Difference Between Economic Profit And Accounting Profit

Difference Between Economic Profit And Accounting Profit

In other  to produce a product or a service, market-supplied resources is required. Market-supplied resources are resources owned by others, and purchased, hired, rented, or leased by the company (e.g labor, raw materials, etc.). The costs associated with market-supplied resources are called explicit costs. The opportunity cost of producing a particular product or service is what you could have produced using the same resources at a particular time. In other words, you use a combination of resources to produce product A, which means that you cannot use the same combination of resources to produce product B.

But there is another type of cost to be considered which is called implicit cost. Implicit cost are owner-supplied resources, which include money, time, and property. The opportunity cost of owner-supplied resources is the best return the owner could have achieved by selling these resources on the market, rather than using them himself.

The most important types of implicit costs are owner-provided cash to his firm, use of owner land or capital, and the owner’s time. Accountants ignore implicit costs. The opportunity costs of owner-supplied inputs is what their current market value is, not what was paid for them. And the implicit cost here is not what the resource can be sold for, but rather what return can be had (for example, a $500,000 resource that earns 6% = a return of $30,000).

Accounting profit is also called the net income or net profit for a company over a period of time. It's the profit after various costs and expenses are subtracted from total revenue or total sales or gross profit as stipulated by the generally accepted accounting principles (GAAP). Some of those costs include:
  • Labor costs such as wages
  • Inventory needed for production
  • Raw materials
  • Transportation costs
  • Sales and marketing costs
  • Production costs and overhead
Economic profit is also similar to accounting profit in the sense that it deducts explicit costs from revenue. However, economic profit also includes the opportunity costs or what it will cost you for taking one action versus another in the period. Economic principles determines economic profit, not by accounting principles. Economic profit also uses implicit costs, which means the costs of a company's resources. Below are examples of implicit costs include:
  • Company-owned buildings
  • Plant and equipment
  • Self-employment resources
To differentiate between accounting profit and economic profit, we will consider the following simple example:
A man started a pizza parlor on the site of a piece of commercial property he owns. He works at the pizza parlor alone for one year without employing anybody. At the end of the year, he informs his accountant that he paid $100,000 for the ingredients he used to make the pizza, and made sales of $200,000. The accountant told the pizza parlor owner that he earned a profit of $100,000 in the period. But to the economist, the $100,000 is accounting profit. If the owner could have made $50,000 in salary had he not opened the pizza parlor, and had he been able to rent his piece of commercial property for $40,000, the economic profit is only $10,000 ($100,000 minus $50,000 minus $40,000).

Accounting Profit is total revenue minus explicit costs.
Economic Profit is total revenue or sales minus explicit costs and implicit costs.
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