Accounting Costs vs.

Economic
Costs (Plus When to Use Each)

Businesses often have a variety of explicit and implicit costs required for running and growing a company.
Accounting and economic costs make up what they actually spend and what a business strategically considers
spending during any accounting period. Understanding the differences between accounting and economic costs can
help you determine the total economic profitability of a business.

Ma
by Mae Ann Joy Lamenta
Accounting Costs
Accounting costs are explicit costs, also referred to as hard costs, that include business necessities
like payroll, production costs and marketing budgets. Businesses can easily track explicit costs
because they include specific dollar amounts. Accounting costs include anything a business spends,
and you deduct them from revenues in an accounting period. This means accounting costs are real
money that leaves the bank each accounting period and includes everything you spend to market,
manufacture and deliver products. You're required to determine accounting costs before you can
calculate the accounting profit.

1 Examples of Accounting Costs

Raw materials and equipment, Utilities and maintenance, Rent or mortgage payments
Calculating Accounting Costs
Step 1: Determine Materials and
Manufacturing Costs
Some accounting expenses are the cost of
raw materials and the manufacturing costs
required to turn the raw materials into a
product. Manufacturing costs overhead
may include the cost of electricity,
property taxes and insurance for the
manufacturing equipment. This also
includes the salaries of manufacturers and
production line employees as well.
1
2 Step 2: Calculate Labor, Salaries
and Taxes
Besides the salaries of people involved in
manufacturing, include the salaries of
other employees. Calculating total payroll
expenses helps you determine the total
accounting costs. Besides payroll,
consider any payroll taxes and potential
fees to figure out the total expenses of
paying employees.

Step 3: Determine Costs for the 3

Facility
After you've calculated all of the labor
costs and employee salaries, you can
move on to the costs of the facility. Paying
rent or a mortgage can be a considerable
business expense. Include the cost of rent,
insurance and utilities when calculating
the accounting cost.
Economic Costs
Economic costs include accounting costs and implicit costs, which are hypothetical expenses used
when making a business decision to forecast potential profit. This means that economic costs include
both explicit and implicit costs. Accountants and business leaders use economic costs when creating
financial projections or determining the best strategic outcome, such as reallocating funds or using a
more efficient mode of production. Economic costs allow accountants to take into consideration both
the explicit accounting costs and the hypothetical costs of a potential business decision.

1 Benefits of Economic Cost Analysis

Finding the difference in cost among business options, Determining which markets to exit or
enter, Giving investors confidence in the company's long-term value
Calculating Economic Costs
1 Step 1: Calculate the Accounting Costs
Using the formula for calculating accounting costs, determine the total amount of expenses you
currently have. Consider all aspects of design, labor, manufacturing, production and distribution.
Adding up all business expenses allows you to determine how much you're currently spending
versus the amount of profit you're rendering.

2 Step 2: Calculate the Implicit Costs

Once you've calculated the explicit costs, you can calculate the implicit costs or the costs that an
alternative option would yield. Perhaps in an alternative option, you would only need three store
managers versus six, affecting the total labor costs. Alternatively, the business option you're
considering may include entering a new market, in which case you can add up all potential
business expenses and investments involved in this process.

3 Step 3: Subtract Implicit Costs from Explicit Costs

You can calculate the economic cost to find out which business option is the right choice. To
calculate the economic cost, subtract the projected implicit costs from the pre-determined
accounting cost. With this calculation, you may determine if an alternative business option could
save the company money. This may help you decide whether to pursue an alternative business
venture.
When to Use Accounting vs. Economic Costs
Accounting Costs
Accounting costs measure the monetary value of an
action, like payroll or utilities. You can use
accounting costs to determine the total expenses and
compare this to the overall gross profit. Accounting
costs allow you to understand how much the
company is spending versus how much profit it's
making.
Economic Costs
Economic costs can allow you to determine if an
alternative option yields a higher profit or minimize
spending in particular areas. You can use economic
costs when deciding between two different business
approaches, allowing you to decide which choice is
best for the company. Considering alternative options
can give you a more complete financial picture than
relying on the accounting cost alone.
Key Takeaways
Accounting Costs
Explicit, hard costs that include payroll,
production, and marketing expenses. Easily
tracked and deducted from revenues.
Calculating Costs
Accounting: Add up all expenses like materials,
labor, facility costs. Economic: Calculate
accounting costs, then add/subtract implicit costs
of alternatives.
Economic Costs
Include accounting costs plus implicit,
hypothetical costs of alternative business
decisions. Used for financial projections and
strategic planning.
When to Use
Accounting for understanding current spending vs.
profit. Economic for evaluating strategic options
and long-term profitability.
Conclusion
Understanding the differences between accounting and economic costs is crucial
for businesses to make informed decisions and maximize profitability.
Accounting costs provide a clear picture of current expenses, while economic
costs factor in hypothetical alternatives to uncover the best strategic path
forward. By calculating both, businesses can gain a comprehensive view of their
financial situation and make data-driven choices that drive long-term success.