nature of Capital and Earnings, he first analyzed the concept of earnings in terms of their manifestations and proposed three different forms of earnings:

• Spiritual gain - spiritual satisfaction
• Real gain - increase in material wealth
• Monetary gain - increase in the monetary value of an asset

Among the three benefits mentioned above, there are both measurable and non-measurable ones. For example, mental gains are not measurable because they are too subjective. 

On the other hand, monetary gains are easily measurable because they do not consider the static concept of currency change. Therefore, economists focus only on the study of real gains.

The economist Lindherr explains earnings as the increase in capital value over time, considering earnings as interest. 

According to Landherr, the difference between interest and expected consumption in a given period is savings (the amount of capital growth in that period). At the same time, earnings are the sum of consumption and savings in a given period.

In 1946, the famous British economist J.R. Hicks, in Value and Capital, developed the concept of earnings into the general concept of economic gain. 

He argued that the practical purpose of calculating earnings was to give people an idea of what they could consume without making themselves poor. 

Accordingly, he gave a generally accepted definition: "the maximum amount that a person can consume during the period, provided that the same level of affluence is maintained at the end and beginning of the period."

 Hicks' definition, while primarily directed at individual earnings, is equally applicable to businesses. 

In the case of a business, this definition can be understood as the maximum amount that can be allocated to a business during the cost accounting period, provided that it has the same amount of capital at the end of the period as at the beginning of the period.

Since Hicks' concept of earnings does not specify what "equal affluence means," this concept constitutes the basis for several revenue streams. 

As a result, this concept of earnings has formed the basis of many debates on earnings. In addition, it has greatly impacted the theory of accounting earnings, especially capital preservation. 

In accounting, it is customary to refer to "maintaining the same level of affluence" as capital preservation.

Accounting Concepts

The concept of earnings in accounting is called accounting income. Accounting revenue is the difference between the realized revenue and the corresponding expense from the enterprise's period transactions. It has the following characteristics.

Accounting revenue is based on the actual economic operations of the enterprise. It is derived from the sales revenue earned from products or services, less the costs expended to generate the actual sales revenue. 

These economic operations include both external and internal transactions. Business activities with outside parties result in the transfer of assets or liabilities of the enterprise. Because it is usually a direct monetary receipt or expenditure, its measurement is generally exact. 

The use or transfer of assets within an enterprise is usually not measured exactly because it is not a direct monetary receipt or expenditure. 

According to traditional accounting, changes in value resulting from changes in market prices or expected prices are not included in internal asset transfers. 

When a transaction occurs, the price of the old asset is usually transferred to the new asset, which is the transaction method of measuring income. 

The transaction method naturally leads to determining earnings at the time of sale or transaction and the cost transfer convention in accounting.

Accounting earnings are based on the assumption of accounting phasing. It refers to the results of the production and operations of a business in a particular period. Earlier accounting earnings were calculated on a cash basis. 

On the other hand, modern accounting earnings are calculated by dividing current income and expenses on an accrual basis after proper matching. However, earnings determined on a cash basis are more easily accepted by users.

The cost of calculating accounting earnings is presented at the historical cost. Since the enterprise's assets are valued at historical cost in the current accounting practice, the consumed cost derived by the transaction method naturally transfers historical cost. 

Thus, the cost as one of the important factors in determining the revenue is also the historical cost.

The determination of accounting revenue to follow the principles of revenue recognition. The current accounting practice and legal opinion on earnings are that earnings can only be generated after the conditions related to the increase in asset value are met. 

Gains and appreciation must be able to be measured objectively and be certain or immutable. In addition, some economic operations or accounting events must also substantiate them. 

In other words, the determination of accounting revenue is based on two principles: the realization principle of revenue determination and the robust principle of revenue determination. 

According to the realization principle of revenue recognition, enterprise revenue should be divided into operating revenue and profit or loss from holding. Operating income must be determined after key events such as goods or services sales. 

Gains or losses on holdings are realized gains or losses on assets, while unrealized gains or losses due to price changes are not recognized.

When there are multiple accounting methods to choose from for a certain economic operation, the method that will not overestimate earnings should be chosen, which includes not overestimating revenue and not underestimating expenses.

Accounting revenue depends on a reasonable proportion of revenue and expenses. Therefore, costs that do not relate to the current period should be carried forward as assets to be expensed in future periods.

