Concept of Income
Like any other profession, the context and content of the word can be interpreted differently according to different situations. The same holds in the accounting profession. The concept of income is interpreted differently according to the specifics of situation and context. In simple terms, Income is the amount of money an individual or business entity receives in exchange for offering a product or service with an invested capital. Individuals receive income in the form of wages or salaries. The business income comes from the sale of products and services. The business world considers cash inflow as ‘earnings’ that are subject to taxation.
The most understood the concept of income is generating cash flows for the services offered. However, it is very important to know in which context we use the concept of income. In many countries, the income is taxed under tax laws, and the same money is used by the government to undertake development and other economic activities for the growth of the country.
Types of income
The income can be broadly classified into two categories:
Income from salary, wage, house property, interest, business income, capital gain, dividend, pensions received during the assessment year is called taxable income in many countries especially India and the United States.
Some of the other concept of income may include, bonuses, rental income, fishing income, farming income, ESOPs, retirement funds, provident fund income, and stock options. Some of the less popular incomes may include, bartering income, jury duty, gambling, etc. In countries like India and the United States, the tax evasion is not appreciated
When we talk about taxable income, taxpayers are free to avoid the tax by taking necessary measures. Yet, tax evasion invites serious legal consequences for the taxpayers.
Tax avoidance and Tax evasion
You must be wondering about these terms, tax avoidance, and tax evasion. Isn’t it? Do not worry. I was one among you when I heard these two together 15 years back.
Tax avoidance is characterised as legal actions to use the tax system to discover methods to pay the lowest rate of tax, e.g. investing your savings and your spouse savings in the pension fund and any government-backed instruments to save tax.
On the other hand, tax evasion is an illegal step to prevent paying tax, e.g. not declaring income to the income tax and government authorities, hiding some of the sources of income, etc.
Examples of Taxable Income
For those individuals working with private sector business organizations, ordinary income is typically only made up of the wages and salaries they earn from their employer’s pre-tax. Let us take an example, individual works in a customer service job at Target and earns INR 3,000 per month, his annual ordinary income would be INR 36,000, derived as INR 3,000 x 12.
If he has no other income sources, this is the amount that would be taxed on his year-end tax return as gross income. Additionally, if the same person also owned a rental property and earned INR 1,000 a month in rental income, his ordinary income would increase to INR 48,000 per year. If the same person earned INR 1,500 in qualified municipal bond interest payments, that portion of income would be tax-exempt.
For businesses, ordinary income is the pre-tax profit earned from selling its product or service. For example, the retailer, Target, had INR 69.5 million worth of total sales or revenue in the year ended in January 2017. The company had INR 48.9 million in costs of goods sold (COGS) and INR 15.6 million in total operating expenses. Target’s ordinary income was INR 5 million, derived as follows:
INR 69,500,000 – INR 48,900,000 – INR 15,600,000
This is the amount of income that would be taxed for the year. Still, businesses are required to pay taxes quarterly.
Tax exempted income
Tax exempted income sources are not taxed under income tax laws. The governments of countries reserve the right to taxing and exempting certain sources of income.
For example, the funds invested in municipal bonds are exempted from tax since these funds are used for the development of infrastructure within the country.
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Concept of Income : Another Perspective
Hold on, we have not done yet with the concept and classification of income. There is another category under which the income is classified as shown below
- National Income
- Per capita income
- Personal Income
National Income is the total of income earned by all the citizens of the country during a period says one year. However, in economic terms, the national income reflects the total value of goods and services produced during a period.
Per Capita Income
Per capita income is the result we derive when the national total income is divided by its population. It can be measured both in a constant price level and the current price level. Generally, it gives a fair idea of the standard of living in the country.
Personal income is the money earned by the citizens of the country during a period. The income earned by an individual during the period is taxable under various slabs. The amount we get after deducting the tax component is the disposal income of an individual.
National Income Accounting
National income accounting is a method of recording business transactions that the government consumes to gauge the level of economic activities within the economy for a period. National income accounting tracks the revenues earned by the domestic companies, salaries, and wages paid to domestic and foreign employees, the amount of money spent on sales, and promotion activities by the companies and individuals living within the geographical territory of the country.
Even Though national income accounting is not accurate science, it offers useful intuition into how well an economy is performing, and where funds are being created and spent. When pooled with information concerning the associated populace, data regarding per capita income and growth can be analyzed over some time.
The data collected through national income accounting can be applied for a range of purposes, such as evaluating the current standard of living or the allocation of income within an inhabitant. Furthermore, national income accounting offers a method for comparing activities within various sectors in a country, as well as adjustments within those segments over time. A detailed analysis can help in deciding overall economic solidity within a nation.
For instance, the United States of America utilizes information concerning the current GDP in the creation of various policies. During the financial crisis of 2008, the GDP started to shrink as heightened market instability and changing supply and demand affected consumer spending and employment levels Consequently, President Barack Obama, after taking office in 2009, established an economic incentive package in reaction.
As an instance, the basic accounting personality for GDP, occasionally known as the national income identity, is computed using the subsequent formula:
GDP = consumption + investment + government spending + (exports − imports).
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