Economic Profit vs. Accounting Profit

While economic profit includes theoretical estimations of loss based on opportunity cost and value, accounting profit is the actual revenue calculations generated by bookkeepers. In other words, bookkeepers see accounting profit in dollars that have actually been spent and earned. As a result, a firm might generate a noticeable accounting profit, but if it experiences a hefty loss in opportunity cost, its economic profit could be negligible.

The Basic Differences

There are several differences that help define economic profit vs. accounting profit. First of all, while economic profit includes the opportunity cost, accounting profit does not take that into consideration. In other words, economic profits include both implicit costs (potential value of goods and services) and explicit costs (money directly paid), while accounting profits consider explicit costs and depreciation provisions. Accounting profits are computed for a particular time period (usually for a quarterly or annual report), and will almost always exceed the relative economic profit.

Example of Variant Calculations

The basic formula for calculating accounting profit is: total income-total expenses. To determine economic profit, on the other hand, the formula would be: total income-total expenses-lost opportunity cost. For example, if a business invests $200,000 in a venture and earns $250,000 in revenue, the accounting profit would be $50,000 ($250,000-$200,000). Yet if that business did not maximize its earning potential and could have earned an extra $40,000, then the firm’s economic profit would only amount to $10,000 ($250,000-$200,000-$40,000).

Depreciation

While the calculation for an accounting profit does not take into account lost opportunity cost, it does include depreciation of assets over the specific time period in question. Therefore, when a bookkeeper is determining a business’s income levels in the years following the purchase of an asset predicted to depreciate, he or she must also subtract the depreciation cost allocated for that period. Depreciation is one of the primary reasons that account profits on a balance sheet will differ from overall.

Types of Accounting Profit

While economic profit is a sweeping term that covers any investment opportunity, accounting profits can be divided into specific categories. For example, gross accounting profit is calculated in accounting by subtracting the cost of goods from overall revenue, while “operating profit” is determined by subtracting a company’s labor and operation expenses from that gross profit. Additionally, accounting departments compute “net profit,” which is the gross profit after taxes.

Increasing Accounting Profit

Planning ways to increase economic profit is a bit difficult, as it relies on potential situations in the market and unforeseen opportunities. Because accountants deal in hard numbers, strategies for increasing accounting profit are a bit clearer. For instance, a business might buy products or materials in bulk to save money in cost, and increase revenue. Or, a company might make an investment (such as additional product features or celebrity endorsements) that would allow them to significantly increase the value—and thus the price—of the product in question.

The most obvious difference that arises when considering economic profit vs. accounting profit pertains to the role of opportunity cost. In other words, accountants work with numbers that can be specifically documented, viewing profit in terms of calculable revenue as opposed to the estimated potential of a transaction that is considered when determining economic profit.