income accounting is a term which is applied to the description of the various
types of economic activities that are taking place in the community in a certain
institutional framework. In
national income accounting, we are concerned with statistical classification of
the economic activity so that we are able to understand easily and clearly the
operation of the economy as a whole. In
national income accounting the following distinctions are drawn between:
forms of economic activity, namely, production, consumption, and
accumulation of wealth;
sectors or institutional division of the economy; and
types of transactions, such as sales and purchases of goods and services,
gifts, taxes, and other current transfers.
national income accounting, a transactor is supposed to keep a set of three
accounts in which transactions are recorded:
In the first account, incomes and outgoings relating a productive
activity of the transactor are brought together.
The difference between the two shows the profit or gain.
The second account seeks to show how this profit and any other income
that accrues to the transactor are allocated to different uses.
The excess of income over outlay is saving.
The third account shows how this saving and any other capital funds are
used to finance the capital expenditure or to give loans to other transactors.
Since in an
economy, there are numerous transactors, therefore, they are grouped into
sectors. In a sector, accounts of a
same type are consolidated. The
‘sector accounts’ form the units in a system of national income accounting.
entry book-keeping: Both national income
accounting system and individual income accounting system are based on the
method of double-entry book-keeping. For
example, under individual income accounting, a cash sale is recorded as a debit
in Cash Account and as a credit in Sales Account.
Whereas, in national income accounting, the cash transactions are not
separately presented. Cash balances
are recorded in the capital transaction account.
The difference is that the national income accounting does not record the
second entry in detail.
vs. collective individuals: Individual income
accounts or private accounts relate to an individual businessman or a corporate
firm. Whereas, the national income
accounts are closely related to all the businessmen or corporate firms in the
loss account: Individual income accounts are
usually presented in the form of a Profit and Loss Account or Income Statement
which shows the flow of income and its allocation during a year.
The Balance Sheet shows the stock of assets and liabilities at the end of
the year. The Profit and Loss
Account of a private businessman resembles in national income accounting to what
is called the Appropriation Account. The
only difference is that in private accounting, the profit often includes some
elements of costs such as depreciation on plant and machinery and fees paid to
the directors of the company. On
the other hand, in national income accounting, these incomes are shown net.
There is no counterpart at all of a Balance Sheet in national income
accounting since there is a great difficulty in collecting such a huge bank of
data accurately and completely especially on uniform basis.
Income Statement of a Typical Firm
the year ended on December 31, 2005
To Sales Account
(50,000 units @ Rs. 25)
National Product Account 2004-05
(500 million units @ Rs. 25)
picture of the economy: The national income
accounts or social accounts give a clear picture of the economy regarding the
GDP, national income, per capita income, saving ratio, production, consumption,
disposable income, capital expenditure, etc.
It gives a clear view of the health of the economy and the way in which
it functions. It also gives a view
on the living standard of the people.
of efficiency and stability of the economy: To
foster the economic growth, any government has to see what she has achieved in
the past and what has to be done in the future.
For this purpose, the preparation of national income accounts is quite
inevitable for the promotion of economic efficiency and stability.
It helps the government to set the national priorities, such as
education, inflation, unemployment, defence, social development, and
industrialisation, etc., in long-term and medium-term planning.
It also helps the planner to set the economic objectives to be achieved
in the near future. Thus it serves
the purpose of planning and controlling tool for public administrators.
of economic welfare: Measurement of economic
welfare is another purpose of the preparation of social accounts.
Through social accounting, we can know at a glace to what extent the
masses are better off than at the time when planning started.
of different sectors of the economy: Through
the study of national income accounts, the reader is in a position to
inter-relate different sectors of the economy.
For example, through the study of national income accounts, we can know
that Pakistan’s industrial sector is largely dependant on agriculture sector,
because most of the raw materials like cotton, silk, leather, sugarcane, milk,
poultry, etc. are supplied from agriculture.
fiscal and trade policies: The national income
accounts are very essential for the statesmen, governments, and politicians,
because they help them to efficiently formulate different economic policies,
including monetary policy, fiscal policy and trade policy.
In the absence of national income accounts, the economic planning would
GNP is the basic
national income accounting measure of the total output or aggregate supply of
goods and services. It has been
defined as the total value of all final goods and services produced in a country
during a year. GNP is a ‘flow’
variable, which measures the quantity of final goods and services produced
during a year. For calculating GNP
accurately, all goods and services produced in any given year must be counted
once, but not more than once.
