Accounting Earnings: earnings calculated after subtracting the costs of doing business, including operating & non-operating expenses, interest, and taxes from total income.
Accounting Earnings Details
Accounting Earnings is another name for net income, accounting profit, or earnings. Companies determine their accounting earnings by subtracting the company's explicit costs from their total revenue; the remaining amount is then distributed to shareholders or kept as retained earnings.
To find the value of a company's accounting earnings, look at the bottom-most part of its income statement. That's why accounting earnings is also known as "the bottom line." Accounting earnings are an important indicator for businesses themselves as well as investors. Management uses their accounting earnings to plan, while investors or shareholders can evaluate a company's profitableness.
To calculate accounting earnings, companies need to adhere to the Generally Accepted Accounting Principles (GAAP). Companies have to include all expenses incurred during the current fiscal period, such as salaries, cost of goods sold, overhead, distribution and marketing costs, depreciation, etc. Companies need to consider all of the identifiable dollar costs listed on the general ledger to determine accounting earnings. Afterward, they need to carry the value of net income or accounting earnings into their current financial statements.
Accounting Earnings Example
There are many ways to calculate accounting earnings. But generally, follow this formula:
Net Income (Accounting Earnings) = Total Revenue – Total Expenses
Mr. Brown owns a general store, and he wants to calculate his accounting earnings. To do this, he first needs to determine all of the expenses and costs of running his store. This may include the cost of inventory, employee salaries, debt interests, taxes, and any other direct and indirect cost. Next, subtract the total of these expenses from total revenue. This will bring us to the figure of accounting earnings.
$10,000 - $3,400 = $6,600 Accounting earnings for the general store.
The store owner can also determine the earnings before interest and taxes (EBIT) by excluding all interest and tax expenses from the calculation.
Accounting Earnings vs. Economic Earnings
Profit is an essential indicator for businesses and analysts alike to gauge the financial situation of a company. Analysts can look at either the accounting earnings and/or economic earnings.
Economic earnings are the same as accounting earnings but with one addition: it also calculates the opportunity costs of taking one action instead of another, also known as implicit costs.
For example, let's say that a bakery has accounting earnings of $5,000 in January. One month later, in February, the owner's net profit rises to $6,000, thanks to the addition of a new piece of kitchen equipment. Knowing this, he regrets not purchasing the equipment sooner. The economic loss would be -$1,000 for January.
(January earnings - February earnings) =Economic earnings or economic loss.
($5,000-$6,000) = -$1,000 economic loss.
Significance of Accounting Earnings
Many companies use accounting earnings to calculate earnings per share (EPS). EPS measures a company's earnings divided by the outstanding shares of the company's common stock. This will further magnify the degree of a company's profitability in the eye of shareholders and investors. Analysts can also utilize accounting earnings to measure other useful indicators such as return on equity, return on asset, and net margin.
That said, accounting earnings may not give an accurate picture of a company's financial health, especially if the number is manipulated. That's why investors may look into economic earnings instead to get a more accurate representation of the company. Still, economic earnings include opportunity costs that require a more thorough analysis and do not usually result in an exact number, so it's more difficult to calculate.