Income Effect

Examples of Income Effect in the following topics:

• Impact of Income on Consumer Choices

  • The wealth effect differs slightly from the income effect.
  • The wealth effect reflects changes in consumer choice based on perceived wealth, not actual income.
  • Income effects on consumer choice grow more complex as the type of good changes, as different product and services demonstrate different properties relative to both other products/services and a consumers preferences and utility.
  • Income increases will thus affect the consumption of these goods interchangeably, resulting in increase in the quantity of either or both.
  • Break down changes in consumption into the income effect and the wealth effect

• Closing the Cycle

  • Closing the revenue accounts—transferring the balances in the revenue accounts to a clearing account called Income Summary.
  • Closing the Income Summary account—transferring the balance of the Income Summary account to the Retained Earnings account (also known as the capital account).
  • After transferring all revenue and expense account balances to Income Summary, the balance in the Income Summary account represents the net income or net loss for the period.
  • Closing or transferring the balance in the Income Summary account to the Retained Earnings account results in a zero balance in the Income Summary.
  • It is not closed to the Income Summary because dividends have no effect on income or loss for the period.

• Effects of GAAP on the Income Statement

• Other Comprehensive Income

  • Accumulated Other Comprehensive Income (AOCI) is all the changes in equity other than transactions from owners and distributions to owners.
  • Gains and losses on the effective portion of derivatives held as cash flow hedges

• Income Elasticity of Demand

  • Zero income elasticity of demand (YED=0): A change in income has no effect on the quantity bought.
  • Income elasticity of demand measures the percentage change in quantity demanded as income changes.

• Return on Assets

  • The Return on Total Assets ratio measures how effectively a company uses its assets to generate its net income.
  • The Return on Total Assets ratio is similar to the Asset Turnover Ratio in that both measure how effective a business's assets are in generating returns for the business.
  • $\frac { Net\quad Income }{ Average\quad Value\quad of\quad Total\quad Assets\quad for\quad Accounting\quad Period } =\quad Return\quad on\quad Assets$
  • $Return\quad on\quad Total\quad Fixed\quad Assets\quad =\quad \frac { Net\quad Income }{ Average\quad of\quad Fixed\quad Assets }$

• The Importance of Aggregate Decisions about Consumption versus Saving and Investment

  • In order to understand the effects of aggregate decisions of consumption, savings, and investment, we must look at aggregate demand (AD).
  • The aggregate demand curve is downward sloping but in variation with microeconomics, this is as a result of three distinct effects: the wealth effect, the interest rate effect and the exchange-rate effect.
  • The wealth effect is specifically related to the value of assets; market participants will adjust consumption in-line with their perception of the appreciation or depreciation of held assets (a home; equity investments, etc.).
  • The interest rate effect has to do with access to inexpensive funding, which provides an incentive to increase current period expenditures; while the exchange-rate effect has to do with expenditure decisions related to imports or foreign related expenditures, as the exchange rate is perceived to be favorable to the domestic currency, expenditures on foreign items or imports will increase.
  • Spending = Income – Net Savings = Income + Net Increase in Debt

• Comparing Statement of Cash Flows with the Income Statement

  • Income statements should help investors and creditors determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows through report of the income and expenses.
  • improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods, and

• Overview of Income Tax Accounting

  • In this method, the deferred income tax amount is based on tax rates in effect when the temporary differences originated.

• Pro Forma Income Statement

  • For example, when a transaction with a material effect on a company's financial condition is contemplated, the Finance Department will prepare, for management and Board review, a business plan containing pro forma financial statements demonstrating the expected effect of the proposed transaction on the company's financial viability.
  • A pro forma Income statement could be planned and prepared in advance, which includes the items below:
  • Income tax expense - sum of the amount of tax payable to tax authorities in the current reporting period (current tax liabilities / tax payable) and the amount of deferred tax liabilities (or assets).