Profit: accounting and economic profit

click fraud protection

analysis activities of any business entity is made using two approaches that are conventionally referred to as the economic and accounting.The second is based on an analysis of the costs that are made in the financial statements.For economic analysis is not only a set of real-world performance records, but also the opportunity cost, that is a benefit that recognizes the loss.

Features terminology

Under accounting costs understood actually made the payments are made to the documentation.If the resulting income is deducted from the cost accounting, it will be a calculation of accounting profit.Further, it is required to deduct from taxes and other required payments, resulting in net income, and it serves as a backup source of funding, and taken into account by the tax authorities.

If profits are calculated and cost accounting, you should know that in addition to the economic costs ranked as implicit accounting or internal, that is, the opportunity cost of the resources available to the entrepreneur.Evaluation of these internal expenses is made depending on the capabilities of alternative use.

For example, an entrepreneur can use your car for production purposes.Economists are convinced of the need to consider these costs, but accounting can not do this because there is no fact of payment from someone to someone.This is not reflected in the accounting.With economists may have believed that the vehicle could be used differently, for example, the entrepreneur has the opportunity to rent it, for which he will receive rent.Therefore, economists uncollectible rents recognized as internal costs.


So if earnings are considered financial and economic, it is worth noting that the latter represents the difference between income and economic costs.In order to reduce the difference between economic and accounting costs required to fix accounting costs as accurately as possible, although usually this difference can not be reduced to zero.But even when the economic profit less financial, and even tends to zero, the entrepreneur still continue to work, getting the accounting profit.

Historical development

Even in the 19th century were considered different types of income: financial and economic, and then there was a fairly strong clear difference between them.It was then that Alfred Marshall developed the first indicator of economic profit.It is defined as the difference between net profit and the cost of capital of the owner, and all this is known as residual income.While the calculations seem simple, in practice it turns out that you need to find a whole array of information necessary for this purpose.

main focus of Alfred Marshall was placed on the fact that in determining the value formed by a particular time, it is imperative to take into account not only the costs that are reflected in the accounting records, and the opportunity costs associated with raising capital.

long development time Marshall was unclaimed, and the value of economic profit was not so great.However, in the 80s of the last century with the beginning of globalization and the outflow of capital to developing countries began to consider the different types of income: financial and economic.They are used to demonstrate alternative performance indicators of the company in order to attract more and more investors.

Economic profit

It was she who acted as one of the indicators by which to attract new business partners.It suggests that the extra cost of the invested capital will be created only when the size of the real income exceeds the opportunity cost of capital.You can simplify the definition as follows: economic profit exists only in the event that the resulting profit or loss upon exceeds all alternative uses of capital under consideration.

How to use the technique?

While the formation of company profits is reflected only in the accounting records.Economic profit is not taken root in the domestic practice of calculations, and for this there are several reasons.First of all we are talking about not knowing how to use this concept in the decisions of managerial personnel.Everyone is used to analyze the accounting profit, so the activity of the company is seen only through the prism of this factor.And those companies that choose to use this method, faced with the challenge of adaptation to the standards of economic profit tax and accounting.

Standards calculate

Currently, the formula used for the calculation of profit, which corresponds to the international standards of accounting and reporting, as well as US standards.Between themselves, they are fully compatible, they use the same principles of accounting and reporting, and on certain issues in the American standard procedure spelled out more clearly.

requirements of international standards aimed at bringing the legislation of the current system of financial reporting standards and accounting for a harmonious state.It is considered that it is useful to characterize the results of business activities of enterprises in a more realistic manner.However, the US method is based on the increasing number of development, so American companies have a tendency to regulate the operations quite clearly with less flexibility of each organization individually.

At the moment, the economic profit in the balance sheet generally has no effect, and its calculations are scientific or confidential nature.The development of its widespread use is hampered due to the standardization the financial statements and certain conservatism in accounting.

elements of economic profit

When using the indicator of residual income, which was proposed by Marshall, companies have problems with comparing the raw data: the cost of capital will take into account the return on the enterprise on the basis of market value, while net profit serves as the accounting term, calculated on the basis of book value.Naturally, the development of the world economy and the market economy has led to aggravation of the differences between the market and the carrying value of the company, which is why the use of the indicator of residual income became impossible.

Types profit

Varies financial, economic and normal profit.Typically, economic profit is the difference between total revenue and costs: external and internal.In this case, the number of internal costs and normal profit is included, which represents a minimal charge for retaining entrepreneurial talent.Profit, which is calculated on the basis of accounting information is the difference between income from the various types of activities and external costs.The real profit - is the income that remains in the accounts of an entrepreneur.

Currently accounting involves the use of five types of income: gross, profit on sales, profit before tax, profit from ordinary activities and net income.Gross - the difference between the proceeds from the sale of goods, products, services and cost of goods sold, services, products.Revenue, which is obtained from the sale of goods, products and services, called the income from ordinary activities.The formula arrived here following:

P (shaft) = BP - C, where BP - proceeds received from the sale;C - Cost of sales.

features of each type of income

Operating profit - is gross profit less selling and administrative expenses.

Profit before tax is a profit from sales, taking into account the remaining expenses and income that may be operating and non.The operating income includes revenues associated with the provision that the organization's assets for payment for temporary use.Non-operating income are recognized as the fines and penalties for violation of contractual terms, the assets of which are received free of charge, earnings from previous years revealed in the reporting period.

Profit from ordinary activities is obtained by deducting from the profit before tax and mandatory payments to the amount of taxes.

net profit represents profit from ordinary activities, which made extraordinary income and expenses.Under the extraordinary income refers to income that arise as a result of extraordinary circumstances of economic activity.Under the extraordinary expenses defined as the costs associated with similar situations.

«we dance" of costs

If we consider financial, economic and normal profit, it is worth noting that in general the profit is determined as the difference between total revenue and total costs.This is the easiest and most common version of the calculation, which can be used at all.

Now we need to pay attention to the costs.Accounting and economic profit suggests different approaches to their definition.Sami costs can be external and internal.The former include payments to external suppliers.When subtracting them from the total revenues can be obtained accounting profit.But she will not allow for internal costs, which accepted to:

  • costs associated with the resources owned by the company itself;
  • normal profit, which depends on a vital resource - entrepreneurial ability.

Economic profit is obtained after accounting will be removed from the internal costs.

most obvious differences

turns out that the accounting profit is intended only to take account of external costs and economic determined by subtracting also internal costs.The amount of internal and external costs of economic form, they are called alternative.That means for determining the volume of real income should be based on the prices of such resources, which would be obtained if the owner of its best use.Formation of the company profits thus occurs regardless of the method of its calculation.But it is important to understand that the best option is to increase economic profit.