# Annual Income

## Definition:

Income is money (or some equivalent value) that an individual or business gets, usually in exchange through investing capital or providing a good or service.

## Overview:

Income, technically, comes from the concept of revenue. Revenue, in accounting definition, is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Revenue arises from the following transactions and events:

1. The sale of goods (whether produced by the entity for the purpose of sale or purchased for resale);
2. The rendering of services;
3. Construction contracts in which the entity is the contractor. A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use;
4. Deposits or receivables yielding interest; and
5. Dividends from investments in shares of stock that are not accounted for using the equity method.

In General term, payment received in lieu of services or goods are called income, for example, salary received by any employee is his income. There are different type of income that can be considered depending on its source, for example, personal income, household income, national income, business income and many more.

Accordingly, for an individual, income is the total amount a person earns in a given period from all taxable wages, tips, and investment income like dividends and interest. For a business, income is the amount an entity earns after rendering services and/or selling goods in the ordinary course of its operation or any activities incidental thereto.

## Annual Income, defined.

Annual income refers to how much income a person earns in one year, fiscal or calendar, before deductions. It is the gross cumulative amount earned by an individual in a span of twelve (12) months. To simply put it, annual means year and income means money earned. Knowledge of annual income, specially in computing such, is very important when it comes to filing taxes or applying for a loan.

## Sources of Income

The following are just the most common sources of income every person encounter.

1. Salary and wages – the regular payment by an employer to an employee for employment that is expressed either monthly or annually.
2. Bonuses, commission and tips – an income given by the employer on top the regular salary. This normally lies on the discretion of the employer in recognition the employee’s work performance.
3. Investment income – generated by investing money as capital in exchange of a dividends, capital gains and interests.
4. Operating income – a company’s earning power from its operations before deduction of operating costs.

## Gross Annual Income versus Net Annual Income

You may encounter the terms “gross” or “net” connecting with the annual income. Gross annual income is your earnings before tax, while net annual income is the amount you’re left with after deductions. For a business, net income is sometimes referred to as profit, which is derived after deducting all the operating costs and expenses incurred in its operation.

## Measurement

In a business financial aspect, income is derived and measured using three common approaches, namely, (1) transaction or operation approach; (2) activities approach; and (3) balance sheet approach.

### 1. Transaction or Operation Approach

The transaction, or operation, approach is the most commonly-used approach. With this approach, accounting is done during the course of operations. This means that profit (or loss) from a given service line or product is booked right away.

Additionally, it separates out income from operations and any other external sources.

When the reporting period ends, say the end of a quarter, you had already booked the cost basis for assets and liabilities when they were incurred. There’s no need to try to go back and figure out values in the past; they are already logged.

### 2. Activities Approach

The activities approach is an assessment of an organization’s activities, instead of the transactions. In this way, it differs from the operations approach. Income is documented when certain activities or events take place, not as a result of specific transactions. In the activities approach, these activities trigger the recording of income: planning, purchasing, production, sales.

This approach is similar to the transaction approach; the activities approach is a little broader in scope, looking at an activity or event versus individual transactions.

### 3. Balance Sheet Approach

Comparison of the closing values (Assets minus outsider’s liabilities) of a firm with the values at the beginning of that accounting period is called as Balance Sheet approach. In above value, an addition to capital will be subtracted and addition of drawings will be added while computing the business income of a firm. Since, income is calculated with the help of Balance Sheet hence called as Balance Sheet approach.

## Computation

Basically, annual income for an individual can be computed by converting the hourly, daily, weekly, or monthly rates by following these formulas (with the assumption that an individual works for eight hours per day, 5 days a week and 50 weeks a year):

• Hourly: annual income = rate per hour x 2,000
• Daily income: annual income = rate per day x 250
• Weekly: annual income = rate per week x 50
• Monthly: annual income = rate per month x 12

For business entities, computation of annual gross income differs in certain ways. Measurement of the income is based on an accrual concept. Income is earned depending on the accounting period applicable to the entity. Therefore, a receipt of cash and income earned are the two different things. We can say that income is earned only when it is actually realized and not necessarily, when it is received.

## Accounting period

For the measurement of any income concerns, instead of a point of time, a span of time is required. Creditors, investors, owners, and government, all of them require systematic accounting reports at regular and proper intervals. The maximum interval between reports is one year, as it helps a businessman to take any corrective action.

## Illustrations

Illustration 1: Ann is a clerk and earns an hourly wage of $5 and works 40 hours a week. On top of that, she is given a commission of 20% of her annual income before any deductions. Compute her gross annual income. Answer: Her gross annual income is$12,000. This is computed as follows:

$$Annual\: income = (rate\: per\: hour\: x\: 2,000) + Commission$$

where, Commission = annual income x 20%

Gross Annual income = ($5 x 2,000) + (20% x$5 x 2,000)

= $12,000 ______________________________________________________________________________ Illustration 2: Brad is a graphic artist freelancer and earns a monthly income of$900. On top of that, he is given a commission of 20% of his annual income before any deductions. During the year, Brad paid a monthly rent of $100, semi-annual car loan of$800 and a monthly internet expense of $40. Compute her gross annual income, total annual deductions and annual net income. Answer 1: Gross annual income is$12,960.

Answer 2: Total annual deduction is $3,280. Answer 3: Total annual net income is$9,680.

