Author Topic: Difference Between Economic and Accounting Profit  (Read 96 times)

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Difference Between Economic and Accounting Profit
« on: April 04, 2017, 05:06:31 PM »
Difference Between Economic and Accounting Profit

Economic profit consists of revenue minus implicit (opportunity) and explicit (monetary) costs; accounting profit consists of revenue minus explicit costs.
KEY POINTS:
#Explicit costs are monetary costs a firm has. Implicit costs are the opportunity costs of a firm's resources.

#Accounting profit is the monetary costs a firm pays out and the revenue a firm receives. It is the bookkeeping profit, and it is higher than economic profit. Accounting profit = total monetary revenue- total costs.

#Economic profit is the monetary costs and opportunity costs a firm pays and the revenue a firm receives. Economic profit = total revenue - (explicit costs + implicit costs).

#Explicit cost
A direct payment made to others in the course of running a business, such as wages, rent, and materials, as opposed to implicit costs, which are those where no actual payment is made.

#Implicit cost
The opportunity cost equal to what a firm must give up in order to use factors which it neither purchases nor hires.

#Economic profit
The difference between the total revenue received by the firm from its sales and the total opportunity costs of all the resources used by the firm.

#Accounting profit
The total revenue minus costs, properly chargeable against goods sold.

EXAMPLE
Consider a simplified example of a firm. In one year, it cost $60,000 to maintain production, but earned $100,000 in revenue. The accounting profit would be $40,000 ($100,000 in revenue - $60,000 in explicit costs). However, if the firm could have made $50,000 by renting its land and capital, its economic profit would be a loss of $10,000 ($100,000 in revenue - $60,000 in explicit costs - $50,000 in opportunity costs).

The term "profit" may bring images of money to mind, but to economists, profit encompasses more than just cash. In general, profit is the difference between costs and revenue, but there is a difference between accounting profit and economic profit. The biggest difference between accounting and economic profit is that economic profit reflects explicit and implicit costs, while accounting profit considers only explicit costs.


Explicit and Implicit Costs

Explicit costs are costs that involve direct monetary payment. Wages paid to workers, rent paid to a landowner, and material costs paid to a supplier are all examples of explicit costs.

In contrast, implicit costs are the opportunity costs of factors of production that a producer already owns. The implicit cost is what the firm must give up in order to use its resources; in other words, an implicit cost is any cost that results from using an asset instead of renting, selling, or lending it. For example, a paper production firm may own a grove of trees. The implicit cost of that natural resource is the potential market price the firm could receive if it sold it as lumber instead of using it for paper production.

Accounting Profit

Accounting profit is the difference between total monetary revenue and total monetary costs, and is computed by using generally accepted accounting principles (GAAP). Put another way, accounting profit is the same as bookkeeping costs and consists of credits and debits on a firm's balance sheet. These consist of the explicit costs a firm has to maintain production (for example, wages, rent, and material costs). The monetary revenue is what a firm receives after selling its product in the market.

Accounting profit is also limited in its time scope; generally, accounting profit only considers the costs and revenue of a single period of time, such as a fiscal quarter or year.

Economic Profit

Economic profit is the difference between total monetary revenue and total costs, but total costs include both explicit and implicit costs. Economic profit includes the opportunity costs associated with production and is therefore lower than accounting profit. Economic profit also accounts for a longer span of time than accounting profit. Economists often consider long-term economic profit to decide if a firm should enter or exit a market.

Senior Lecturer in Accounting
Department of Business Administration
Faculty of Business & Economics
Daffodil International University