Question

Draw and explain the bar graph that describes accounting profit and economic profit. Referring to the graph, explain accounting costs, accounting profit, economic costs, economic profit, normal profit, implicit and explicit costs, and zero economic profit.

Answer 1

Accounting Profit:--

Accounting profit uses realized or actual gains and losses and is calculated according to generally accepted accounting principles (GAAP). It is a company's total revenue reduced by the explicit costs of producing goods or services. These explicit costs involve direct monetary movement and include expenses such as the cost of raw materials, employee wages, transportation, rent and interest on capital. Usually, accounting profit is limited to time periods, such as a fiscal quarter or year. Accounting profit computations are primarily used for income tax purposes, financial statement preparations and to review financial performance.

Economic Profit:--

Economic profit is determined by economic principles, not GAAP. Just like accounting profit, costs are deducted from revenues. Economic profit uses implicit costs, not just explicit costs. Implicit costs are considered opportunity costs and are normally the company's own resources. Examples of implicit costs include company-owned buildings, equipment and self-employment resources. Economic profit computations are not normally limited to time periods like accounting profit computations are. Economic profit is used more to judge total value of the company somewhat like the performance metric economic value added (EVA) would and is helpful in calculating total production costs.

Economic cost:-Economic costs consider both the explicit and implicit costs to the company that occur during the fiscal year.

--> Implicit costs are associated with resources that are provided to the company with no price tag.

--> accounting cost:-Accounting costs come from the total explicit costs of the company during the fiscal year.

---> Explicit costs are defined monetary values and are used to calculate net income at the end of the fiscal year.

NORMAL PROFIT:-A normal profit is an economic condition that occurs when the difference between a firm’s total revenue and total cost is equal to zero. Simply put, normal profit is the minimum level of profit needed for a company to remain competitive in the market.