There are thus two basic types of profit—accounting and economic
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Open it 2.1. Types of Profit Measures
The economics discipline has its own concept of profit, which differs substantially from what accountants consider profit. There are thus two basic types of profit—accounting and economic—and analysts need to be able to interpret each correctly and to understand how they are related to each other. In the theory of the firm, however, profit without further qualification r
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2. OBJECTIVES OF THE FIRM he firm’s efficiency in producing that level of output when utilizing inputs, and resource prices as established by resource markets. TR is a function of output and product price as determined by the firm’s product market.
<span>2.1. Types of Profit Measures
The economics discipline has its own concept of profit, which differs substantially from what accountants consider profit. There are thus two basic types of profit—accounting and economic—and analysts need to be able to interpret each correctly and to understand how they are related to each other. In the theory of the firm, however, profit without further qualification refers to economic profit.
2.1.1. Accounting Profit
Accounting profit is generally defined as net income reported on the income statement according to standards established by private and public financial oversight bodies that determine the rules for financial reporting. One widely accepted definition of accounting profit—also known as net profit, net income, or net earnings—states that it equals revenue less all accounting (or explicit) costs . Accounting or explicit costs are payments to non-owner parties for services or resources that they supply to the firm. Often referred to as the “bottom line” (the last income figure in the income statement), accounting profit is what is left after paying all accounting costs—whether the expense is a cash outlay or not. When accounting profit is negative, it is called an accounting loss . Equation 2 summarizes the concept of accounting profit:
Accounting profit = Total revenue – Total accounting costs
When defining profit as accounting profit, the TC term in Equation 1 becomes total accounting costs, which include only the explicit costs of doing business. Let us consider two businesses: a start-up company and a publicly traded corporation. Suppose that for the start-up, total revenue in the business’s first year is €3,500,000 and total accounting costs are €3,200,000. Accounting profit is €3,500,000 – €3,200,000 = €300,000. The corresponding calculation for the publicly traded corporation, let us suppose, is $50,000,000 – $48,000,000 = $2,000,000. Note that total accounting costs in either case include interest expense—which represents the return required by suppliers of debt capital—because interest expense is an explicit cost.
2.1.2. Economic Profit and Normal Profit
Economic profit (also known as abnormal profit or supernormal profit ) may be defined broadly as acc
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