Question

John was a high school teacher earning $ 80,000 per year. He quit his job to start his own business in pizza catering.In order to learn how to run the pizza catering business, John enrolled in a TAFE to acquire catering skills.John’s course was for 3 months. John had to pay $2,000 as tuition for the 3 months.

After the training, John withdrew $110,000 from his savings account. He had been earning 5 percent interest per year for this account. He also borrowed $50,000.00 from his friend whom he pays 6 percent interest per year. Further, to start the business John used his own premises. He was receiving $12,000from rent per year. Finally, to start the business John uses $50,000 he had been given by his father to go on holiday to USA.

John’s first year of business can be summarised as follows:

Item	Amount $
Revenue- Pizza Section	400,000
Revenue- Beverages Section	190,000
2 Cashiers (wages per worker)	55,000
Pizza ingredients	50,000
Manager	75,000
3 Pizza bakers (wages per baker)	60,000
Equipment	10,000

                       

Based on your calculated accounting profit and economic profit, would you advise John to return to his teaching job? Show your work    

Answer 1

What is Accounting Profit?

Accounting profit is a company's total earnings, calculated according to Generally Accepted Accounting Principles (GAAP). It includes the explicit costs of doing business, such as operating expenses, depreciation, interest and taxes but does not include any implicit and oppurtunity cost.

Accounting Profit Calculation:

Particulars	Amount	Amount
Revenue:
	Pizza Section	$       4,00,000
	Bevrages Section	$       1,90,000	$       5,90,000
Expenses:
	Tution Fees	$             2,000
	Interest on Loan Taken (50000 @6%)	$             3,000
	Cashier Wages (2 X 55000)	$       1,10,000
	Baker (3 X 60000)	$       1,80,000
	Manager	$           75,000
	Ingredients	$           50,000
	Equipments	$           10,000	$       4,30,000
Accounting Profit		$       1,60,000

What Is Economic Profit (or Loss)?

An economic profit or loss is the difference between the revenue received from the sale of Pizza and Breverages and the costs of all inputs used and any opportunity costs foregone. In calculating economic profit, opportunity costs and explicit costs are deducted from revenues earned.

Economic Profit Calculation:

Particulars	Amount	Amount
Revenue:
	Pizza Section	$       4,00,000
	Bevrages Section	$       1,90,000	$       5,90,000
Expenses:
	Tution Fees	$             2,000
	Interest on savings (110000 @5%)	$             5,500
	Interest on Loan Taken (50000 @6%)	$             3,000
	Intrest on Holiday fund used in business (50000 @5%)	$             2,500
	Rent Foregone	$           12,000
	Salary foregone	$           80,000
	Cashier Wages (2 X 55000)	$       1,10,000
	Baker (3 X 60000)	$       1,80,000
	Manager	$           75,000
	Ingredients	$           50,000
	Equipments	$           10,000	$       5,30,000
Economic Profit		$           60,000

Note:

Funds receaved for father for holiday in USA was used for the business. It is asumed that if this fund was not used and kept in a savings bank account, it would have earned a intrest of 5% pa.

Decision:

From the above calculation, it is quite obvious that John would be earning an additional $60000 pa over and above the sallary of $80000 if he continues with the business even after considering all other implicit and opportunity costs.