Difference between accounting and economic profit
accounting vs economic profit
When it comes to profit, it is often assumed that the only kind of profit there is the amount that is left after the deduction of costs from the revenue, but this is not so. There exits two kinds or profits, accounting profit and economic profit which bear several differences from each other.
What is accounting profit?
The accounting profit can be defined as the difference between the total revenue and the total explicit cost which does not include the opportunity cost such as time and capital whatsoever. This is obtained by deducting the total amount of costs by the total revenue. For example, if a company has earned $50,000 one month and the total amount of costs for that month stands at $10,000 the accounting cost would be calculated as $40,000.
What is economic profit?
The economic profit can be defined as the difference between the sales revenue minus all implicit and explicit costs including the opportunity cost of equity capital, time and the owner’s own resources. This is done so because it is important that the revenue which these self employed resources could have brought in their best alternative uses should be worked at and added in the cost as well. Therefore, the economic profit is calculated by deducting the implicit and explicit costs from the total revenue. For example, if a company has earned $50,000 one month and the owner has invested $10,000 in the business and the amount of explicit costs stand at $10,000, the economic profit would be calculated at $30,000 that month.
What is the difference between economic and accounting profit?
While the accounting profit is calculated without deducting the opportunity cost from the revenue, the economic profit is calculated by deducting the explicit costs, opportunity cost and all implicit costs as well from the revenue. In calculating economic profit, in addition to explicit costs such as the production cost, etc, all other costs including the company’s own building, the owner’s own resources, the use of its own capital, the time dedicated are calculated and then deducted from the revenue. This is done so because it is considered important that one calculates what revenue these assets would have brought in if used in other projects other than this particular one. This is called the opportunity cost. Accounting profit need not consider all those factors. And therefore, as a result, the economic profit is often much lower that the accounting profit.
Another difference would be as opposed to the accounting profit of a company which would be calculated every year, the economic profit of a company would be only produced ever leap year.
If the total revenue exceeds both explicit and implicit costs, it is considered hat the firm has earned economic profit.