The following points highlight the five main areas where income information is used. The areas are: 1. Income as a Guide to Dividend and Retention Policy 2. Income as a Measure of Managerial Efficiency 3. Income as a Guide to Future Predictions 4. Income as a Means of Determining Tax 5. Income as a Guide to Creditworthiness and other Economic Decisions.
Area # 1. Income as a Guide to Dividend and Retention Policy:
Income information determines as to how much of a business enterprise’s periodic income can be distributed to its owners and how much shall be retained to maintain or expand its activities. The income is the maximum amount which can be distributed as dividends and retained for expansion.
However, because of the differences in accrual accounting and cash accounting income, a firm may not distribute the total recognised income as dividends. Liquidity and investment prospects are necessary variables for the determination of dividend policy.
Area # 2. Income as a Measure of Managerial Efficiency:
Income is regarded as an indicator of management’s effectiveness in utilizing the resources belonging to the external users. Income tends to provide the basic standard by which success is measured. Thus, income is a measure to evaluate the quality of management’s policy making, decision-making, and controlling activities.
The True-blood Committee Report comments:
“An objective of financial statements is to supply information useful in judging management’s ability to utilise enterprise resources effectively in achieving the primary enterprise goal.”
Area # 3. Income as a Guide to Future Predictions:
Income helps in predicting the future income and future economic events of a business enterprise as current income acts to influence future expectations. It helps in evaluating the worth of future investments while making investment decisions.
Area # 4. Income as a Means of Determining Tax:
Income figure determines the tax liability of a business enterprise. How tax is determined is important to management and investors both. The taxation authorities generally accept accounting income as a basis of assessing the tax.
Area # 5. Income as a Guide to Creditworthiness and other Economic Decisions:
Credit grantors—individuals and institutional both—require evidence of sound financial status before advancing loans to business enterprises. Income—current and future both—is a relevant data to determine a concern’s ability to repay loans and other liabilities at maturity. Besides, income figure is useful in other decision areas also such as pricing, collective bargaining, governmental, social and economic regulation and policies.