Accounting Profit vs Economic Profit

The key difference between accounting profit and economic profit is that accounting profit refers to profits that are recorded in the books of accounts which is calculated by deducting all the direct costs incurred, which refers to monetary cost from the revenue and other income generated from the business activities, whereas, Economic profit refers to the profit which is calculated taking into consideration both explicit as well as implicit cost where implicit cost refers to the opportunity cost of the resources of the organization.

In a general sense, profit refers to the surplus which remains out of the total income after deducting the necessary expenses. However, we will be analyzing two different types of profits.

• Accounting profit refers to the Gross revenue minus the explicit costs (deductible expenses). E.g., Mrs. 'B' is running a pastry shop and must maintain 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 subtracting both Implicit costs and Explicit costs from the Total Revenue. Implicit costs are the opportunity costs that are not measurable and not seen in the books of accounts. 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 into the frame, such as the value of having their 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

1. Accounting profit is the real profit/realized by a firm during an accounting year. It includes opportunity costs. In contrast, Economic profit refers to the abnormal profit, i.e., gains above what is required to cover the expenses.
2. Accounting profit is normally more than Economic profit since economic profit can involve multiple categories of income and expenses accompanied by relevant assumptions.
3. The aspects included in calculating 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 to 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 their impact on profitability. It was considered as production costs. In contrast, when economists describe costs, they are interested in how the company has decided to implement any strategy. It will also analyze how those strategies can impact the firm and the economy.

A firm aims to earn positive economic profits. If accounting profits exceed 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 businesses should 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.

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 is impossible since a business can always choose not to act on available opportunities, thus in a situation of neither earning nor spending anything.

The entire future of any company depends on the profit earning potential shortly and how it has performed in the recent past. As a shareholder/investor, the accounting profit is important 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 that make way for current activities. Though economic profits can involve a lot of assumptions, they can give an approximate answer to the desired direction.

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

• Operating Profit vs Net Profit
• Equity in Economics
• Accounting Convention
• Profit vs Revenue