Income in the Context of Hicks and Fischers Theories - Literature review Example

Income in the Context of Hick’s and Fischer’s Theories al Affiliation) Introduction The concept of income has been awarded various forms of definition from different stakeholders; these differences have been attributed to the different perspectives and opinions regarding income (Parker & Harcourt, 1969). However, in the general description and definition of income, it has been referred as the savings as well as the consumption opportunities gained by a certain business or non-business entity. The level or the amount of income made by any business or non-business entity is usually evaluated or assessed within a specific period of time. In most cases, it is usually assessed in regard to the amount of profits expressed in monetary values within an organization or business entity (Norton, 1946). There are various theoretical perspectives that have been greatly applied to describe the concept of income in the contemporary society. These theories vary from one stakeholder to another owing to the difference in regard to understanding of issues ascribed to income. The International Accounting Standards Board and the Financial Accounting Standards Board are the major organs that stipulate procedures applied in issues ascribed to financial reporting: These organs have recommended certain theories that can be applied to facilitate issues of financial management (Bromwich, Sunders & Macve, 2010). This discussion will focus on the description of income as indicated by the Hicksian Income theory and Fisher’s Theory. Moreover, it shall focus on the challenges that have been associated with the Hicksian Income theory in Accounting Policy. Income in the Context of Hicksian Theory Hick applied three theories that guided his understanding and description of income; the first theory of income as described by Hick is based on his idea that: The amount of income of an individual is the maximum value of resources that can be consumed by an individual within a specific period of time and still remains stable with regard to possess of such resources just like at the beginning of that period (Hicks, 1946). This is referred as the number one measure of income. This theoretical perspective according to Hick is based on various economical facets as in: Evaluating the level of welloffness regarding to the Net Present Value of his future financial cash flows; this is achieved by evaluating the individual’s cash flows at that time plus the present capital value together with the capital value at the beginning indicated as time zero (0). The corpus of capital value according to Hick is equal to the Present Value of the individual’s Free Cash Flows from a specific amount of time to the future time period. That is, the cash flow that has been realized within a period of time together with the variation in the value of the individual’s capital over that specific period of time (Bromwich, Sunders & Macve, 2010). The secondary theory proposed by Hick to describe the concept of income is that; it entails the value of the resources that can be consumed by an individual within a period of one year and still remains in a position to consume the same amount of resources in the up-coming years. Hick asserts that this theory is based on the idea of calculating the ex ante income and the aggregate of discounted values of the projected future incomes within the period of planning followed by allocation to each subsequent year (Hicks, 1946). Bromwich and his colleagues argue that the logic behind this theory is based on the fact that it prevents an ex post counter-part. In addition, the third theoretical perspective that was applied by Hick to facilitate the understanding of income; this is referred as the Income Number three. It is an ideology based on the definition of income by Hick as the maximum amount of the value of resources that can be consumed by a person within a period of one year and still project to consume the same value of resources in real terms in the subsequent years (Whittington, 2008). That is, according to Hick, income is the total value of resources that can be consumed by an individual within a period of one year in real terms, while his real wealth remains intact. Income according to Fisher’s Theory Another theoretical perspective that has been used to define income is the theory of income as described by Professor Fisher. To begin with, Fisher defines income as the flow of services within a specific period of time, while on other hand; he describes income as the quantity of wealth that exists in a period within a particular period of time (Fisher, 1965). According to Fisher, the corpus of wealth owned by an individual entails the possession of material objects. They also go ahead and identify the specific definition of services according to Fisher, which asserts that services are basically the resultant benefits of wealth that an individual or an organization accrues within a particular period of time. According to Professor Fisher, wealth that provides benefits (services) may be held by an individual within an instant period of time. During this time, this person is subjected to receiving benefits of the services provided by the wealth. Fisher goes ahead and specifically points out that the Income Theory and the Income Taxation in Practice are not focused on the changes with the capital but rather the services that are accrued from the capital. In regard to Fisher’s view, the two concepts, the Income Theory and the Income Taxation in Practice are usually subjected to confusion with many people arguing that the changes in capital are capital gains therefore concluding that they are services, while in the real sense, capital gains are not capital and thus are not services, which does not make them income. Professor Fisher also introduces a notation that can be used to facilitate a simple understanding of income according to his theory. Specifically, notations include: Y= Psychical Service gained; this may include incidences of satisfaction as well as dissatisfaction that are usually generated by a specific quantity of wealth estimated in dollars within a specific period of time interval (Fisher, 1965). Challenges of the Application of the Hicksian Theory in Accounting Policy according to Bromwich, Sunders and Macve Despite the fact that the Hicksian Theory plays a great role in facilitating accounting issues, specifically income, there are various challenges that have been identified and discussed to a great extent by many scholars. Among the scholars that have identified the challenges of application of these theories in accounting policy are Bromwich, Sunders and Macve, who goes into a great detail of discussion major to elaborate the challenges to economic stakeholders. Foundations of Accounting The first challenge associated with the application of the Hicksian theory of income to accounting policies is associated with the first income theory number 1 (Bromwich, Sunders & Macve, 2010). This concept has been studied and advanced by many economic scholars. However, the major challenge evident in the case of application of this theory in a real