Income is an important concept in economics as well as in accounting. Accountants prepare an income statement to measure a company's income for a given accounting period. Economists are concerned with measuring and defining such concepts as national income, personal income, disposable personal income, and money income versus real income. In each field the concept of income is defined in slightly different terms.
For accounting purposes, income is distinguished from revenues. A company's revenue is all of the money it takes in as a result of its operations. Another way of defining a company's revenue is as a monetary measure of outputs, or goods sold and services rendered, with expense being a monetary measure of inputs or resources used in the production of goods or services. On the other hand, a company's net income or profit is determined by subtracting its expenses from its revenues. Thus, revenues are the opposite of expenses, and income equals revenues minus expenses. For example a store may sell $300 worth of merchandise, for which it originally paid $200. In that example the company's revenue is $300, its expense is $200, and its net income or profit is $100. Other expenses that are typically deducted from sales or revenues include salaries, rent, utilities, depreciation, and interest expense.
When looking at a company's income statement, it is easy to distinguish between revenues, which appear at the top of the statement, and net income, which appears at the bottom. In other contexts, however, it is easy to confuse the two through improper usage. It is misleading to refer to revenues as income, for a company with revenues of $1 million is much different than a company with net income of $1 million.
Since revenues increase owners' equity in a company, and expenses decrease owners' equity, income can also be defined as the increase in owners' equity due to transactions and other events and circumstances from nonowner sources. If we recognize that income results in an increase in owners' equity, then it becomes clear that income is not the same as a company's cash receipts. For example, a company may increase its cash account by taking a loan from a bank. Such an increase in cash does not increase owners' equity, though, because there is also an increase in the company's liability to the bank.
For personal income tax purposes, gross income is money received by an individual from all sources. Many of the items that the Internal Revenue Code defines as income and that are called income on tax form 1040 are actually revenues, such as dividend income, investment income, and interest income. The Internal Revenue Code also provides for exclusions and exemptions as well as for nontaxable types of income to arrive at the concept of taxable income.
While accountants measure a single company's income for a specific accounting period, economists are concerned with the aggregate income for an entire industry or country. In looking at an entity as a whole, economists define its gross income as the total value of all claims against its output. That is, when goods are produced and services are rendered by the entity, workers, investors, the government, and others have a claim against those goods and services. Workers are paid wages or salaries, investors receive interest payments for their investment, and the government collects taxes. The total value of these claims represents the entity's gross income and is equal to the total value added through activities that have contributed to the production of the entity's goods and services.
In looking at the economy as a whole, economists view gross national income as the total of all claims on the gross national product. These include employee compensation, rental income, net interest, indirect business taxes, capital consumption allowances, incomes of proprietors and professionals, and corporate profits. National income includes all compensation paid to labor and for productive property that is involved in producing the gross national product. In addition, about 20 percent of national income includes such items as depreciation or capital consumption allowances, indirect business taxes, subsidies less surpluses of government enterprises (such as the U.S. Postal Service), and business transfer payments to employees not on the job.
Personal income includes all payments received by individuals, including wages, transfer payments such as sick pay or vacation pay, and the employer's contribution to Social Security. Personal income differs from national income in two important aspects: (1) some national income is received by entities other than individuals, and (2) some individuals receive personal income from social insurance programs that are not connected with producing the current gross national product.
Disposable personal income is the amount of personal income that remains after an individual's taxes have been paid. It is estimated that approximately 70 percent of the gross national income ends up as disposable personal income. The remaining 30 percent includes such items as depreciation, retained corporate profits, and the government's net tax revenue.
Economists also distinguish between money income and real income. While money income is measured in terms of the number of dollars received, real income is measured by the purchasing power of those dollars. After all, what is important is not how much money you earn, but how much you can buy with that money. Economists use a deflator based on a price index for personal goods and services to calculate an individual's real income from his or her money income. Since rising prices reduce the dollar's purchasing power, real income provides a truer measure of buying power than does money income.
[ David P. Bianco ]
Meigs, Robert F., et al. Accounting: The Basis for Business Decisions. IIth ed. Boston: Irwin/McGraw-Hill, 1999.