Solutions:

$$Annual\: income = (monthly\: income\: x\: 12) + Commission$$

where, Commission = annual income x 20%

Gross Annual income = ($900 x 12) + (20% x$900 x 12)

= $12,960 $$Annual\: deduction = annual\: rent + annual\: car\: loan + annual\: internet\: expense$$ = ($100 x 12) + ($800 x 2) + ($40 x 12)

= $1,200 +$1,600 + $480 =$3,280

$$Annual\: Net\: Income = Gross\: Annual\: Income - Total\: Annual\: Deductions$$

= $12,960 +$3,280

= $9,680 _____________________________________________________________________________ Illustration 3: ABC Corp’s a retail and service company. During the year, the company’s financials are as follow: • Receipts from: • Construction Materials:$78,000
• Service Billings: $170,000 • Miscellaneous:$12,000
• Cost of Goods Sold: $100,000 • Salaries and Wages:$20,000
• Rent Expense: $15,000 • Advertising Expense:$35,000
• Cost of repairs resulting from fire: $50,000 Required: Question 1: Given the above information, calculate ABC Corp’s Annual Gross Income. Question 2: Given the above information, calculate ABC Corp’s Net Income. Question 3: Using the above information, calculate ABC Corp’s Operating Income. Question 4: Using the above information, calculate ABC Corp’s Gross Profit. Answers and Solutions: Answer to Question 1$260,000

Explanation: Receipts from the sale of construction materials, rendered services and other miscellaneous income earned incidental to the business’s operations.

Answer to Question 2$40,000 Explanation: Sales of$260,000 minus $220,000 of total expenses. Answer to Question 3$90,000

Explanation: Operating Income is intended to represent income from typical business operations.  As a result, expenses resulting from a fire would certainly not be included when calculating Operating Income.)

Answer to Question 4$160,000 (Sales minus Cost of Goods Sold) ______________________________________________________________________________ ## Relevance of Computation of Annual Income The household income and annual operating income are good indicators of a financial health of an individual or a business entity as a whole, respectively. The financial state of a business or individual impacts their way of living and purchase decisions. By monitoring their respective inflows, an entity or an individual can easily identify their expenses, create a budget, and better understand where and what they spend their money on if they have a clear picture of their annual income. On the other hand, federal government make use of the citizen’s annual income as source of its financial capacity. Such income then become the basis of imposing federal and local taxes. Taxes support national defense programs, roadway construction, social service programs, public health and education. Without taxpayer support, many of these programs cannot exist. It is believed that taxes are the bloodstream of the federal government. ## How to Calculate Taxable Income There’s no hard and fast formula for calculating taxable income, as a taxpayer’s total annual taxable income depends on his tax deductions, filing status and the standard deduction. Just know that the goal is to take the maximum amount of deductions possible to lower the tax bill. In order to have a smooth way of calculating the annual taxable income, the following steps can be followed: • Figure out the total taxable income for the year, including both earned and unearned income. • Calculate the adjusted gross income. The adjusted gross income is the gross annual income, with any adjustments (or above the line tax deductions) subtracted. • Subtract any standard or itemized tax deductions from the adjusted gross income. • Subtract any tax exemptions that an individual is entitled to, like a dependent exemption. • Once done subtracting any tax form adjustments, deductions, and exemptions from the gross income, taxable income figure will now the Illustration 4: Computing taxable income John Doe is an independent investor. During the year end December 31, 2020, he hired an accountant to help him figure out his tax responsibilities for the year. His books contained the following financial data: • Gross salary –$46,910
• Interest earnings – $225 • dividend income –$80
• one personal exemption – $3,650 • Itemized deduction –$7,820
• adjustments to income – $1,150 Required: What amount would John report as taxable income? Taxable Income =$34,595

His federal tax is determined based on his taxable income.

To calculate his taxable income, follow these four steps:

1. Calculate Gross Income

3. Calculate Deductions

4. Calculate Taxable Income

Step 1: Calculate GROSS INCOME

$$Gross\: Income = Gross\: salary + Interest\: earnings + Dividend\: income$$

Gross salary: + $46,910 Interest earnings: +$225

Dividend income: + $80 Gross Income:$46,910 + $225 +$80 = $47,215 Step 2: Calculate ADJUSTED GROSS INCOME $$Adjusted\: Gross\: Income = Gross\: salary - Adjustments\: to\: Income$$ Total Gross Income (computed above): +$47,215

Adjustments to Income: – $1,150 Adjusted Gross Income:$47,215 – $1,150 =$46,065

Step 3: Calculate DEDUCTIONS

There are two options:

1. Standard Deduction and exemptions,
2. Itemized Deductions and exemptions.

The majority of people filing a 1040 use the Standard Deduction. However, for this problem we will use Itemized Deductions because that information is given in the problem statement.

$$Deductions = itemized\: deduction + one\: personal\: exemption$$

Itemized Deduction: $7,820 One personal exemption:$3,650

Deductions: $7,820 +$3,650 = $11,470 Step 4: Calculate TAXABLE INCOME $$Taxable\: Income = Adjusted\: Gross\: Income - Deductions$$ Adjusted Gross Income (computed above):$46,065

Deductions (computed above): $11,470 Taxable Income:$46,065 – $11,470 =$34,595