Defining and Reevaluating the Concept of Income - Literature review Example

Reviewing Fisher and Hicksian Incoming Theories Defining and Reevaluating the Concept of Income Introduction Bromwich, Michael, Macve, Richard, and Sunder (2010) seek to replace various accounting concepts in search of principles-based standards; the IASB/FASB project on the conceptual model has developed its approach on a known income definition by Hicks. The paper welcomes the use of various theories through various accounting standards practitioners and setters. The objectives of these standards risks being distorted, misinterpreted, and misunderstood of the chosen theory elements, which would otherwise lead to increase the level of distortion. Bromwich et al. (2010) argue that Boards have misquoted, misapplied, and misunderstood Hicksian concepts of income. The paper explores alternative approaches to income how Hicks suggests and the relevance of this debate over the conceptual framework and model (Bromwich et al. 2010). This paper reviews the models of national income and economic theory of national income accounting. Crisp and Tumer (2007) affirm that there are two main building blocks- the concepts of Fisher and Hicks concerning income being an expenditure level, which can be continued into the future, the general equilibrium, and the notion of income as a measure of welfare emerging from welfare economics. The income is defined as a construct that is closely related with the exchange of services and products which helps the companies in terms of generating cash receipts (Bromwich et al. 2010). The cash receipts generated as a result of the exchange of goods and services are called revenues in the language of accounting (Alvord, brown, and Letts 2004). The traditional concept of income was associated with the need to do something in order to qualify for receiving income or revenues. In the modern times, the concept of income changes as others does as well. Bromwich et al. (2010) confirm that the income is generally identified as a construct that causes an entity’s money supply to increase for a specific period of time. The means which help the organization in increasing cash reserves is called an asset whereas, the source that causes the money supply of the company to drain is known as expense or liability (Bromwich et al. 2010). The expense occurs when an organization has to pay money in order to keep its daily operations running and this particular head includes salaries of employees, utility bills and other office related short term costs. However, the liability is of two kinds (Auger et al. 2003). The first one is called short term liability that has to be paid within one year while the other one which is usually of a long term nature and has to be paid over the tenure of more than one year (Badelt and Weiss 1990). The companies always attempt to keep its expenses and liabilities less than the value of income. The notion of income changed a great deal whereas, other business models emerged that included no tangible product but they started to sell services such as hotels, medical professionals and even psychologists (Dowling and Pfeffer 1975). The revenues are generated against rendering services to the customer base in the industry. In the past times, services industry was not a common way of making a living but now it is considered the most lucrative one regarding its ability to help people in generating income. The professional lenders are also lending their money in order to obtain substantial level of return on the base amount. The capitalists are making money with the help of lending their financial resources to others and interest income is realized as a consequence. Bromwich et al. (2010) say that the traditional income’s definition is modified, and now one does not have to do anything for anyone in order to make the obscene amount of money. The professional lenders have accumulated financial power by either inheriting the wealth or they managed to make money by hard working in the early years of their life (Edvardsson & Gruber, 2011). The point is simple that professional lenders do not do anything for their lenders and do not share business risks with lenders as well but make a fortune by lending money (Bromwich et al. 2010). The abovementioned type of income is not identified by traditional philosophy of income that requires oneself to have a social exchange in order to become qualified for receiving an income. The modern definition of income was made out of twisting and turning the original one in order to make interest income a legitimate type of revenue (Edvardsson & Gruber, 2011). The contemporary economists are of the view that when one lends money to another then he or she expose him or herself to inflation risks and against them he or she has to compensate. Additionally, the interest income is identified as a rent of lent money according to the modern financial literature (Bromwich et al. 2010). The income’s definition has modified in order to accommodate different and newest realities in the business world (Fisher & Montalto, 2011). The income is also generated by individuals and companies through receiving royalties and other similar fees. The sources of income diversified but the basic underlying concept remained similar in the recent years (Greve & Salaff, 2003). The social exchange is the elemental notion that renders individuals and companies to qualify for receiving of money. The money is no doubt a conventional medium of exchange but other tangible things can also be used for the featured purpose. The whole idea is to help others in order to get helped. One has to scratch others back so that his or her’s can be scratched as well. The companies sell products and services in order to generate revenue while capitalists help businesses and individuals in the process of fulfilling financial needs in order to makeinterest income (Bromwich et al. 2010). Based on the above argument, it can be established that income is a result of effort or set of efforts that have been made in order to benefit the company, individual or set of individuals and the receiving party of efforts then compensates the provider by either paying money or helping them in any other possible way. In an informal setting, the efforts are paid off by returning the favors (Hemingway, 2005). The simplistic human psyche impresses people to return good deeds with equally generous acts (Bromwich et al. 2010). The problem lies with legality of favors and therefore, it is the legal duty of every individual to ensure that he or she should not suppress others’ rights in order to return the favor. The companies often identify lessening of expenses and production cost as income and this treatment is logical in nature as well