Question

1. How does accounting profit differ from economic profit? Explain why accounting profit is more useful for paying your taxes while economic profit is more useful for deciding whether you should continue to stay in business. Give an example of an implicit cost and an example of implicit revenue.

Answer 1

Accounting profits is what goes into the books of accounts. It shows all the costs that are tangible and will be included in the profit and loss account. Economic profit includes the idea of opportunity cost that is the cost of the next best alternative forgone. This is included in the economic profit but not in the accounting profit. Accounting profit is correct for determining taxes to be paid as it includes the operating profit line item. The economic profit shows opportunity cost and so it will show the next best alternative forgone if choosing to stay in business. For this we use the economic profit.An example of an implicit cost could be the cost of the next best alternative forgone. An example of an implicit revenue would be the additional revenue achieved without putting in direct effort.