Difference Between Accounting and Economic Profit (With Table)

Difference Between Accounting and Economic Profit (With Table)

Accounting is a way of collecting and recording all kinds of transactions in one place. The phrase “profit” is a term mainly used in accounting. In business, if the amount spent to manufacture any product is less than the amount received from selling a product, it is called profit.

Accounting vs Economic Profit

The main difference between accounting profit and economic profit is that accounting profit represents any business or company’s net profit or revenue. On the other hand, economic profit is the quantity earned from the sale or production of different products.

Difference Between Accounting and Economic Profit 1

Accounting profit is the net profit earned by a company or a business organization by selling products. Accounting profit is one type of financial profit. After deducting the explicit costs from the revenue of any business, we get the amount of account profit. All these profits help to understand the financial condition of a business.

Unlike accounting profit, economic profit includes both implicit and explicit costs. It also helps to understand the measure of success of a product. As a result, it also expresses the efficiency in resource allocation of the business. However, one major problem of economic profit is that it is difficult to calculate the estimated economic profit accurately.

Comparison Table Between Accounting and Economic Profit

Parameter of ComparisonAccounting ProfitEconomic Profit
DefinitionAccounting profit represents the net profit or revenue of any business or company.Economic profit represents the revenues received from any business (explicit & implicit costs excluded).
FormulaAccounting profit = Total Revenue – Explicit CostsEconomic profit = Total Revenue – Explicit costs – Implicit costs
Type of CostsIt only includes the explicit cost only.It includes both explicit and implicit costs.
DeterminationGAAP determines accounting profit.Economic principles determine economic profit.
ApplicationsIncome taxMarket entry (stay or exit)

What is Accounting Profit?

Accounting profit calculates a company’s net profit, i.e., the total earnings of the company. GAAP (Generally Accepted Accounting Principles) determines this type of profit. Subtracting the explicit costs from total revenue is accounting profit. The explicit costs mentioned earlier include the company’s wages, labour, transportation, sales & marketing, raw materials, and expenses.

It is one type of financial profit. It can be used for loan considerations. Accounting profit determines a company’s earnings, including interests and growth estimates. The net profit is also known as the net income of the company. Companies use accounting profit to determine the success rate of a product. So they can get the data for future reference.

Net profit is written at the bottom of the income statement. It is a mostly used term in finance. This type of profit is calculated using various methods and principles. As accounting profit gives the success rate of any product or business, it is a way to determine the efficiency or the success rate of that product or marketing.

What is Economic Profit?

Economic profit is similar to accounting profit. The difference is that it includes explicit and implicit costs from the company’s revenue total income or net profit. These explicit costs include- wages, raw 8materials, utilities, supplies, rent, etc. On the other hand, implicit costs include cash flow, types of equipment, depreciation, etc.

It is used for internal data analysis. The implicit and explicit costs included in economic profit are implied or imputed. It is not determined by accounting principles but resolute by economic principles. It clarifies how the company can allocate its resources and adapt according to the changes in the market. It only follows economic principles such as cost, incentives, margins, and tradeoffs.

Economic profit excludes all the expenses of a company for an annual period. Most companies choose economic profit over accounting profit. It shows how much quantity is left after selling the products. In other words, economic profit is a way to measure success rate and efficiency, but difficult to estimate. When the capital cost decreases or revenues increase, EVA (Economic Value Added) improves. And economic profit escalates.

To maintain the profit in any business, more revenues (by selling raw materials and goods) maximizes the economic profit. When a new company enters the market, then the market value of another company falls. Therefore, in the long run, financial enlargement is always zero.

Main Differences Between Accounting and Economic Profit

  1. The difference between accounting profit and economic profit is that accounting profit is a company’s net profit, and economic profit represents the revenue after deducting explicit and implicit costs.
  2. Accounting profit includes only implicit costs (i.e., machinery, funds, depreciation, etc.), but economic profit includes both explicit (raw materials, wages, rent and equipment, etc.) and implicit costs.
  3. Accounting profit is based on the accounting period. Economic profit is based on the market view (how a company approaches the market).
  4. Accounting profit is used in income tax and financial statements of a company. Economic profit determines a company’s financial situation.
  5. Accounting profit can be accurate and useful in the short run, but economic profit is difficult to estimate and based on assumptions, and it is useful in the long run.

Conclusion

Profit assists in how a company is doing by selling any products. It helps to understand the company and how long it can stay in the market for several businesses. Thus, a businessman needs to know both accounting and economic profit.

In business accounting, profit and economic profit are related and used for different purposes. Accounting profit is for short-run business, but economic profit gives the result in the long run. Economic profit excludes the expenses of a company, both implicit and explicit costs. Accountants mostly use accounting profit. Economists use economic profit.

Economic profit indicates the total profit a company earns from the resource supplied. Accounting profit is much more practical than theoretical assumptions of economic profit. The accounting profit of a company is based on actual gains and losses, and it also shows excess revenue gains over and above the explicit costs incurred by the company during any particular accounting period.

References

  1. https://link.springer.com/article/10.1007/s11365-013-0248-5
  2. https://scholarworks.sjsu.edu/econ_pub/39/
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