With many objectives of the business, the main goal the business is to earn profits, so the company remains operational and brings economic stability to the people affiliated with it. The profit is the reward for the entrepreneur or the businessman who bears the risk and offers the services to the people.
In the common mindset, profit is the difference between the costs and revenue of the company, the three terms accounting profit, and economic profit, are similar in many regards but yet they differ from each other in many ways.
The accounting profit is the net income that remains after the deduction of its explicit cost of it. To calculate the accounting profit one needs to subtract the explicit cost from the total revenue of the company.
On the other hand, economic profit is the supernormal profit as it is the difference between the revenue generated and the total cost (including explicit cost well as implicit cost).
What is Accounting Profit?
The accounting profit is the actual gains and losses made by the company in a particular year. The calculation of the accounting profit is made by the accepted accounting principles (GAAP). In easy words, we can say that it is the total revenue earned by the company after the explicit cost is subtracted from it.
Other than the accounting profit, this type of profit is also known as the net income of the company. To better understand accounting profit, one needs to know a little more about the terms of net income and explicit cost.
The net income is the income of the company or the person after the taxes, and other deductions are made from the gross income. It should be kept mentioned that the gross income is the income of the company or the person without exclusion of expenses, taxes, or any other adjustments.
On the other hand, An explicit cost is a cost that is directly incurred by the firm, company, or organization during the production period. In this type of cost, the outflow of cash takes place to utilize the factors of production.
The record of the explicit cost is noted by the accountant of the company, and can easily be traced as each and every expenditure is carefully noted, and is kept as a record. If one wants to know about the profitability of the company or the firm, the accounting profit is the profit that describes it all.
What is Economic Profit?
The economic profit is the supernormal profit as it is the difference between the revenues generated and the total cost (including explicit cost well as implicit cost). It is quite similar to that of the accounting profit, the main point which distinguishes it from all other profits is the implicit cost, which mainly revolves around the concept of the opportunity foregone.
To know comprehensively about the concept of economic profit, one should have a basic how-to know of the implicit cost. Implicit cost is the cost that is not directly incurred by the firm or the company.
In this type of cost, an outlay of cash doesn’t take place, so that is why it isn’t noted, and subsequently, it can’t be traced. It mainly revolves around the concept of opportunity cost, which tells about the (indirect) cash or profit foregone due to opting for the alternative. The loss or the profit in the implicit cost doesn’t directly have any impact on the profitability of the company.
Accounting, Economic vs. Normal Profit
- The accounting profit is the actual gains and losses made by the company in a particular year. On the other hand, economic profit is the supernormal profit.
- The calculation of the accounting profit is made by the accepted accounting principles (GAAP). Contrary to this, the economic profit is not calculated using GAAP it revolves around the concept of implicit costs and the opportunity foregone.
- The accounting profit tells about the profitability of the company, whereas the economic profit, tells about that how well the company is allocating its available resources.
- Accounting Profit = Total Revenue – Total Explicit Cost, Economic Profit = Total Revenue – (Total Explicit + Total Implicit Cost).