The concept of cost differs between economists and accountants, as their approaches to analyzing business operations are distinct. While accountants are mainly concerned with the calculation of the financial performance of an organization, economists are more interested in the opportunity cost of resources employed by the organization. This essay will discuss the difference between economic and accounting profit and how they affect business operations.
Accounting Profit is the difference between the total revenue generated from sales and the total explicit costs incurred in producing those goods or services. Explicit costs refer to the actual cash outflows incurred in the production of goods or services, such as rent, wages, utilities, raw materials, and taxes. To compute accounting profit, total revenue is subtracted from total explicit costs. Accounting profit is a crucial concept for businesses because it reflects the overall financial performance of the organization. If the accounting profit is positive, the business is profitable; if it is negative, the company is operating at a loss.
On the other hand, economic profit considers both explicit and implicit costs when computing profit. Implicit costs are the opportunity costs of resources employed in the production process, such as the opportunity cost of time or the interest income that could have been generated if the resources had been invested elsewhere. In contrast to accounting profit, which only takes explicit costs into account, economic profit considers all the costs of production, including those that are not reflected in accounting records.
Economic profit is computed by subtracting total explicit and implicit costs from total revenue. Therefore, economic profit takes into account the cost of all resources used in the production process, including resources that are not paid for by the business. If the economic profit is positive, it indicates that the business is profitable after taking into account all costs, including the opportunity costs of resources employed in the production process. If the economic profit is negative, it means that the organization is not profitable when all costs are considered.
To illustrate the difference between accounting profit and economic profit, consider the following hypothetical income statement of a company:
Particulars Amount
Total Revenue $500,000
Cost of Goods Sold $200,000
Gross Profit $300,000
Operating Expenses $100,000
Depreciation $20,000
Total Explicit Costs $120,000
Accounting Profit $180,000
In this case, the accounting profit is $180,000, which is calculated by subtracting total explicit costs from total revenue. However, this does not take into account the implicit costs, such as the opportunity cost of the owner's time, which is not reflected in the accounting records. Suppose the owner of the company could earn $50,000 per year if they were to work for another company. In that case, the implicit cost of the owner's time is $50,000. Therefore, the economic profit of the company would be:
Particulars Amount
Total Revenue $500,000
Cost of Goods Sold $200,000
Gross Profit $300,000
Operating Expenses $100,000
Depreciation $20,000
Total Explicit Costs $120,000
Implicit Cost (opportunity cost of owner's time) $50,000
Economic Profit $130,000
In this case, the economic profit is $130,000, which is calculated by subtracting both explicit and implicit costs from total revenue. The difference between accounting and economic profit in this case is $50,000, which reflects the opportunity cost of the owner's time.
In conclusion, the concept of cost differs between economists and accountants. While accountants focus on explicit costs, economists consider both explicit and
To calculate the economic profit, we need to consider not only the explicit costs but also the implicit costs. The implicit costs are the opportunity costs of using resources in a particular way. In other words, it is the cost of the next best alternative foregone.
For example, suppose a person has invested $50,000 in starting a business, and the explicit costs of running the business are $20,000, including wages, rent, and utilities. The revenue generated by the business is $30,000. The accounting profit is calculated as revenue minus explicit costs, which is $30,000 - $20,000 = $10,000.
However, the implicit costs should also be considered while calculating the economic profit. Suppose that the person could have earned $10,000 if they had worked in a different company. Then the economic profit would be calculated as revenue minus explicit costs minus implicit costs, which is $30,000 - $20,000 - $10,000 = $0. In this case, the economic profit is zero, indicating that the person would have been better off working for another company rather than starting their own business.
Therefore, the difference between the accounting and economic profit is that the former considers only the explicit costs, while the latter considers both the explicit and implicit costs.
In conclusion, the definition of cost is different for economists and accountants. While accountants focus on the explicit costs incurred in the production process, economists consider both the explicit and implicit costs. Economic profit takes into account the opportunity cost of using resources in a particular way, which is often ignored in accounting profit. Both accounting and economic profit are essential in evaluating the financial performance of a business, and a company should consider both while making business decisions.
0 Comments
Please do not enter any Spam link in the comment box