Accounting Profit
What is Accounting Profit?
Accounting profit is total revenue minus explicit costs, as recorded on a firm's financial statements.
Explicit costs are direct, out-of-pocket payments like wages, rent, and materials. Accounting profit does not include opportunity costs, so it is typically higher than economic profit. It is used for tax and reporting purposes.
Accounting Profit: a worked example
A bakery takes in $180,000 in sales for the year. Its explicit costs are staff wages of $70,000, shop rent of $24,000, flour and other ingredients of $36,000, and utilities of $6,000. Add the explicit costs: 70,000 + 24,000 + 36,000 + 6,000 = $136,000. Accounting profit is $180,000 minus $136,000, or $44,000, and that is the figure the bakery's income statement and tax return will show. Notice that the owner's forgone $50,000 salary from her old job never appears in this calculation, because no check was written for it. An economist would subtract it as an implicit cost and report a very different bottom line.
The mistake students make with accounting profit
On a free response question that lists an owner's forgone salary alongside wages and rent, students subtract everything and call the result accounting profit. The list format invites it, since every line looks like a cost. Accounting profit subtracts only explicit costs, the payments the firm actually makes to outside parties. Forgone salary, forgone interest on the owner's own money, and the rental value of a building the owner already owns are implicit and belong only in the economic profit calculation. Sort the list into paid and not paid before subtracting.
Accounting Profit questions
Is the owner's salary an explicit or implicit cost?
Both answers can be right, and the test is whether money actually changes hands. If the owner is on payroll and the business writes her a $60,000 paycheck, that is an explicit cost and it reduces accounting profit. If she draws nothing but gave up a $60,000 job to run the firm, the amount is an implicit cost, invisible to the accountant and subtracted only when computing economic profit.
Why is accounting profit usually larger than economic profit?
Accounting profit leaves out implicit costs, so it starts from a smaller pile of subtractions. A consultant with $200,000 of revenue and $120,000 of explicit costs books $80,000 of accounting profit, but if she gave up a $95,000 salary to start the firm, her economic profit is negative $15,000. The gap between the two numbers equals total implicit costs, which is why accounting profit can look healthy while the owner is worse off than before.
Which profit number appears on a firm's tax return?
Accounting profit, computed from revenue minus explicit costs under standard reporting rules, is the number that flows onto financial statements and tax filings. Tax authorities need amounts that can be checked against receipts, invoices, and payroll records, and implicit costs leave no paper trail. Economic profit stays an analytical tool used to judge whether resources are in their best use, so no accountant reports it.
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