What is Accounting Profit
Accounting profit is a company's total earnings, calculated according to generally accepted accounting principles (GAAP). It includes the explicit costs of doing business, such as operating expenses, depreciation, interest and taxes.
Accounting profit differs from economic profit in that accounting profit only represents the monetary expenses a firm pays and the monetary revenue it receives; it tends to be higher than economic profit since it omits certain implicit costs, such as opportunity costs.
BREAKING DOWN Accounting Profit
Accounting profit can be thought of as bookkeeping profit. It is the net income earned by a company after subtracting all dollar costs from its total revenue. Accounting profit is derived by preparing and analyzing a company's income statement.
How to Calculate Accounting Profit
For example, a company operates in the manufacturing industry and sells widgets for $5. It sells 2,000 widgets in January for a total monthly revenue of $10,000. This is the first number entered into its income statement. The cost of goods sold (COGS) is then subtracted from revenue to arrive at gross revenue. If it costs $1 to produce a widget, the company's COGS would be $2,000, and its gross revenue would be $8,000, or ($10,000 - $2,000).
After calculating the company's gross revenue, all operating costs are subtracted to arrive at the company's operating profit, or earnings before interest, taxes, depreciation, and amortization (EBITDA). If the company's only overhead were a monthly employee expense of $5,000, its operating profit would be $3,000, or ($8,000 - $5,000). Once a company derives its operating profit, it then assesses all non-operating expenses, such as interest, depreciation, amortization, and taxes.
In this example, the company has no debt but has depreciating assets at a straight line depreciation of $1,000 a month. It also has a corporate tax rate of 35%. The depreciation amount is first subtracted to arrive at the company's earnings before taxes (EBT) of $1,000, or ($2,000 - $1,000). Corporate taxes are then assessed at $350, to give the company an accounting profit of $650, calculated as ($1,000 - ($1,000 * 0.35).
Difference Between Accounting Profit and Economic Profit
Accounting profit only deals with explicit costs that require direct payment. Economic profit, on the other hand, includes implicit costs, which are the various opportunity costs a company incurs when allocating resources elsewhere.
For example, if a person invested $100,000 to start a business and earned $120,000 in profit, his accounting profit would be $20,000. Economic profit, however, would add implicit costs, such as the opportunity cost of $50,000, which represents the salary he would have earned if he kept his day job. As such, the business owner would have an economic loss of $30,000 ($120,000 - $100,000 - $50,000).