What Is Accounting Profit?

Accounting profit is a company's total earnings, calculated according to generally

accepted accounting principles (GAAP). It includes the explicit costs of doing
business, such as operating expenses, depreciation, interest, and taxes.

KEY TAKEAWAYS
Accounting profit shows the amount of money left over after deducting the explicit
costs of running the business.
Explicit costs include labor, inventory needed for production, and raw materials,
together with transportation, production, and sales and marketing costs.
Accounting profit differs from economic profit as it only represents the monetary
expenses a firm pays and the monetary revenue it receives.
Accounting profit also differs from underlying profit, which seeks to eliminate the
impact of nonrecurring items.
Accounting Profit

How Accounting Profit Works

Profit is a widely monitored financial metric that is regularly used to evaluate
the health of a company.

Firms often publish various versions of profit in their financial statements. Some
of these figures take into account all revenue and expense items, laid out in the
income statement. Others are creative interpretations put together by management
and their accountants.

Accounting profit, also referred to as bookkeeping profit or financial profit, is

net income earned after subtracting all dollar costs from total revenue. In effect,
it shows the amount of money a firm has left over after deducting the explicit
costs of running the business.

The costs that need to be considered include the following:

Labor, such as wages

Inventory needed for production
Raw materials
Transportation costs
Sales and marketing costs
Production costs and overhead
Accounting Profit vs. Economic Profit
Like accounting profit, economic profit deducts explicit costs from revenue. Where
they differ is that economic profit also uses implicit costs; the various
opportunity costs a company incurs when allocating resources elsewhere.

Examples of implicit costs include:

Company-owned buildings
Plant and equipment
Self-employment resources
For example, if a person invested $100,000 to start a business and earned $120,000
in profit, their accounting profit would be $20,000. Economic profit, however,
would add implicit costs, such as the opportunity cost of $50,000, which represents
the salary they would have earned if they kept their day job. As such, the business
owner would have an economic loss of $30,000 ($120,000 - $100,000 - $50,000).

Economic profit is more of a theoretical calculation based on alternative actions

that could have been taken, while accounting profit calculates what actually
occurred and the measurable results for the period. Accounting profit has many
uses, including for tax declarations. Economic profit, on the other hand, is mainly
just calculated to help management make a decision.

Accounting Profit vs. Underlying Profit

Companies often choose to supplement accounting profit with their own subjective
take on their profit position. One such example is underlying profit. This popular,
widely-used metric often excludes one-time charges or infrequent occurrences and is
regularly flagged by management as a key number for investors to pay attention to.

The goal of underlying profit is to eliminate the impact that random events, such
as a natural disaster, have on earnings. Losses or gains that do not regularly crop
up, such as restructuring charges or the buying or selling of land or property, are
usually not taken into account because they do not occur often and, as a result,
are not deemed to reflect the everyday costs of running the business.

Example of Accounting Profit

Company A operates in the manufacturing industry and sells widgets for $5. In
January, it sold 2,000 widgets for a total monthly revenue of $10,000. This is the
first number entered into its income statement.

The cost of goods sold (COGS) is then subtracted from revenue to arrive at gross
revenue. If it costs $1 to produce a widget, the company's COGS would be $2,000,
and its gross revenue would be $8,000, or ($10,000 - $2,000).

After calculating the company's gross revenue, all operating costs are subtracted
to arrive at the company's operating profit, or earnings before interest, taxes,
depreciation, and amortization (EBITDA). If the company's only overhead was a
monthly employee expense of $5,000, its operating profit would be $3,000, or
($8,000 - $5,000).

Once a company derives its operating profit, it then assesses all non-operating
expenses, such as interest, depreciation, amortization, and taxes. In this example,
the company has no debt but has depreciating assets at a straight line depreciation
of $1,000 a month. It also has a corporate tax rate of 35%.

The depreciation amount is first subtracted to arrive at the company's earnings

before taxes (EBT) of $1,000, or ($2,000 - $1,000). Corporate taxes are then
assessed at $350, to give the company an accounting profit of $650, calculated as
($1,000 - ($1,000 * 0.35).

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Related Terms
Accounting Earnings Definition
Accounting earnings is the profit a company reports on its income statement and is
calculated by subtracting the cost of doing business from revenue. more
Economic Profit (or Loss) Definition
Economic profit (or loss) is the difference between the revenue received from the
sale of an output and the costs of all inputs, including opportunity costs. more
Gross Profit
Gross profit is the profit a company makes after deducting the costs of making and
selling its products, or the costs of providing its services. more
How Implicit Costs Work
An implicit cost—also called imputed, implied, or notional costs—are any cost that
has already occurred but not necessarily shown or reported as a separate expense.
more
EBITDA – Earnings Before Interest, Taxes, Depreciation, and Amortization
EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a
measure of a company's overall financial performance. more
Understanding Cost of Goods Sold – COGS
Cost of goods sold (COGS) is defined as the direct costs attributable to the
production of the goods sold in a company. more