1-1

BUSINESS ADMINISTRATION
DEPARTMENT

LECTURE NO: 2

Accounting Profit &

Economic Profit

COURSE INSTRUCTOR:
SHAGUFTA SALEEM SHAIKH

BBA 2k22
 1-2

Lectures Outlines

 Profit
 Accounting Profit & Economic Profit
 Explicit Cost
 Implicit Cost

BBA 2k22
 1-3

PROFIT
 Profit is the reward to the owners of firms for
taking risks / engaging in enterprise It is the
difference between revenue and costs.

 Each of the businesses, regardless of size or

complexity, tries to earn a profit:

Profit = Total Revenue - Total Cost

BBA 2k22
 1-4

TOTAL REVENUE
 Total revenue is the income brought into the
firm from selling its products. It is calculated
by multiplying the price of the product times
the quantity of output sold:

Total Revenue = Price × Quantity

BBA 2k22
 1-5

ACCOUNTING PROFIT
 The actual profit earned by the company during a
particular financial year is known as Accounting
Profit.
 The profit is obtained by deducting the total explicit
cost from total revenue.
 Here explicit cost means the direct cost spent on
account of running a business, i.e. rent on land and
building, the wages of labor, salary for employees,
etc.

BBA 2k22
 1-6

ACCOUNTING PROFIT Cont..

 Accounting profit is also known as the net

income for a company. It's the profit after
various costs and expenses are subtracted
from total revenue or total sales.

FORMULA:
Accounting Profit = Total Revenue - Explicit Cost

BBA 2k22
 1-7

ECONOMIC PROFIT

 Economic Profit also referred as extra profit or

supernormal profit. It is the difference
between total revenue earned by the
company and the total costs (explicit as well
as implicit).

BBA 2k22
 1-8

ECONOMIC PROFIT Cont..

 Economic profit is similar to accounting profit
in that it deducts explicit costs from revenue.
However, economic profit also includes the
opportunity costs for taking one action versus
another in the period.
 Economic profit also uses implicit costs, which
are typically the costs of a company's
resources.

BBA 2k22
 1-9

ECONOMIC PROFIT Cont..

• Economic profit is the profit from producing
goods and services while factoring in the
alternative uses of a company's resources Cost

 FORMULA:
Economic Profit = Total Revenue - Explicit Cost -
Implicit Cost

BBA 2k22
 1-10

EXPLICIT COSTS
 Explicit costs are costs that involve direct payment.
Wages paid to workers, rent paid to a landowner, and
material costs paid to a supplier are all examples of
explicit costs.
 Explicit costs are out-of-pocket costs, that is,
payments that are actually made. Wages that a firm
pays its employees or rent that a firm pays for its
office are explicit costs.

BBA 2k22
 1-11

EXAMPLES OF EXPLICIT COSTS

 Labor costs, such as wages

 Inventory needed for production
 Raw materials
 Transportation costs
 Sales and marketing costs
 Production costs

BBA 2k22
 1-12

IMPLICIT COSTS
 In contrast, implicit costs are the opportunity
costs of factors of production that a producer
already owns.
 The implicit cost is what the firm must give up
in order to use its resources; in other words,
an implicit cost is any cost that results from
using an asset instead of renting, selling, or
lending it.

BBA 2k22
 1-13

EXAMPLES OF IMPLICIT COST

• Implicit Costs are more subtle, but just as important.
They represent the opportunity cost of using
resources already owned by the firm.
Examples of implicit costs include:
 Company-owned buildings
 Plant and equipment
 Self-employment resources

BBA 2k22
 1-14

EXAMPLE of Economic & Accounting Profit

Fred currently works for a corporate law firm. He

is considering opening his own legal practice,
where he expects to earn $200,000 per year
once he gets established. To run his own firm, he
would need an office and a law clerk. He has
found the perfect office, which rents for $50,000
per year. A law clerk could be hired for $35,000
per year. If these figures are accurate, would
Fred’s legal practice be profitable?

BBA 2k22
 1-15

Step 1. First you have to calculate the costs.

You can take what you know about explicit
costs and total them:

Office rent: 50,000

Law clerks salary: 35,000
Total Explicit costs: 85,000

BBA 2k22
 1-16

Step 2. Subtracting the explicit costs from the

revenue gives you the accounting profit.

Revenues: 200,000
Explicit costs: 85,000
Accounting profit: 115,000

BBA 2k22
 1-17

But these calculations consider only the explicit

costs. To open his own practice, Fred would have
to quit his current job, where he is earning an
annual salary of $125,000. This would be an
implicit cost of opening his own firm.

BBA 2k22
 1-18

Step 3. You need to subtract both the explicit and

implicit costs to determine the true economic profit.

Economic Profit =Total revenues- explicit costs- implicit costs

=$200,000 - $85,000 - $125,000
= -$10,000 Per year

• Fred would be losing $10,000 per year.

BBA 2k22
 1-19

Exercises
 Problems & Solution on White Board

BBA 2k22
 1-20

Example 1:
Clifford produces 20 shoes at a cost of $200 and
sells all 20 shoes for a total of $300. Clifford
could have produced 20 belts instead of shoes
and would have made $50 more. Calculate
Clifford's accounting profit and economic profit.
 1-21

Example 2:
Ava runs a painting business. She spends $100 a
day on workers and machines and makes a
revenue of $150 a day. Instead of the painting
business, Ava could have operated a home
cleaning service and spent the same $100 each
day on workers and machines. However, the
home cleaning business would have made Ava
$50 more each day.
Let's find Ava's accounting profit and economic
profit.
 1-22

Example 3: Kent runs a shoe company that sold 200

pieces at $5 a piece in the year under review. Kent's
company owns all its equipment and spent a total of $500
to produce the shoes. He conducts an assessment and
finds out that his machines depreciated by $100. He has
also been looking into the belt business, and would have
made about $300 more had he manufactured and sold
belts instead of shoes.
a. What is Kent's accounting profit?
b. What is Kent's economic profit?
 1-23

Special Thanks…..

BBA 2k22