The primary purpose
of national accounts is to provide a coherent and comprehensive picture of the
economy. To be concise, these estimates tend to answer questions such as:
(a) What is the output of the economy, its size its composition, and its uses? And
What is the economic process by which this output is produced and
distributed? These questions are addressed below in relation to estimation of
GDP/GNP and final uses of the GNP.
The gross national
product (GNP) is the market value of all final goods and services, produced in
the economy during a year. GNP is measured in Rupee terms rather than in
physical units of output. Gross domestic product (GDP) is a better idea to
visualize domestic production in the economy. GDP may be derived in three ways
or in combination of them.
Approach: It measures the contribution to
output made by each producer. It is obtained by deducting from the total value
of its output the value of goods and services it has purchased from other
producers and used up in producing its own output, i.e.:
VA = value of output
– value of intermediate consumption.
value added by all producers equals GDP.
Approach: In this approach, consideration is
given to the costs incurred by the producer within his own operation, the income
paid out to employees, indirect taxes, consumption of fixed capital, and the
operating surplus. All these add up to value added.
Approach: This approach looks at the final
uses of the output for private consumption, government consumption, capital
formation and net of imports & exports.
According this approach, GDP is the sum of following four major
Personal consumption expenditure on goods and services,
Gross private domestic investment,
Government expenditure on goods and services, and
export to the rest of the world.
The concepts of expenditure approach and cost approach have been illustrated in the following diagram of circular flow of a simplified two-sector economy:
In the above
diagram, the upper loop represents the ‘expenditure’ side of the economy. Through this loop, all the products flow from business sector
to household sector. Each year the
nation consumes a wide variety of final goods and services: goods such as bread,
apples, computers, automobiles, etc.; and services such as haircuts, health,
taxis, airlines, etc. But we
include only the value of those products that are bought and consumed by the
consumers. In our ‘two-sector
economy’ illustration, we have excluded the investment expenditure, government
expenditure and taxes from GDP calculation.
The lower loop
represents the ‘cost or revenue’ side of the economy.
Through this loop, all the costs of doing business flow. These costs include wages paid to labour, rent paid to land,
profits paid to capital, and so forth. But
these business costs are revenues that are received by households in exchange of
supplying factors of production to the business sector.
statisticians and economists have to be very careful in measuring GDP or
preparing national income accounts. The
following precautionary measures should be taken:
source of data: All the data for national
accounts are collected from different sources, including surveys, income tax
returns, retail sales statistics, and employment data.
Inaccurate or incomplete data can severely damage the integrity of the
national accounts. The economists
have to be very careful in collection and selection of national income
Measuring Some Services in Money Terms:
National Income of a country is always measured in money terms, but there are
some goods and services, which cannot be measured, in monetary terms.
Such goods include, the services of the housewife, housemaid and the
singing as a hobby by an individual. Exclusion
of these services from the national income, underestimate the national income
in the Economy/The Growth of “Black Economy”:
The “Black Economy” refers to that part of economic activity, which is
undeclared and therefore unrecorded for tax purposes and is therefore deemed to
be ‘illegal’. Many illegal
activities in the economy generally escape both the law and measurement in the
national income. Such illegal
activities include, smuggling, drug trafficking and all parallel market
transactions. Since such activities
are outlawed, income earned, through them are not captured in the national
income, thus, under estimating the national income account.
double counting: While measuring GDP, we have
to distinguish between the three forms of goods:
product: A final product is one that is
produced and sold for consumption or investment.
good: Intermediate goods are semi-finished
goods or goods-in-process.
material: Raw materials are unfinished and
double or multiple counting, it is necessary to add the value of only those
goods which have reached their final stage of production, i.e., final goods, and
to not add the value of intermediate goods and raw materials, which are already
included in the value of final goods. GDP,
therefore, includes bread but not wheat, cars but not steal.
Including All Inventory Change in GNP:
Firms generally record inventories at their original cost rather than at
replacement costs. When prices
rise, there are gains in the book value of inventories but when prices fall,
there are losses. So, the book
value of inventories overstates or understates the actual inventories.
Thus, for correct computation of GNP, inventory evaluation is required.
This is achieved when a negative valuation of inventory is made for
inventory gains and a positive valuation is made for losses.
