Analyzing Operating Activities 6 CHAPTER
6 CHAPTER Analyzing Operating Activities
Income measurement Concepts Illustration Facts Company with $100,000 in cash Buys condo for $100,000 Rents condo for $12,000 per year End of the first year: Condo valued at $125,000
Illustration Facts: • Company with $100,000 in cash • Buys condo for $100,000 • Rents condo for $12,000 per year • End of the first year: Condo valued at $125,000 Income Measurement Concepts
Income measurement Concepts lustration Facts Net (free)cash flow=$(88,000) Operating cash flow = $12,000 Economic income $37,000 ($12, 000 rental income $25, 000 holding gain) Accounting income=$11, 500( $12,000 rental income -$500 depreciation*) Condo's useful life is 50 years and its salvage value is $75,000--yearly straight-line depreciation is $500
Illustration Facts: • Net (free) cash flow = $(88,000) • Operating cash flow = $12,000 • Economic income = $37,000 • ($12,000 rental income + $25,000 holding gain) • Accounting income = $11,500 ($12,000 rental income - $500 depreciation*) *Condo’s useful life is 50 years and its salvage value is $75,000—yearly straight-line depreciation is $500 Income Measurement Concepts
Income measurement Concepts Economic comer Two measures reflect the economic concept economic ncome ● permanent income
Economic Income: Two measures reflect the economic concept • economic income • permanent income Income Measurement Concepts
Income measurement Concepts Economic comer Equals net cash flows the change in the present value of future cash flows Measures change in shareholder value--reflecting the financial effects of all events in a comprehensive manner Includes both recurring and nonrecurring components rendering it less useful for forecasting future earnings potential Related to Hicksian concept of income-income includes both realized(cash flow) and unrealized(holding gain or loss)components
Economic Income: • Equals net cash flows + the change in the present value of future cash flows • Measures change in shareholder value—reflecting the financial effects of all events in a comprehensive manner • Includes both recurring and nonrecurring components— rendering it less useful for forecasting future earnings potential • Related to Hicksian concept of income—income includes both realized (cash flow) and unrealized (holding gain or loss) components Income Measurement Concepts