INCOME METHOD

INCOME METHOD

As per this method, all the incomes that accrue to factors of production by way of wages, profits rent, interest, etc. are summed up to obtain the national income.

Components of Factor Income

The following are components of the Income Method. Sum of all the items given below is known as Domestic Income (NDP at FC)

1. Compensation of Employees (COE) –

Definition: COE is the amount paid to employees by employers for rendering productive services. It includes all the benefits received by employees from employers.

• Wages and Salaries in cash- It includes all the benefits, which are in monetary terms like wages, Salaries, bonus, commission, etc.
• Wages and Salaries in kind- it includes all the benefits in non-monetary terms like free house, car, medical facilities, etc.
• Employer’s Contribution to social security schemes – it includes contribution by an employer for social security schemas for Example- provident fund, gratuity, etc.

2. Rent and royalty-

Rent: is income from ownership of land and building. It includes both the actual rent (rent of left out land) as well as imputed rent (rent of self - occupied factors).

Royalty: refers to income received from granting leasing right of sub-soil assets. For example – Royalty from leasing of Iron mine, Gold mine, etc.

3. Interest –

Definition: Interest refers to the amount received from lending funds to a production unit. It involves both actual interest and imputed interest. For example, interest on loans taken for productive services only.

 It does not include the following:

• Interest paid by the government on National Debt.
• Interest paid by consumers as such interest is paid on loans taken for consumption purposes.
• Interest paid by one firm to another firm.

4. Profits –

Definition: Profits are excess of revenues over the expenditure of any corporation. It is a residual income.

This profit earned by an entrepreneur can be used for three purposes:

• Corporate Tax – it is a tax paid by a corporate to a government on total profits. It is also known as ‘Profit Tax’ and ‘Business Tax’.
• Dividend – it is divided part of profit given to share - holders. It is also known as distributed profits.
• Retained Earnings – Out of total profit a part is distributed among shareholders and a part is retained in business in business, this is kept for future as Retained Earning. It is also known as undistributed profits, Savings of the Private sector and Reserve & Surplus.

5. Mixed Income –

Definition: It is income generated by people who are self-employed. For example- Barber, farmers, etc. or unincorporated enterprises like the retail trader, small shopkeeper.

Mixed income arises from productive services of self-employed persons, whose income includes wages, rent, interest and profit. These elements cannot be separated from each other. For Example: the income of a doctor running a clinic at his residence.

Steps of Income Method

Step-1 Identify and classify the production units.

All the producing units are classified in Primary, Secondary and tertiary sectors.

Step-2 Estimate the factor income paid by each sector.

Factor incomes paid by each factor are classified under:

• Compensation of Employees,
• Rent and Royalty
• Interest
• Profit
• Mixed income.

Step-3 Calculate Domestic Income (NDP at FC)

When all factor incomes are summed up, we get domestic income (NDP at FC) i.e. NDP at FC= Compensation of Employees + Rent and Royalty + interest +profit + mixed income of self-employed.

Step–4 Calculating National income from Domestic income.

In the final step, we need to add NFIA to domestic income to get National Income.

National Income (NNPFC) = Domestic Income (NDPFC) + NFIA.

PRECAUTIONS OF INCOME METHOD

Transfer Income – Transfer incomes are not included in National income as such incomes are not productive and there is no value addition.

Income from the sale of second-hand goods – Sale of second-hand goods are not included in national income as their sale are already recorded when these were first sold. However, commission, brokerage or any other income is to be recorded.

Income from the sale of shares, bonds and debentures are not included- Such items are not included in national income, as they do not contribute to the current flow of goods and services. However, any brokerage or commission is to be included in national income.

Windfall gains- These are gains like on lottery, horse race, etc are not included as there is no productive activity.

The imputed value of services provided by owners of production unit be the included-  Imputed value of owner-occupied houses, interest on own capital, etc are included as it is a productive activity and add to flow of goods and services.

Payments out of past savings-  These Payments like death duties, gift tax, interest tax, etc are not included in national income as they are paid out of past savings and do not add to the current flow of goods and services.