Accounting Profit vs Economic Profit | Find Out the Best Differences!

Accounting Profit vs Economic Profit | Find Out the Best Differences!

hello everyone hi welcome to the channel
of Wallstreetmojo. Watch the video till the end and also if you are new to this
channel then you can subscribe us by clicking the bell icon. Friends today we have topic which is our accounting profit vs economic profit. We will try to
understand this topic you know much more detailed format so let me begin with
this by saying that you know in general sense now profit refers to a thing
called surplus which remains out of the total income you know after deducting
the necessary what we call as expenses. However we will be analyzing
two different types of profits. One is called it’s known as the accounting profit and the second is known as the economic
profit. So let’s discuss both of this in a detail format see if you see for
accounting profit it refers to the thing called gross revenue known as your
gross revenue less you’ll be deducting the explicit cost from so this explicit
cost over here is the deductible expenses like you know I’ll give an
example here. Let’s say there’s a guy called mr. B and he’s running a pastry
shop and he is required to maintain a track of his earning so let’s say if the
total revenue which he has let’s say it is standing at 3 lakh dollars and the
explicit I am just writing EC the explicit cost over here let’s say he has
$50,000 then the accounting profit will be 30000 less 50,000 that is 250000.
Now let’s talk about economic profit. Economic profit involves you know
subtraction of both the implicit cost and thing called explicit
cost so there are both the things involve implicit and explicit cost
from the total revenue from the total revenue so implicit cost are basically
what we know what we call as the opportunity cost and which are not
measurable and not seen in the books of account as well and extending the
example above you know the implicit cost shall include anything that is loss in
case of Mr. B. Let’s say Miss. B was working for someone else or the potential of interest
one could earn if the money of the pastry shop is invested elsewhere so the
concept of implicit revenue also comes in the frame such as the value having
their own business. Let’s say over here we’ll take an example again if the
implicit cost I see if it is standing at let’s say $75,000 and the implicit
revenue that is the IR is standing at let’s say 30000 right and the
economic profit over here will be 30000 right plus the revenue because
the implicit revenue plus previous revenue 330000 and less
you will be deducting over here the explicit cost 50000 less the
implicit cost and that’s where 205000
comes into picture so this is how the accounting profit and the economic
profit are computed and let’s try and discuss the differences between the same with help of the infographics. Let’s start first with the meaning if you see
with the accounting profit it is the net income that is earned during the account
so that includes only the explicit cost but not the implicit cost and income
that has been earned during accounting period and this is the surplus that is
remaining after deduction of all the total cost from the total revenue so the
total revenue includes what you implicit revenue also and your total cost
includes both implicit and the explicit cost now what exactly is the relevance
here if you see for the accounting profit it is practical from the
financial perspective if you are preparing for the books of account basis
then this accounting profit is more suitable option but if we talk about
economic profit it may not be precise picture it may not be the
precise features and since there are many aspects that are based on the
assumptions or maybe it is estimated so probably that can be a backdrop over
here in case of economic profit now what is the benefit what are the advantages
that are involved if you see for the accounting profit it reflects the
profitability of the firm that is the profits of the firm on the books basis
but if you go for the economic profit it highlights the efficiency not only the
profit but it highlights the efficiency of the company in resource allocation
and how exactly those resources have been allocated and be allocated
according to the requirement. let’s see the forth the formula part the
accounting profit is the revenue minus explicit cost tried calculating the
with the help of an example in case of economic profit is revenue plus IRR less
the explicit cost plus the implicit cost over here the IRR should be added. so well this were all the four differences that you were supposed to understand and now we will try and make it will quickly run through some of the really key
differences which forms part of this particular topic the key differences
between the economic profit and the accounting profit in open concepts can
be assessed in a detailed format I will try one by one the accounting profit is
what is known as the real profit that is realized by the firm during the
accounting year whereas if you see for the economic profit it refers to the
abnormal profit that is gains in excess of what is required to cover the
expenses so this includes what is called as the opportunity cost second
accounting profit is normally more than is normally it is greater than economic profit since you know economic profit can involve multiple categories
of income and expenses we just saw that implicit income or maybe explicit or in
implicit expenses which is accompanied by the relevant assumptions as well so
assumptions we know that it no is involved in economic profit.The third
aspect included in the calculation of the accounting profits are basically
like leased assets you’ll see that non-cash adjustments, we have
depreciation, allowances and provisions if any capitalization of the development
cost we have the opportunity cost residual value if any we have any
inflation level of changes or rates of Taxation interest rates on cash flows
and so on and so forth it goes the list is long fourth part we’ll accounting
profit can be referred to as revenue that has been obtained post meeting all
the economic cost right and economic profit also so it is obtained when
revenue exceeds the opportunity cost the accountant you know shall consider you
know the accounting profit as you know they will consider the production cost
if any and the impact on the profitability so accounting profit
is economic profitability was considered themselves as the production cost.
Accounting profit vs economic profit they are interested in
how company has decided to implement any strategy it will also analyze you
know how those strategy can have an impact on the firm and the economy as a whole. So a firm you know he will always try to
aim at earning positive economic profits like you know if if the accounting
profits if they are greater than the what we call as the implicit cost the
form would earn positive economic profit here and should continue the business if
the accounting profit that is EP if this is less than the implicit cost and the
economic profit that the EP will be negative that is economic profit will be
negative and it is advisable for the business to divest
their business interest into some other place so in equilibrium we
have a zero economic profit that is the firm is covering all implicit cost and
the explicit cost and netholders and the equity holders are earning the
required rate of returns. So let me give me my final thoughts the entire future
of any company depends on the profit earning potential in the near future and
also in our tasks it it has performed in the recent past so as shareholders
investor the accounting profit AP is important is of the importance that will
give the true picture of the financial performance the economic profit may be
used for what we call as the internal analysis or by specific individual to
assess the opportunity cost which are making the way for current activities
though economic profit can involve a lot of assumptions it can give an
approximate answer of the desired direction so that’s it for this
particular topic if you have learned and enjoyed watching this video please like
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thank you very much Cheers

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