Problem of Price
national income is measured in money terms, fluctuation in the general price
level will render unstable the measuring rod of money for national income.
When prices are rising, the national income figures are rising even
though production might have gone down. On
the other hand, when prices are falling, GNP is declining even though the
production might have gone up. To
solve this problem, economist and statisticians have introduced the concept of
Capital Gain or Losses from GNP:
Capital gain or losses accruing to property owners by increase or decrease in
the market value of their asset are not included in GNP computation because such
changes do not result from current economic activities.
Such exclusions underestimate or overestimate the GNP.
added: ‘Value added’ is the difference
between a firm’s sales and its purchases of materials and services from other
firms. In calculating GDP earnings or value added to a firm, the
statistician includes all costs that go to factors other than businesses and
excludes all payments made to other businesses. Hence business costs in the form of wages, salaries, interest
payments, and dividends are included in value added, but purchases of wheat or
steel or electricity are excluded from value added. The following table illustrates the concept of value addition
Non-productive transactions are
excluded from GDP: The non-productive
transactions are excluded from GDP measurement. There are two types of non-productive transactions:
financial transactions: Purely financial
public transfer payments, which do not add to the current flow of goods such
as social security payments, relief payments, etc.
private financial transactions, such as receipt of money by a student from
his father, etc.
and selling of marketable securities, which make no contribution to current
Sale proceeds of second-hand goods.
GDP is the most
widely used measure of national output in Pakistan.
Another concept is widely cited, i.e., GNP.
GNP is the total output produced with labour or capital owned by
Pakistani residents, while GDP is the output produced with labour and capital
located inside Pakistan. For
example, some of Pakistani GDP is produced in Honda plants that are owned by
Japanese corporations. The profits
from these plants are included in Pakistani GDP but not in Pakistani GNP.
Similarly, when a Pakistani university lecturer flies to Japan to give a
paid lecture on ‘economies of under-developed countries’, that lecturer’s
salary would be included in Japanese GDP and in Pakistani GNP.
product (NNP) or national income at market price can be obtained by deducting
depreciation from GNP. NNP is a sounder measure of a nation’s output than GNP,
but most of the economists work with GNP. This
is so because depreciation is not easier to estimate.
Whereas the gross investment can be estimated fairly-accurately.
NNP equals the
total final output produced within a nation during a year, where output includes
net investment or gross investment less depreciation.
Therefore, NNP is equals to:
= GNP – Depreciation
It is the net
market value of all the final goods and services produced in a country during a
year. It is obtained by subtracting
the amount of depreciation of existing capital from the market value of all the
final goods and services. For a
continuous flow of money payments it is necessary that a certain amount of money
should be set aside from the GNP for meeting the necessary expenditure of wear
and tear, deterioration and obsolescence of the capital and ‘it should remain
In the above
definition, the phrase ‘maintaining capital intact’ is meant to make good
the physical deterioration which has taken place in the capital equipment while
creating income during a given period. This
can only be made by setting aside a certain amount of money every year from the
annual gross income so that when the income creating equipment becomes obsolete,
a new capital equipment may be created out.
If the depreciation allowance is not set aside every year, the flow of
income would not remain intact. It
will decline gradually and the whole country will become poor.
(NI) or national income at factor cost is the aggregate earnings of all the
factors of production (i.e., land, labour, capital, & organisation), which
arise from the current production of goods and services by the nation’s
economy. The major components of
national income are:
(i) Compensation of employees (i.e., wages, salaries, commission, bonus, etc.);
(ii) Proprietors income (profits of sole proprietorship, partnership, and joint stock companies);
(iii) Net income from rentals and royalties; and
Net interest (excess of interest payments of the domestic business system
over its interest receipts and net interest received from abroad).
