THE ACCOUNTING AND ECONOMIST DEFINITION OF PROFIT

THE ACCOUNTING AND ECONOMIST DEFINITION OF PROFIT

(A) ACCOUNTING DEFINITION OF PROFIT:

               There is no satisfactory definition of the term profit. Generally profit of a firm is defined as the access of revenue over its current costs. The word cost carries. Different meaning with economists and accountants, in accounting, the term profit equals total revenue – explicit costs. This is the profit used by accountants to determine a firm’s taxable income. Explicit costs are the actual cash payments for resources purchased in resource markets. These are the rent the rent paid on land and plant and equipment, wages to labour, interest on capital, cost of raw material, transport charges etc. when all these explicit costs are substracted from the firm’s total revenue, we get gross profit or accounting profit. Accounting profit = total revenue – explicit costs.

      Accounting profit is explained by taking a simple example, let us suppose, the total revenue of a firm from the sale of goods inn 2006 is Rs. 90,000. Its costs on the purchase of raw material, payment of wages and other utilities i.e. explicit costs are 35,000. The firms accounting profit will be Rs. 55,000.

Total sales revenue……………Rs.90,000.

Cost of raw material……… = Rs. 15,000.

Wages to labour and other utilities = Rs. 20,000

Accounting profit = Rs. 90,000 – 15,000 + 20,000 = 55,000

(total revenue – explicit cost)

           When deprecation charges of capital equipment used by the firm and the amount of money paid to the government as taxes is deducted from gross profit accounting profit, we get net profit of accountants.

(B) ECONOMIC PROFIT:

           Economic profit is different from accounting profit. Accounting profit ignores the opportunity cost of the firm’s own resources used in the production of goods. The economist include cost of production. Thus economic profit equals total revenue less all costs both explicit and implicit.

   A firm’s implicit costs are the opportunity costs of using its self-owned, self-employed resources, implicit cost include use of firm’s own building, use of its own capital, and the business owner time given for the production of goods. While determining the total costs, the money payment which these self-employed resources could have earned in their best alternative uses should be worked out and added in cost. The implicit costs are in a way opportunity costs. Economic profit takes into account the opportunity costs of all resources used in production. Implicit costs also include normal profit earned by a firm. Normal profit is the minimum amount required to keep on entrepreneur engaged in the present line of production.

ECONOMIC PROFIT = TOTAL REVENUE LESS ALL COSTS BOTH EXPLICIT AND IMPLICIT.

Example: Suppose a person uses, his own resources, land, capital, his own time in the production of goods. The opportunity costs of these resources in included below in finding out economic profit of the firm.

Accounting profit                                   = Rs. 55,000

Entrepreneur’s own foregone salary     =Rs. 40, 000

Foregone interest on capital                  = Rs.   1,000

Foregone rent                                          =Rs.    2,000

Economic profit                                        =Rs.  12,000

                           OR

 Summing up (a) Accounting profit is the firm’s total revenue less its explicit costs (b) Economic profit to the economist, is the total revenue of a firm less explicit and implicit cost. Implicit cost includes normal profit to attract and retain an entrepreneur engaged in the present line of production Economic profit: if a firm’s total revenue exceeds all its economic costs both explicit and implicit, the residual which goes to the entrepreneur is called an economic or pure profit.