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Home Profit   Difference Between Accounting Profit and Economic Profit

Difference Between Accounting Profit and Economic Profit:

 

Accounting Profit:

 

There is no satisfactory definition of the term profit. Generally profit of a firm is defined as:

 

"The access of revenue over its current costs".

 

The word cost carries different meanings with economists and accountants. In accounting:

 

The term Profit equals total revenue - explicit costs.

 

This is the profit used by accountants to determine a firm's taxable income. Explicit costs are the actual cash payments for resources purchased in resource markets. These are the rent paid on land and plant and equipment, wages to labor, interest on capital, cost of raw material, transport charges etc., etc. When all these explicit costs are subtracted from the firm's total revenue, we get  accounting profit.

 

Formula For Accounting Profit:

 

Accounting Profit = Total Revenue - Explicit Costs

 

Example of Accounting Profit:

 

Accounting profit is explained by taking a simple example. Let us suppose, the total revenue of a firm from the sale of goods in 2006 is $90000. Its costs on the purchase of raw material, payment of wages and other utilities i.e., explicit costs are $35000. The firms accounting profit will be $55000.

 

Total sales revenue.............$90000

 

Cost of raw material = $15000

 

Wages to labor and other utilities = $20000

 

Accounting profit = $90000 - ($15000 + $20000) = $55000

 

(Total Revenue - Explicit Cost)

 

When depreciation charges of capital equipment used by the firm and the amount of money paid to the government as taxes is deducted from gross profit or Accounting profit, we get net profit of accountants.

 

Economic Profit:

 

Economic profit is different from accounting profit. Accounting profit ignores the opportunity cost of the firm's own resources used in the production of goods. The economist include these costs named as implicit costs while determining the total cost of production.

 

"If a firm's total revenue exceeds all its economic costs both explicit and Implicit, the residual which goes to the entrepreneur is called an economic or pure profit".

 

Thus economic profit equals total revenue less all costs both explicit and implicit.

 

A firm's Implicit costs are the opportunity costs of using its self owned, self employed resources. Implicit cost include use of firm's own building, use of its own capital, and the business owners time given for the production of goods. While determining the total costs, the money payments which these self employed resources could have earned in their best alternative uses should be worked at and added in cost. The implicit costs are in a way opportunity costs. Economic profit takes into account the opportunity costs of  all resources used in production. Implicit costs also include normal profit earned by a firm.

 

Normal profit is the minimum amount required to keep on entrepreneur engaged in the present line of production.

 

Formula For Economic Profit:

 

Economic Profit = Total revenue - (Explicit Cost + Implicit Cost)

 

Example of Economic Profit:

 

Suppose a person uses, his own resources, land, capital, his own time in the production of goods. The opportunity costs of these resources is included below in finding out economic profit of the firm.

 

Accounting Profit = $55000

 

Entrepreneur's own forgone salary  = $40000

 

Foregone interest on capital = $1000

 

Foregone rent = $2000

 

Economic Profit = $12000

 

Summing Up:

 

(a) Accounting profit is the firm's total revenue less its explicit costs (b) Economic profit to the economist is the total revenue of a firm less explicit and implicit cost.

 

Implicit cost includes normal profit to attract and retain an entrepreneur engaged in the present line of production.

Relevant Articles:

Definition of Profit
Difference Between Accounting Profit and Economic Profit
Theories of Profit
Should Profit Be Controlled
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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