What is an Accounting Profit?

Accounting Profit is a company's gross revenue minus its explicit costs. It is the net earnings on its income statement calculated according to generally accepted accounting principles (GAAP). The explicit costs of a company include the labor costs, costs of the raw materials, transportation costs, distribution expenses, and all other production costs. While calculating the accounting profit, the implicit costs of the company are not considered and thus the accounting profit of a company tends to be higher than its economic profit.

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How to Calculate the Accounting Profit?

Accounting profit only represents the monetary expenses and doesn't consider the opportunity costs. For example, Sandra is a full-time employee in a multinational company and earns $120,000 a year. Now she decides to leave her job and open a cafe in her locality. She expects sales of $300,000 a year and her explicit cost for running the cafe is estimated at $200,000. The explicit cost includes the labor wage, raw material costs, property rental, and others. According to this estimation, her accounting profit would be $100,000. So, it seems the business is profitable, but an economist will see things differently. They will argue that Sandra should consider what she would give up that includes the investment she is making (otherwise she could earn interest on this amount) and her salary. So, according to economists, shell be making a loss as her economic profit is negative. The economic loss doesn't imply that Sandra is losing money, but it indicates that Sandra would make more by using her time and resources in her current job. Lets look at the calculation of the accounting profit. X is a company that produces toys. For the sake of simplicity let's assume that they sell each of their toy for $10. In the first month of an economic year, they sell 5,000 toys for total monthly revenue of $50,000. This is the first number to be entered into the income statement of the company. Now, the gross revenue of the company is calculated as the total monthly revenue minus the cost of goods sold (COGS). Suppose the cost of making each toy is $3 then the company's COGS would be $15,000 and the gross revenue would be $35,000. Then, the operating costs are subtracted from the gross revenue to get the company's operating profit. If the operating cost is $10,000, the operating profit would be ($35,000- $10,000) = $25,000. After deriving the operating profit, the non-operating expenses are assessed. This includes interest, depreciation, taxes, and amortization. Lets assume this company does not have any debt and has depreciating assets at a straight-line depreciation of $5,000 a month and has a corporate tax rate of 35%. The company's earnings before taxes (EBT) is $25,000-$5,000 = $20,000. The accounting profit of the company are then calculated as {$20,000-($20,000*0.35)} = $13,000. The accounting profit is also called bookkeeping profit or financial profit. Monitoring the profit of a company is important to assess its financial health.

Related Topics

• Marginal Revenue
• Value of Marginal Product
• Accounting Profit
• Economic Profit
• Normal Profit