National income can
be calculated as follows:
National Income = NNP
– Indirect Taxes + Subsidies
Personal Income is
the total income which is actually received by all individuals or households
during a given year in a country. Personal
income is always less than NI because NI is the sum total of all incomes earned,
whereas, the personal income is the current income received by persons from all
sources. It should be noted here
that all the income items which are included in NI are not paid to individuals
or households as income. For
instance, the earnings of corporation include dividends, undistributed profits
and corporate taxes. The
individuals only receive dividends. Corporate
taxes are paid to government, and the undistributed profits are retained by
firms. There are certain income
items paid to individuals, but not included in the national income, commonly
known as ‘transfer payments’. Transfer
payments include old age benefits, pension, unemployment allowance, interest on
national debt, relief payments, etc. Personal
income can be measured as follows:
Income = NI at Factor Cost – Contributions to Social Insurance – Corporate
Income Taxes – Retained Corporate Earnings + Transfer Payments
is that income which is left with the individuals after paying taxes to the
government. The individuals can
spend this amount as they please. However,
they can spend in categorically two ways, i.e., either they can spend on
consumption goods, or they can save. Therefore,
the disposable personal income is equal to:
Income = Personal Income
– Personal Taxes
Income = Consumption +
It is very
important to take a brief tour of major components or particulars of national
accounts or product accounts. In
this way, we can thoroughly understand the concept of GDP/GNP:
Deflator: The problem of changing prices is
one of the problems economists have to solve when they use money as their
measuring rod. Clearly, we want a
measure of the nation’s output and income that uses an invariant yardstick. This problem can be solved by using ‘price index’, which
is a measure of the average price of a bundle of goods. The price index is used to remove inflation from GDP or to
deflate the GDP, that is why, it is also called ‘GDP deflator’.
The function of GDP deflator is to convert the ‘nominal GDP’ or the
‘GDP at current prices’ to ‘real GDP’.
The formula of real GDP is as follows:
GDP or PQ represents the total money value of final goods and services produced
in a given year, where the values in terms of the market prices of each year.
Real GDP or Q removes price changes from nominal GDP and calculate GDP in
constant prices. And the GDP deflator or P is defined as the price of GDP.
produces 100,000 litres of coconut oil during the year 2005 at a price
of Rs. 25 per litre. During
the year 2006, she produces 110,000 litres of coconut oil at a price of
Rs. 27 per litre. Calculate
nominal GDP, GDP deflator and real GDP (using 2005 as base year).
2006, the nominal GDP grew by 18.8%.
P1 = Current year price ÷ Base year price = Rs. 25 ÷ Rs. 25 = 1
Current year price ÷ Base year price
Rs. 27 ÷ Rs. 25 = 1.08
2006, the real GDP grew by 10%.
and Capital Formation: Investment consists of
the additions to the nation’s capital stock of buildings, equipment, and
inventories during a year. Investment
involves sacrifice of current consumption to increase future consumption. Instead of eating more pizzas now, people build new pizza
ovens to make it possible to produce more pizza for future consumption.
economists, investment means production of durable capital goods.
In common usage, investment often denotes using money to buy shares from
stock exchange or to open a saving account in a bank. In economic terms, purchasing shares or government bonds or
opening bank accounts is not an investment.
The real investment is that only when production of physical capital
goods takes place.
can be further categorised as:
investment: Gross investment includes all the
machines, factories, and houses built during a year – even though some were
bought to replace some old capital goods. Gross
investment is not adjusted for depreciation, which measures the amount of
capital that has been used up in a year.
investment: Gross investment does not adjust
the deaths of capital goods; it only takes care of the births of capital.
However, the net investment takes into account the births as well as
deaths of capital goods. In other
words, net investment is adjusted for depreciation. Therefore, the net investment plays a vital role in
estimating national income:
Gross Investment – Depreciation
Expenditure: Government expenditures include
buying goods like from roads to missiles, and paying wages like those of marine
colonels and street sweepers. In
fact, it is the third great category of flow of products.
It involves all the expenditures incurred on running the state.
However, it does not mean that GDP includes all the government
expenditures including ‘government transfer payments’.
The government transfer payments, which include payments to individuals
that are not made in exchange for goods and services supplied, are excluded from
GDP measurement. Such transfers payments include expenditures on pensions,
old-age benefits, unemployment allowances, veterans’ benefits, and disability
payments. One peculiar government
transfer payment is ‘interest on national debts’. This is a return on debt incurred to pay for past wars or
government programmes and is not a payment for current government goods and
services. Therefore, the interests
are excluded from GDP calculations.
(d) Net Exports: ‘Net exports’ is the difference between exports and imports of goods and services. Pakistan is facing negative net export situation since her birth, except for few years. The biggest reason is that Pakistan is a developing nation and consistently importing capital goods and final consumption goods from developed countries at much higher prices. Whereas, we export raw materials and intermediate goods at lower prices, which have less demand due to their poor quality or because of availability of much cheaper substitute goods in the market.