Accounting income is subject to the prudent principle. According to the prudent principle, when multiple accounting methods are available for a particular economic operation with an enterprise, the method that neither overestimates nor devalues earnings should be selected. 

Enterprises manipulate earnings to pursue profit uniformity, mostly overestimating earnings and subjectively choosing the period to arrange for appreciation.

Concept Comparison

Since economists understand earnings as the absolute increase in real material wealth, accountants consider the difference between the value of output over the value of input as earnings. Thus, there is a contradiction between the two concepts of earnings.

• Difference between realized gains and all gains

Accounting earnings include only realized earnings and exclude unrealized gains and losses. Economic income, on the other hand, treats the operating income of a business in the same way as the profit from holding, regardless of whether the income has been realized. 

Therefore, accounting income is generally smaller than economic income, and the difference is mainly the profitability of the holdings.

• Difference between historical cost and current value

Accounting earnings follow the historical cost principle and the matching principle, which are conducive to objectively reflecting the business management responsibility of the enterprise management. 

However, due to the inherent shortcomings of the historical cost principle, revenue is measured at a current value while expenses are charged at historical cost. 

This makes the calculation of accounting revenue lack inherent logical unity and makes it difficult to implement the matching principle so that the book value of assets does not reflect their actual value, and the cost is not fully compensated. 

In contrast, economic income is measured at its current value, which reflects the actual value of assets and facilitates full compensation of costs.

• Difference between financial capital preservation and physical capital preservation

Accounting income maintains financial capital preservation. That is, it only requires that the monetary value of the owner's input is not eroded, and the part of the enterprise's income exceeding the value of the input is treated as accounting income. 

Accounting focuses on reporting the financial results of operations. On the other hand, economic income maintains the preservation of physical capital and recognizes income only when the actual production capacity of the owner's input resources is preserved. 

It is believed that only when the actual production capacity of the enterprise is maintained can the reproduction of the enterprise proceed smoothly. 

Physical capital preservation is more meaningful than financial capital preservation in determining earnings, but it isn't easy to measure.

Earning Options

The inherent flaws of accounting earnings can be identified by comparing and analyzing the above two concepts of earnings. 

Accounting earnings do not consider the effects of inflation, profits from holdings, goodwill enhancement, and value changes but only pursue reliability, verifiability, and measurability, thus affecting enterprises' profitability and going concerns. 

Since the 1950s, accounting scholars have been paying attention to absorbing some reasonable kernel of the earnings concept of economics and guiding the earnings concept of modern accounting theory toward the earnings concept of economics.

In 1985, the conceptual framework (SFAC) NO.6, published by the Financial Accounting Standards Board (FASB), elaborated on earnings. 

In 1989, the IASB's Framework for the Preparation and Presentation of Financial Statements explicitly stated that earnings also include unrealized gains. In 1997, the FASB's FASB N0.130 required the presentation of comprehensive income. 

In 1998, the IASC's IAS NO.1 required the preparation of a statement of changes in equity, i.e., a statement of comprehensive income, including a statement of held gains reflecting the enterprise's assets.

The earliest efforts in this area were made by Canning, Alexander, Muniz, and Sprouse, among others. For example, economists were cited in Canning's 1929 book, Economics in Accounting. He believed that the value of an asset is determined by the present value of the asset's future cash flows.

In their article "A Primer on the Major Accounting Principles of Business, "Muniz and Sprouse emphasized the need to determine profits promptly. 

They also emphasized the need to improve the comparability and understandability of financial reporting by delineating the effects of operating earnings, profits from holdings, and price changes.

Edwards and Bell followed this in their 1961 book, Theory, and Measurement of Corporate Earnings. They defined operating profit for the period as the amount by which sales revenues exceeded production and selling costs. 

Realizable cost savings is the increase in the price of assets owned during the period. Also, realizable cost savings is the difference between the historical cost of goods sold and the current purchase price. 

On the other hand, realized capital gains are the amount sales proceeds exceed historical costs when disposing of long-lived assets. 

They emphasize that any complete earnings analysis should consider realized and unrealized held earnings and categorize them by source. 

Failure to record held earnings when they occur can result in earnings for the period not being faithfully reflected. Moreover, such actions can misallocate revenues to unrelated costs when assets are sold later. 

On the other hand, operating income and profit from holdings are usually generated by different management decisions and use different circular patterns. Therefore, evaluating both equally would weaken the usefulness of the income statement.

Researched and authored by Zezhao Fang | LinkedIn

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