Accounting Profit: is the net income of a company calculated after subtracting all explicit costs from total earnings.
Accounting Profit Details
Accounting profit = Revenue – Explicit Costs
To find the accounting profit, first identify the explicit costs. Explicit costs are all business costs appearing in the ledger that influence a company’s profitability. This includes the cost of goods sold, wages, marketing costs, depreciation, taxes, interests, and any other direct or indirect cost. The similarity between these costs or expenses is that they have determined a dollar amount in the book.
The Accounting profit is the net income; this number is listed at the bottom of a company’s income statement. It reflects the remaining revenue after the company has paid all costs. The revenue can then be distributed to shareholders, reinvested in the company, or retained. The accounting profit or net income is an essential indicator of a company's plan for the future. For investors, the accounting profit is also a critical metric to gauge a company’s profitability.
Companies need to follow the Generally Accepted Accounting Principles (GAAP) to calculate accounting profit or net income. They are also required to include the result of the calculation into their financial statements.
Accounting Profit Example
To calculate the accounting profit, use the same formula used to calculate the net income:
Net Income (Accounting Profit) = Total Revenue – Total Expenses – Taxes
Total Expenses refers to all direct costs and expenses related to producing goods. This includes operating expenses—consisting of costs of goods sold (COGS), lease payments, marketing, depreciation & amortization, administration expenses—and non-operating expenses such as debt interests. Finally, the residual income is taxed to brings us the figure of the accounting profit.
As an example, let’s determine the accounting profit of a spaghetti restaurant. The restaurant has total monthly earnings of $100,000. Furthermore, the total monthly expenses of the restaurant are $85,000. Calculate the earnings before tax (EBT) of the restaurant by subtracting both numbers:
$100,000 - $85,000 = $15,000.
The total monthly tax is $5,000, so the accounting profit of the restaurant is $10,000.
Accounting Profit vs. Economic Profit
The only difference between accounting profit and economic profit is the inclusion of implicit costs. Implicit costs are a company’s opportunity costs of using its assets instead of allocating them elsewhere. For example, the building used for business could be sold or rented. Economic profit serves as a theoretical indicator rather than a measurable result.
Let’s take advantage of the previous example to make things more clear. The accounting profit of the spaghetti restaurant from before is $10,000. However, if the owner chooses to rent the restaurant building instead of running a food business, they could’ve gained a monthly profit of $8,000.
Thus, the business owner's economic profit is $2,000 ($10,000 - $8,000).
Implicit costs can also be in the form of other things, like employment. For instance, Mike is a former employee that has started his own business. In the past year, he has spent about $150,000 on his business and has gained a total profit of $190,000.
Mike’s accounting profit is $40,000 ($190,000 - $150,000). But, a year ago, if he decided to keep his job instead, he could’ve earned a yearly salary of $45,000.
This makes Mike suffer an economic loss of $5,000 ($45,000 - $40,000).
Significance of Accounting Profit
Investors gauge a company's profitableness by using numerous indicators such as return on asset, return on equity, and earnings per share, all of which use accounting profit or net income as the main factor. That said, analysts tend to utilize economic profit, which includes implicit costs, to determine a business's profitability. Apart from the fact that economic profit potentially gives a more accurate picture, accounting profit is also considered more prone to manipulation.