Accounting Profit vs Economic Profit Differences

In general sense, Profit refers to the surplus which remains out of the total income after deducting the necessary expenses. However, we will be analyzing 2 different types of profits i.e. Accounting Profit vs Economic Profit.

• Accounting profit refers to the Gross revenue minus the explicit costs (deductible expenses). For e.g. Mrs. ‘B’ is running a pastry shop and is required to maintain a track of their earnings.
  • If the total revenue is $300,000 and the explicit costs are $50,000 then accounting profit will be $300,000 – $50,000 = $250,000.
• Economic Profit involves subtraction of both Implicit costs and Explicit costs from the Total Revenue. Implicit costs are the opportunity costs which are not measurable and not seen in the books of accounts as well. Extending the example above, the implicit costs shall include the loss in case Mrs. ‘B’ was working for someone else or the potential interest one could earn if the money of the pastry shop is invested elsewhere. The concept of implicit revenue also comes in the frame such as the value of having own business.
  • Say, if the implicit cost was $75,000 and the implicit revenue was $30,000, then economic profit will be: $300,000 + $30,000 – $50,000 – $75,000 = $205,000

Accounting Profit vs Economic Profit Infographics

Here are the top 4 differences between accounting profit and economic profit

Accounting Profit vs Economic Profit Key Differences

The key differences between economic profit and accounting profit concepts can be assessed in detail

1. Accounting profit is the real profit/realised by a firm during an accounting year whereas Economic profit refers to the abnormal profit i.e. gains in excess of what is required to cover the expenses. This includes opportunity cost.
2. Accounting profit is normally more than Economic profit since economic profit can involve multiple categories of income and expenses accompanied by relevant assumptions as well.
3. The aspects included in the calculation of accounting profits are Leased assets, Non-cash adjustments/Depreciation, Allowances & Provisions and capitalization of Development Costs. However, the calculation of Economic profits shall include: Opportunity costs, Residual value, Inflation level changes, Rate of taxation and Interest rates on Cash flows
4. Accounting profit can be referred as the revenue obtained post meeting all economic costs and Economic profit is obtained when revenue exceeds the opportunity cost.
5. The accountant shall consider accounting profit as they will consider production costs and its impact on profitability. Accounting profit vs economic profit was considered themselves as production costs. In contrast, when an economist describes costs, Accounting profit vs economic profit are interested in how the company has decided to implement any strategy. It will also analyze how those strategies can have an impact on the firm and the economy.

A firm aims at earning positive economic profits. If accounting profits are greater than implicit costs, the firm would earn a positive economic profit and should continue the business. If accounting profits are less than implicit costs, the economic profit would be negative and it is advisable for a business to divest their business interest.

In equilibrium we have zero economic profit, i.e., the firm is covering all implicit and explicit costs and both debt holders and equity holders are earning their required rate of return.

Accounting Profit vs Economic Profit – Head to Head

Let’s look at the head to head differences between economic profit and accounting profit-

Important – Economic profit will have to be greater than accounting profit for the concept to exist. Since opportunity cost cannot be negative, economic profit will be lower than accounting profit. An opportunity cost being negative is not possible since a business can always choose not to act on available opportunities, thus in a situation of neither earning nor spending anything.

Accounting Profit vs Economic Profit – Final Thoughts

The entire future of any company depends on the profit earning potential in the near future and also how has it performed in the recent past. As a shareholder/investor, the accounting profit is of importance as that will give the true picture of the financial performance. Economic profit may be used for internal analysis or by specific individuals to assess the opportunity costs which are making way for current activities. Though economic profits can involve a lot of assumptions, it can give an approximate answer of the desired direction.

Recommendation Articles

This has a been a guide to the top differences between Accounting Profit and Economic Profit. Here we also discuss the Accounting Profit vs Economic Profit key differences with infographics, and comparison table. You may also have a look at the following articles –

• Profit vs Income
• Profit vs Revenue
• Revenue vs Income
• Cost-Benefit Analysis Steps

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