Question

Describe Economic Income and Economic Depreciation, and suggest why they can provide a superior measure of expected future performance. Use a numerical example to demonstrate the benefits of Economic Income and Economic Depreciation

Answer 1

ECONOMIC INCOME:

Economic income is the way for companies to account for changes in the value of a given asset in the market. It generally recognizes unrealized gains, in addition to recognizing realized gains.

A change in market value rather than cash received is the perfect example of an economic income. Economic income or loss recognizes all gains and losses whether realized or unrealized. This differs from accounting income which only recognizes realized gains: gains resulting from an actual business transaction. This defines the difference of accounting earnings vs economic earnings.

For income to be realized it must result from actual business transactions. A change in market value rather than cash received is economic income and not accounting income. When a gain or loss is unrealized it may or may not be accounted for in general. This depends on the placement of the gaining or losing asset in the balance sheet. Despite that this gain or loss may be accounted for, the fact that it is unrealized makes it an economic income or loss. The term economic income was born out of the need for financial accounting income vs economic income comparisons.

EXAMPLE:

ASSET	VALUE(PREVIOUS YEAR)($)	VALUE(CURRENT YEAR)($)	ECONOMIC INCOME ($)
Building	100,000	120,000	20,000
Land	90,000	90,000	0

ECONOMIC DEPRECIATION:

Economic depreciation is the decline in the economic value of an asset over time. It also may refer to consumption of fixed capital for the purpose of estimating national accounts. Economic depreciation, in general, can be attributed to indirect factors such as a decline in the quality of living, deterioration in the quality of neighborhood roads, etc.

Economic Deprecation is the opposite of Economic Income.

EXAMPLE:

ASSET	VALUE(PREVIOUS YEAR)($)	VALUE(CURRENT YEAR)($)	ECONOMIC DEPRECIATION ($)
Building	100,000	80,000	20,000
Land	90,000	85,000	5,000

Economic Income and Depreciation is like the current value of an asset giving us a clear view of the performance to be expected from an asset. If an asset is depreciating from a few years then it can be expected for it to reduce in the forthcoming future also and vis-à-vis for Economic Income. By this we find that Economic Depreciation and Income provide a superior measure of expected future performance of an asset.