because an income is an increase in financial reserves of the organization and as lessening of expenses and cost cause net level of financial resources to increase and that is why it is compulsory to treat lessening of costs and expenses as income. According to Bromwich et al. (2010) the lessening sales are treated and taken as a loss because when it happens potential income is lost and therefore, extremely committed businessmen treat lost sales opportunities as loss as well. The management is often defined as planned and calculated human behavior and the emphasis remains on human behavior and in the light of the above statement it can be argued that accounting treatments of a business reflect the personality of financial managers and if they are traditional minded then they might not consider lost sales as loss because they are more concerned with actually closing the deals and others who are more committed towards enhancing sales performance may burst in reaction to finding out that the customers are going back empty handed (Bromwich et al. 2010). Fisher’s Theory of Income Fisher attempts to identify the interest as a legitimate means of generating income. The theory treats interest as an index of return rates which incorporate various risks of lending. The lenders hedge against inflation and default risks (Mort, Weerawardena, & Carnegie, 2003). The money is losing value literally every passing moment. The new dollars are printed in obscene amounts every day and therefore, existing currency notes lose market demand and as a consequent, their price keeps on decreasing and in this way, the inflationary pressures are very real (Shaw, 2009). Fisher as a liberal economist identifies interest as an encouraged method of maximizing one’s financial returns and because of this reason, the philosophy of Fisher allows the companies to treat interest income equivalent to other sources of income (Bromwich et al. 2010). Fisher’s thoughts are being used in order to logically defend the practice of predatory lending. The companies consider interest income as revenue while they treat payments in this regard as expense and the abovementioned treatment of interest are backed up by Fisher’s mindset (Zou, 1994). Fisher is of the view that income is generated when a company or an individual is compensated against their services or products sold (Bromwich et al. 2010). The theorist establishes that generation of income is dependent on the legitimate presence of social exchange in which both parties are helped in one way or another (Peredo & Mclean, 2006). The legitimization of interest as an income and expense occurred when Fisher argued that lenders help companies and individuals in terms of getting through rough times and therefore, they should be compensated with interest payments so that they should not suffer from adverse effects of inflationary pressures. Hicks’ Theory of Income Bromwich et al. (2010) emphasize that Hick’s income analysis proceeded in steps. The first step he offered a general definition of concepts he thought to be central or basic. This is the maximum that the individual receiving income can consume during a given week and he or she still expects to be well off by the end of that week as he was at the beginning of the week. Hicksian used the week as a simplification to show that nothing much would be expected to change within the short period. Hicksian affirms that there is meaning on “as well of,” “maximum value,” and “still expect” on the income estimation. Bromwich et al. (2010) discuss the variations around this fundamental concept and named the concept as income 1. Hicks termed these concepts as approximations that are made by economists and businessmen. Hicks introduced another concept terming it income 2 that he derived from money capitalization of the value of money of an individual receipts (Bromwich et al. 2010). The expectations of rates of interest will vary, bringing about the flexibility, affirming that the second income definition would be more appropriate from property than income from an individual’s wage (Muntaner, 2013). Fisher’s Income Theory versus Hicks’ Income Theory and Accounting The Fisher’s income theory considers interest income as a legitimate one because lender is exposed to inflation risks and therefore, he or she qualifies to receive compensation and the previous description of lending is complementary to the prevalent accounting system in the world which treats interest benefit as income and expense in this regard as liability of short term nature (Bromwich et al. 2010). However, the theory of Hicks considers interest as an unethical way of making money and therefore, recommends businesses to handle cash on current value basis. The philosophy of Hicks’ needs a turnaround to happen in the ranks of international finance because it wants to eliminate interest altogether (Bromwich et al. 2010). The chances of Hicks’ theory becoming accepted as a financial norm in management are negligible, given the current economic mindset of international economic arena. Hicks’ Income Theory and Marxism Marxism is the leading economic philosophy of the world and therefore, it is the very base of accounting cycle. Marxism states that the organization is an entity developed in order to serve capitalistic objectives and goals of making more money (Bromwich et al. 2010). The accounting principles urge companies to meet their payment obligations with the debt on an immediate basis and that means that the accounting processing is also developed with the help of following Marxism (Peredo & Mclean, 2006). The Hicks’ income philosophy defines the underlying notions of the economic system and because of this very reason, cannot be implemented in the world of Marxism where capitalistic agendas are top priority of all fiscal activities. Conclusion This paper reviewed and analyzed the basic theoretical foundations of the construct known as income. Both of the leading economic philosophers who worked on the subject matter collectively argued that income is a byproduct of a social exchange which ends up at the climax where all the parties involved are benefitted (Bromwich et al. 2010). Hicks furthered his work and arrived at the conclusion that identified interest as an unethical construct because according to him, it is a means of exploitation (Badelt & Weiss, 1990). He added that capitalistic hands do not make any substantial amount of effort in order to earn the interest and therefore, Hicks’ school of thought tends to eliminate interest from international financial system (Bromwich et al. 2010). The Hicks’ philosophy does not support presence of interest and therefore, cannot become a leading economic framework in the present times. 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