Difference Between Accounting Profit and Economic Profit in Tabular Form
Understanding the difference between accounting profit and economic profit is important for students, exam preparation, and practical business decisions. These two profit types use different calculation methods and have different applications in accounting and economics. Knowing both helps in board exams, competitive tests, and real-world business planning.
| Basis | Accounting Profit | Economic Profit |
|---|---|---|
| Definition | Profit after subtracting explicit (actual) costs from total revenue | Profit after subtracting both explicit and implicit (opportunity) costs from total revenue |
| Costs Considered | Only explicit (out-of-pocket) costs | Both explicit and implicit (opportunity) costs |
| Formula | Total Revenue – Explicit Costs | Total Revenue – (Explicit Costs + Implicit Costs) |
| Reported In | Financial statements, for tax purposes | Not reported in financial statements, used for decision-making |
| Normal Profit | May ignore opportunity cost | Normal profit included in implicit costs |
| Usage | Financial accounting, tax calculation | Economic analysis, business strategy |
Accounting Profit: Definition, Formula and Example
Accounting profit is the net profit a business earns when explicit costs are subtracted from total revenue. Explicit costs include wages, rent, raw materials, and utility expenses. This figure appears in official financial statements and is essential for filing taxes and evaluating firm performance.
Accounting Profit Formula
Accounting Profit = Total Revenue – Explicit Costs
Example of Accounting Profit
Suppose a shop earns ₹5,00,000 revenue and pays ₹3,00,000 on wages, inventory, and rent. Accounting profit = ₹5,00,000 – ₹3,00,000 = ₹2,00,000.
Economic Profit: Meaning, Formula and Example
Economic profit accounts for both explicit and implicit costs (the value of the next-best alternative use of resources). It shows the true profitability after considering all alternatives sacrificed by using resources in the current business.
Economic Profit Formula
Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs)
Example of Economic Profit
Using the above example, suppose the owner could have earned ₹1,00,000 working elsewhere (implicit cost). Economic profit = ₹5,00,000 – (₹3,00,000 + ₹1,00,000) = ₹1,00,000.
Difference Between Accounting Profit and Economic Profit in Tabular Form
| Criteria | Accounting Profit | Economic Profit |
|---|---|---|
| Definition | Profit after explicit costs | Profit after explicit and implicit costs |
| Cost Type | Explicit (out-of-pocket) | Explicit + Implicit (opportunity costs) |
| Formula | Total Revenue – Explicit Costs | Total Revenue – (Explicit + Implicit Costs) |
| Reported In | Company financials, tax reports | Not in financials, used in economic analysis |
| Purpose | Evaluate operational performance | Assess true profitability and resource allocation |
| Level | Usually higher | Usually lower |
Real-World Example: Calculating Both Profits for a Business
Imagine you start a bakery that earns ₹10,00,000 per year. Your explicit costs are ₹6,00,000 (wages, ingredients, rent). If you could have earned ₹2,00,000 managing another bakery (opportunity cost), your profits are calculated as follows:
- Accounting Profit = ₹10,00,000 – ₹6,00,000 = ₹4,00,000
- Economic Profit = ₹10,00,000 – (₹6,00,000 + ₹2,00,000) = ₹2,00,000
This shows economic profit is always equal to or less than accounting profit.
Meaning of Zero/Normal Profit
Zero accounting profit means a business's total revenue equals explicit costs — it covers costs but earns nothing extra. Zero economic profit (also called normal profit) means total revenue covers all explicit and implicit costs. In perfect competition, firms often earn zero economic profit in the long run, indicating efficient resource use but not losses.
- Zero Accounting Profit: No profit after covering only actual expenses.
- Zero Economic Profit: All costs—including opportunity costs—are just covered; the owner earns a "normal return."
Key Takeaways: Difference Between Accounting Profit and Economic Profit
- Accounting profit considers only explicit costs; economic profit also considers implicit/opportunity costs.
- Accounting profit appears in financial records; economic profit is used for decision making and economic analysis.
- Economic profit gives a broader view of business performance and helps in strategic planning.
- This topic is essential for exams and understanding true business gains.
- At Vedantu, students can find clear examples and comparison tables to master this concept.
- Related concepts include explicit and implicit costs and National Income.
In summary, the difference between accounting profit and economic profit lies in the inclusion of opportunity costs. Accounting profit shows net income for financial reporting, while economic profit gives a complete picture for economic decisions. Mastering both is important for Commerce exams and smart business planning.
FAQs on Difference Between Accounting Profit and Economic Profit Explained
1. What is the primary difference between accounting profit and economic profit?
The main difference between accounting profit and economic profit lies in the inclusion of opportunity costs. Accounting profit only considers explicit costs (direct, out-of-pocket expenses), while economic profit incorporates both explicit and implicit costs (opportunity costs, the forgone benefits from the next best alternative). This means economic profit provides a more comprehensive picture of profitability.
2. How do you calculate accounting profit and economic profit?
Accounting profit is calculated as Total Revenue - Explicit Costs. Economic profit is calculated as Total Revenue - (Explicit Costs + Implicit Costs). Understanding the difference between explicit and implicit costs is crucial for accurate calculation.
3. What are explicit costs vs. implicit costs? Give examples.
Explicit costs are direct, out-of-pocket payments. Examples include rent, salaries, raw materials. Implicit costs represent the opportunity cost of using resources already owned. For example, the forgone salary a business owner could have earned elsewhere is an implicit cost.
4. Why is economic profit usually lower than accounting profit?
Economic profit is typically lower because it subtracts implicit costs (opportunity costs), which are not included in accounting profit calculations. These opportunity costs represent the potential benefits forgone by choosing a particular course of action. Therefore, economic profit reflects a more realistic assessment of profitability.
5. What does zero economic profit mean for a business?
Zero economic profit means the business is earning a return equal to its opportunity cost. While it may still show a positive accounting profit, it implies the resources could be employed more profitably elsewhere. In a competitive market, zero economic profit is considered a normal outcome in the long run.
6. Can economic profit ever be higher than accounting profit?
No, economic profit cannot be higher than accounting profit. This is because economic profit includes all costs (explicit and implicit) while accounting profit only considers explicit costs. Therefore, economic profit will always be equal to or less than accounting profit.
7. What is the difference between economic profit and accounting profit?
Accounting profit is the difference between total revenue and explicit costs. Economic profit considers both explicit and implicit (opportunity) costs, providing a more complete picture of profitability. The key difference is the inclusion of opportunity costs in economic profit.
8. What is the difference between accounting and economic costs?
Accounting costs are the actual monetary outlays of a business (explicit costs). Economic costs encompass both explicit and implicit costs, representing the total opportunity cost of using resources.
9. Can you provide an example of an implicit cost?
An example of an implicit cost is the forgone salary a business owner could have earned working elsewhere. It represents the opportunity cost of using their time and skills in their own business instead of accepting alternative employment.
10. What is the difference between accounting profit and economic profit with examples?
Let's say a bakery has $100,000 in revenue, $60,000 in explicit costs (ingredients, rent, wages), and the owner could have earned $40,000 elsewhere. Accounting profit is $40,000 ($100,000 - $60,000). Economic profit is $0 ($100,000 - $60,000 - $40,000), indicating the business isn't generating returns above the opportunity cost.
