Clean Surplus Accounting

Clean surplus accounting  is the estimation of company's earning and expected return. It is calculated on the basis of effect of the operation of business. We can estimate the earning by making estimated income statement. If we add goodwill in it, it will become clean surplus. Goodwill is just excess of actual earning over expected earning. It is the present value of future abnormal earning. It is important to know that we calculate clean surplus for knowing company's total estimated earning not the given  portion of shareholders. So, we do not include dividends on share capital in it.

Formula of Clean Surplus

= Expected Earning from Business + expected PV of future abnormal earnings (goodwill)

Importance of Clean Surplus Accounting

1. Actual Market Value

Every company's actual market value should be calculated on the basis of its clean surplus. A company whose clean surplus is more, value of that company will be more.

2. Unrealized Gains and Losses on Securities Held for Sale

Clean surplus accounting theory is just to clean the dirt of income statement. We do not include unrealized gains and losses on securities held for sale in clean surplus accounting. So, our estimated income will just like our real income.

3. Foreign Currency Translation Gains and Losses

We also do not include foreign currency translation gain and losses in clean surplus accounting. Its advantage is that our estimated income will be more normal.

4. Employee Stock Options

ESOs or employee stock options means that company gives power to employees to buy stock of company at lower price in future date. Normally, we do not calculate this loss when we calculated our net earning. If you see this with your deep eye, it will become a dirty hidden surplus. Its loss should be deducted if we have to clean our surplus in clean surplus accounting.