Accounting Profit and Economic profit – Meanings & Differences
What is the main difference between accounting and economic profit?
Accounting profit = Total revenue – Explicit cost. But, Economic profit = Total revenue – Explicit cost – Implicit cost. The main difference between accounting and economic profit is the implicit cost.
Accounting profit and economic profit could never be equal because of the implicit cost. We do not consider the implicit cost when calculating the accounting profit. We consider the implicit cost when calculating the economic profit.
However, accounting profit and economic profit are the same if that organization does not have implicit costs.
Accounting profit vs economic profit differences
- Accounting profit and economic profit meaning
Accounting profit means total revenue minus explicit cost. Explicit cost means the types of costs which a business has to bear by paying money. We do not consider the implicit cost when calculating the accounting profit.
The amount of total revenue that exceeds the total cost can be defined as the economic profit (supernormal profit) for a particular business organization. In other words, economic profit can be recognized as the difference between the total revenue minus explicit and implicit costs.
2. Accounting profit and economic profit formula
Economic profit formula
Economic profit = Total revenue – Total cost
Total cost includes two major categories. They are explicit cost and implicit cost.
So, Economic profit = Total revenue – (explicit cost + implicit cost)
Accounting profit formula
Accounting profit = Total revenue – Explicit cost
3. Accounting profit and economic profit example
Following example graphically shows the difference between accounting profit and economic profit.
4. How do you calculate accounting profit and economic profit?
To calculate accounting profit, we should reduce explicit costs from the total revenue.
To calculate economic profit, we should reduce explicit costs and implicit costs from the total revenue.
5. The accounting profit is calculated to realize the profit during an accounting year. But economic profit is the surplus after decreasing total costs from the total revenue.
6. To measure the financial performance and to align with tax purposes, the accounting profit is calculated. Economic profit is calculated to determine the expected profit of a business, to decide whether enter to the market, whether stay in the market or whether exit from the market.
7. When preparing the accounting profit, we should align with GAAP. When preparing the economic profit, we should align with economic principles.
8. We should report accounting profit to IRS. But it is not compulsory to report economic profit to IRS.
Economic Profit vs. Accounting Profit – Table Comparison
What is economic profit or supernormal profit?
The amount of total revenue that exceeds the total cost can be defined as the economic profit (in other words, supernormal profit) for a particular business organization.
In other words, it is the total revenue minus explicit and implicit costs.
Economic profit, in the views o some experts, is the difference between accounting profit and the opportunity cost the company has incurred by investing in its current initiative.
The economic profit is alternatively called as supernormal profit and abnormal profit
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What is Supernormal Profit? – With Diagrams
Monopoly make an economic profit in short run as well as long run. Oligopolistic firms earn an economic profit in the both short run and long run. A monopolistic competitive company can earn economic profit in the short run. In the short run, firms in perfect competition can earn an economic profit, normal profit for economic loss.
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Monopoly Graph, Characteristics, Types, Examples and Causes
Oligopoly: Definition, Characteristics and examples
Monopolistic competition graph , characteristics & examples
Perfect Competition Graph in Short Run and Long Run
Economic profit formula/ Supernormal profit formula
Economic profit = Total revenue – Total cost
Total cost includes two major categories. They are explicit cost and implicit cost. So,
Economic profit = Total revenue – (explicit cost + implicit cost)
What are the components of economic profit?
There are two major components of the economic profit. They are, Total revenue and total costs. Among them, total cost is comprised with two types of costs. They are implicit costs and explicit costs. Let’s discuss about these components.
Total Revenue (TR)
Total revenue means the summation of the income is occurred by selling a total number of units of goods or services. According to the particular information is given, total revenue can be calculated by the number of units multiplied by the unit price
Unit price means the amount of income that occurred because of selling a single unit of good or service.
So, Total Revenue = Unit Price X Quantity
Total Costs (TC)
The summation of all the costs are occurred to produce the total number of units of goods or services is the total cost.
So, Total cost =Average cost X Quantity of units
According to the above mentioned economic profit formula, we can identify two main types of costs. They are explicit costs and implicit costs. So, let’s discuss about these costs.
1. Explicit costs
Explicit cost means the types of costs which a business has to bear by paying money. Therefore, these costs are presented in the financial statements of an organization. So, we can directly see the explicit cost.
Examples for explicit costs:
Employee salaries and wages
Material cost
Phone bills
Advertising expenses
Electricity charges
Bank loan interest
Rent for land
Rent for equipment
2. Implicit costs
Implicit cost means the opportunity cost of the company for utilizing its resources. We cannot directly see the implicit costs. We have to imply the cost for them. So, these costs are implicit costs. In other words, implicit costs are the cost of resources that could have been better used like opportunity costs, time, etc.
One of the major implicit costs that can be occurred is the opportunity costs.
According to the Andrea Caceres-Santamaria, senior economic education specialist at the St. Louis Fed, in a recent Page One Economics: Money and Missed Opportunities, “Opportunity cost is the value of the next-best alternative when a decision is made; it’s what is given up”.
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What is opportunity cost and how to calculate opportunity cost?
An example for opportunity costs: A business organization may have two or more business opportunities. But that business organization cannot invest in all the business opportunities. Because factors of production (resources utilized in the production process) have an opportunity cost. To read more about factors of production, kindly click here.
Economic profit vs normal profit
What happens when economic profit is zero?
When economic profit is zero, it is called as the “nominal profit”.
Normal profit
The normal profit is the zero economic profit. When a firm earns the normal profit, it earns the minimum amount of revenue that needs to prevail in the industry or market. In other words, when a firm produces normal profit, its total revenue will be equalized to total cost (TR = TC). At this point, the firm produces an efficient level of output.
Normal profit is there when,
Total revenue – Total cost = 0
So, Total revenue = Total cost
Accounting profit
Also, there is another concept is called accounting profit. Accounting profit means total revenue minus explicit cost. In other words, accounting profit means the profit that is presented in the financial statements. So, most of the time, accounting profit is larger than economic profit. Because when we calculate the accounting profit, we do not concern about the implicit cost.
Accounting profit is a measure of how fiscally successful a business is. You can compare your business to other businesses in your field using accounting profit.
How to calculate accounting profit?
Accounting profit means total revenue minus explicit cost. Explicit cost means the types of costs which a business has to bear by paying money. These costs are presented in the financial statements of an organization.
The accounting profit formula
Accounting profit = Total revenue – Explicit costs
