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May 29, 2009

What is the transaction approach and balance sheet approach to measuring net income?

The transaction approach to measuring net income is the traditional bookkeeping and accounting method. That is, individual transactions such as each sale, each purchase, and every expense are recorded into general ledger accounts. At any point you can go to an account such as Salaries Expense for Sales Staff and see the year to date amount of such an expense. With the use of accounting software, an enormous quantity of transactions can be recorded into many detailed accounts.

I believe that the balance sheet approach is also referred to as the capital maintenance approach. Under the balance sheet approach one looks at the change in stockholders’ or owner’s equity to determine the amount of net income during the period between balance sheets. This approach requires that you exclude any additional capital from the owners as well as any dividends or withdrawals distributed to the owners. For example, if stockholders’ equity increased by $5 million with $2 million caused by the issuance of new shares of stock, and $1 million distributed as dividends, the net income would have been $4 million. We can verify the calculation with the following:  net income of $4 (an addition to equity) plus new investor money of $2 (an addition to equity) = $6 of additions to equity, minus dividends of  $1 (a decrease to equity) = $5 (the net increase to equity). Under this balance sheet approach you will not have the detailed information on revenues and expenses that would be available under the transaction approach.

Learn more about Stockholders’ Equity.

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Comments

24 Responses to “What is the transaction approach and balance sheet approach to measuring net income?”

  1. Michael F. Martin on May 29th, 2009 11:46 am

    But shouldn’t the two numbers end up being equal?

    Net income by the balance sheet approach should equal revenue minus expenses for the same period, right?

  2. Nicole on June 1st, 2009 10:06 am

    Yoric Inc, has two classes of capital stock outstanding: 25,000 shares of 5%, $100 par value cumulative preferred and 30,000 shares of $10 par value common.
    The company had a deficit of $160,000 at the beginning of the current year, and preferred dividends were three years in arrears. During the current year, the company earned net income of $970,000.
    What will be the balance in retained earning at current year, if dividend of 2.5 per share on the common stock?

  3. Timah on June 3rd, 2009 10:13 am

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  4. Ramon on June 3rd, 2009 11:08 am

    I am not familiar with the transaction approach for net income!

  5. ABDUL RAZAK on June 4th, 2009 10:24 am

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  9. sadaf on June 11th, 2009 5:53 am

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  10. qudsia ahmadi on June 13th, 2009 12:28 am

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  12. Vincent Ray Boron on June 26th, 2009 12:32 am

    Hello Sir,
    What is the difference between capital maintenance approach and transaction approach? and how to compute the net-income/loss of the entity under capital maintenance approach?Is there any formula?

    pls. answer…tnx……

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  21. qudsiasahar on September 14th, 2009 1:20 am

    what is balance per bank.

  22. ACoach on September 14th, 2009 6:47 am

    Balance per bank is the amount appearing on the bank statement or in the bank records.

  23. qudsiasahar on September 14th, 2009 11:14 pm

    what is deposit in transit?

    Qudsiasahar
    thank you.

  24. qudsiasahar on October 1st, 2009 12:59 am

    what is payout ratio?

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