relation that governs the articulation of the income statement and balance sheet: = Book Valuet + or, in more operational terms, earnings for a period Book Valuet-1 Earningst Net Dividendst – are closed to book value and dividends are paid out of book value. Accordingly, Net Dividendst = (Book so, substituting into the dividend discount model Earningst Valuet Book Valuet-1) – ‒ and iterating over future periods, (2) where is book value and r.Bt-1 is referred to as residual income. The equivalence B Earningst – of model (2) with model (1) says that one recognizes that there is value on the balance sheet (in the book value) and then utilizes information that forecasts future earnings. If those forecasted earnings cover the required return applied to book value, one adds value to the balance sheet. Book value is value that has already been recorded (on the balance sheet), while the remainder is value that has not yet been recorded on the balance sheet―it is value that is expected to be booked to the balance sheet in the future. It is remarkable that accounting, in the form it has been practiced for centuries, ties so elegantly to value. Further, with only a mild additional condition (that is also honored in accounting as practiced)―dividends are not included in earnings but are paid out of book value―the accounting-based valuation in model (2) honors the Miller and Modigliani principle of dividend irrelevance, so foundational to modern finance. However, with a view to establishing accounting principles, it is important to recognize that only one accounting principle is involved in model (2), the clean-surplus operation. So, at this point only one normative statement can be made: accounting should clearly report comprehensive income, for the equivalence of the model with the dividend discount model only holds if earnings
relation that governs the articulation of the income statement and balance sheet: Book Valuet = Book Valuet-1 + Earningst – Net Dividendst or, in more operational terms, earnings for a period are closed to book value and dividends are paid out of book value. Accordingly, Net Dividendst = Earningst – (Book Valuet ‒ Book Valuet-1) so, substituting into the dividend discount model and iterating over future periods, (2) where B is book value and Earningst – r.Bt-1 is referred to as residual income. The equivalence of model (2) with model (1) says that one recognizes that there is value on the balance sheet (in the book value) and then utilizes information that forecasts future earnings. If those forecasted earnings cover the required return applied to book value, one adds value to the balance sheet. Book value is value that has already been recorded (on the balance sheet), while the remainder is value that has not yet been recorded on the balance sheet―it is value that is expected to be booked to the balance sheet in the future. It is remarkable that accounting, in the form it has been practiced for centuries, ties so elegantly to value. Further, with only a mild additional condition (that is also honored in accounting as practiced)―dividends are not included in earnings but are paid out of book value―the accounting-based valuation in model (2) honors the Miller and Modigliani principle of dividend irrelevance, so foundational to modern finance. However, with a view to establishing accounting principles, it is important to recognize that only one accounting principle is involved in model (2), the clean-surplus operation. So, at this point only one normative statement can be made: accounting should clearly report comprehensive income, for the equivalence of the model with the dividend discount model only holds if earnings
CJAR%20Fundamentalist%20Perspective%20on%20Accounting%20Jiang-Penman.docx