Question

What is accounting profit? Give an example of how to calculate accounting profit.

What is economic profit? Give an example of how to calculate economic profit.

Answer 1

1. The word "accounting profit" refers to the overall profits of a corporation after deducting all the specific costs of doing business. Explicit costs cover operating expenses, depreciation and amortization, interest and taxes. In other words, accounting income is equivalent to net income, which is the difference between sales and all other dollar costs defined in the Generally Accepted Accounting Principles ( GAAP). The formula for accounting income can be extracted by subtracting the specific costs incurred by the company from the overall revenue generated by the company. Mathematically, this is expressed as,

Accounting Profit = Total Revenue – Explicit Costs

Example of a company that reported total revenue of $500,000 and explicit costs of $350,000 during FY19

• Accounting Profit = $500,000 – $350,000
• Accounting Profit = $150,000

2. The word "economic profit" refers to the income that a company receives after accounting for the opportunity cost that the company has foregone. In other words, that is the difference between the cost of accounting income and the cost of opportunity. The formula for economic benefit can be calculated by deducting the explicit costs ( i.e. business expenses) and the implied costs ( i.e. opportunity costs) from the gross profits received by the company. Mathematically, economic profits are interpreted as

Economic Profit = Total Revenue – Explicit Costs – Implicit Costs

Example of a company with total revenue of $200,000 and explicit costs of $150,000. Calculate the economic profit of the company if the implicit costs are $30,000.

• Economic Profit = $200,000 – $150,000 – $30,000
• Economic Profit = $20,000