Question

Difference between accounting income and economic income

Answer 1

Accounting income or loss recognizes realized gains and losses, and does not recognize unrealized gains and losses.Economic income or loss recognizes all gains and losses, whether realized or unrealized.

When the related transaction is settled or completed, gains and losses are realized. Until atransaction is completed, any gains or losses related to that transaction are considered unrealized. Unrealized gains and losses are also called paper gains or paper losses, because the nominal value of the assetor liability has changed, but thecash has not actually changed hands.

There are exceptions to the methodology of reporting net income, based solely on the historical cost of acquiredassets. US GAAP includes the principle of “Mark to Market Accounting.” Under this accounting principle, valuation of commodities, securities and other financial instruments on a company’s balance sheet are based on the market values of such assets.

For example, if the cost of a precious metal acquired by a company for use in its production process, such as using silver to produce a catalyst used by the petrochemical industries was $10 per troy ounce and the market value of silver increases to $ 15 per troy ounce, the company would value the silver on its balance sheet at $15 per troy ounce. It would also report the increase in inventory value as an element of its net income for the period being reported.

Answer 2

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