accounting scenario occurs in the sense that it can only be determinable and objective in the case that it is applied in a perfect market, which is not easily available in the real economic scenario. According to Bromwich, Sunders and Macve, a perfect market occurs in the case that: Every claim, resource et cetera, on projected future cash flows is commoditized into a scenario of exchangeable assets and ever person is subjected to fair pricing as well as discount rates. Therefore, the application of the Income Number theory according to Hick cannot be valid since such perfect markets are rare in the real economic sector. Evaluation of a Company’s Net Assets or Firms In regard to firm’s net assets, the application of the income number theory according to Hick is also questionable, with regard to its credibility and validity. Despite the fact that there are myriad economic researches that have been undertaken to show the relationship between Hick’s argument on capital value and the measures of assets and liability, there is a major challenge that has been identified by the International Accounting Standards Board and the Financial Accounting Standards Boards, which states that it is quite challenging to identify the changes in the net assets and their relationship with the notion of Income Theory Number 1. This is due to the numerous and substantial restrictive assumptions that are required to facilitate the handling of the changes. These may subject the economic analysts to incidences of uncertainty, which is not appropriate in the units of accounting as well as the intentions of management. The applicability of the Hick’s mode of firm’s asset evaluation is supported by examples that were applicable during the 19th century i.e. the example of the mill owner: Bromwich, Macve and Sunders cites that this could be a challenge owing to the fact that the mode of asset management and control in the 21st century has changed over time and is continuously changing. Applicability of Income Tax ex Post Taking a careful analysis of the theories of income by Hick, as depicted by Bromwich, Sunders and Macve, Hick asserts that accounting approaches requires the accountants to be objective in order to facilitate the minimization of incidences of disagreements that might arise when the accountants apply financial measurement approaches that may not be applied by the real owners of businesses. According to Hick, the duties of accountants entail the application of long traditional modes of accountancy even in scenarios whereby the measurement of sales and trades can simply be undertaken by carrying forward the company’s inventories at cost. From this perspective, it clear that Hick identifies the aim of an ex post measure of a company’s income (variation in the company’s market value) but does not indicate the foundations used to measure the change in the firm’s assets as required by the International Accounting Standards Board and the Financial Accounting Standards Board. This may pose a great problem to effective accounting. Hick also asserts that the application of the ex post income no. 1 is characterized certain challenge i.e. the fact that they lack significance in evaluating business significance. However, according to Bromwich, Sunders & Macve, the Hicksian theory with regard to the application of ex post income no.1, can only be applied to assess the progress of a business in relation to assessing the business statistical history. Applicability of the Income ex ante Another major challenge that has been noted with the application of the Hick’s Income Theory Number 1 ex ante, emanates in accounting assets and liability. Hick’s ex post calculation is based on a general principle that asserts that “bygones are bygones”, that is, post calculations cannot be used to assess the current conduct of any business or organization (Ronen, 2008). This principle undermines the efforts of FASB and IASB directed towards evaluation of asset-liability perspectives to serve the objectives of complete accounting decision making owing to the fact that it cannot be used for overall future decision making. In addition, Bromwich Sunders and Macve identify inefficiency with regard to application to project future financial situation of a company. The main challenge in this case, is the application of ex post income to project future financial status; this is due to the fact that there are certain forms of bias that may be performed by accountants during the process of financial evaluation. For instance; the ex ante income theory as described by Hick, entails a scenario whereby past financial status of a company is subjected to assumption hence creating jeopardy in the quality of the results of the financial analysis. Conclusion Bromwich, Sunders and Macve 2010, presents various accounting perspectives that indicates the reason why the Hicksian Income theories cannot be applied to support the application of the asset-liability dimension as described by the International Accounting Standards Boards as well as the Financial Accounting Standards Board. Generally, the ideas presented by Hick do not indicate the practical measures that can be applied to evaluate the amount of income reflected in accounts. This is due to the fact that the ideas presented by Hick, involves a scenario where the analysis of change in the value of a firm is undertaken on the firm itself rather than focusing on the asset values of the firm. The evaluation of a firm using Hick’s ideas is performed among proprietors instead of the entire business enterprise. Consequently, the measure of income as indicated is basically driven by variations in the firm’s income expectation (Cash Flows), instead of the already realized financial cash flows within a specific period of time. Bibliography WHITTINGTON, G. W. (2010). Measurement in Financial Reporting. Journal of Accounting, Finance and Business Studies, 46(1), 104-110. Bromwich, M., Macve, R., & Sunder, S. (2010). Hicksian Income in the Conceptual Framework. Journal of Accounting, Finance and Business Studies, 46(3), 350-376. Fisher, I. (1906). The nature of capital and income,. New York: The Macmillan Company;. Fisher, I. (1965). The nature of capital and income.: by Irving Fisher.. New-York: Augustus M. Kelley. Ronen, J. (2008). To Fair Value or Not to Fair Value: A Broader Perspective. Abacus, 44(2), 181-208. Whittington, G. (2008). FAIR VALUE & CONCEPTUAL FRAMEWORK: AN ALTERNATIVE VIEW. Journal of Accounting, Finance and Business Studies, 44(2), 104-120. Hicks J. R. (1946), ‘Income’ in Value and Capital, 2nd Edition, OUP, reprinted in R. H. Parker and G. C. Harcourt (1969) Readings in the Theory and Measurement of Income Harcourt (1969) Readings in the Theory and Measurement of Income, CUP Fisher, I. (1930). The Theory of interest: as determined by impatience to spend income and oportunity to invest it. New York: Augustus M. Kelley. Fisher, I. (2011). The nature of capital and income. Boston: A.M. Kelley. Norton, F. E. (1946). Readings in the theory of income distribution,. Philadelphia: The Blakiston Co.. Parker, R. H., & Harcourt, G. C. (1969). Readings in the concept and measurement of income;. London: Cambridge U.P.. Read More