What is the Difference Between Accounting Profit and Economic Profit?
🆚 Go to Comparative Table 🆚The difference between accounting profit and economic profit lies in the costs they consider. Here are the key differences between the two:
- Explicit costs: Accounting profit considers only explicit costs, such as wages, rents, and operating expenses. Economic profit, on the other hand, includes both explicit and implicit costs, such as the cost of idle resources or the opportunity cost of pursuing a different business decision.
- Opportunity costs: Economic profit accounts for opportunity costs, which represent the profit that could be made by pursuing different business decisions or using resources more efficiently. Accounting profit does not consider opportunity costs.
- Uses: Accounting profit is used to determine a company's true profitability and is reported to the Internal Revenue Service (IRS) for tax purposes. Economic profit is generally used for internal purposes, such as determining whether to enter or stay in a particular market or assessing the efficiency of a company's resource allocation.
- Calculation: Accounting profit is calculated as total revenue minus total costs, resulting in net income or the bottom line. Economic profit is calculated by considering the company's free cash flow, which is the actual amount of cash generated by a business, and then taking into account the opportunity cost that managers of the business can expect to earn.
In summary, accounting profit focuses on a company's net income after subtracting explicit costs, while economic profit includes both explicit and implicit costs, as well as opportunity costs, providing a more comprehensive view of a company's financial performance.
Comparative Table: Accounting Profit vs Economic Profit
Here is a table comparing the differences between accounting profit and economic profit:
| Feature | Accounting Profit | Economic Profit |
|---|---|---|
| Definition | Accounting profit is the net income obtained after deducting explicit costs (such as wages and rents) from total revenue. | Economic profit is the profit derived when revenue exceeds both explicit and implicit costs (opportunity costs). |
| Formula | Accounting profits = Revenue - Explicit expenses. | Economic profits = Revenue - (Explicit + Implicit expenses). |
| Applicability | Accounting profit is used to assess the financial performance and productivity of a company. | Economic profit considers opportunity costs and is more relevant for decision-making and strategy evaluation. |
| Considerations | Accounting profit only considers explicit costs, such as payroll and rent. | Economic profit considers both explicit and implicit costs, including the cost of idle resources that could be put to better use. |
In summary, accounting profit focuses on the financial performance of a company and is calculated using explicit costs, while economic profit takes into account opportunity costs and implicit expenses, providing a more comprehensive view of a company's financial health and decision-making.
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