What is Accounting Profit?
Accounting profit represents 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 highlights the alone amount left after deducting the explicit costs involved in running a business.
- Explicit costs incorporate the cost of labor, inventory, raw materials, transportation, production, and sales and marketing.
- Accounting profit deviates from economic profit as it only comprises the explicit and monetary expenses and revenues.
- Underlying profit seeks to normalize earnings by stripping out the impact of nonrecurring items.
How Accounting Profit Works
Profit is a well-observed financial metric frequently utilized to evaluate a company’s health. Companies usually report varying profit versions in their financial statements. Some incorporate all revenue and expense items listed in the income statement, while others might be creative manipulations by management and accountants.
Accounting profit, also known as bookkeeping profit or financial profit, is the net income obtained after subtracting all costs from total revenue. Essentially, it illustrates the remaining amount after deducing the explicit costs required to operate the business.
Costs to consider include:
- Labor (wages)
- Inventory for production
- Raw materials
- Transportation costs
- Sales and marketing expenses
- Production costs and overhead
Accounting Profit vs. Economic Profit
Both accounting profit and economic profit subtract explicit costs from revenue. However, economic profit also considers implicit costs or opportunity costs – potential income from alternative resource allocations.
Examples of implicit costs are:
- Company-owned buildings
- Plant and equipment
- Self-employment resources
For instance, if an individual invests $100,000 to initiate a business yielding a $120,000 profit, the accounting profit amounts to $20,000. Conversely, economic profit would deduct implicit costs (e.g., a $50,000 salary from a day job), indicating a $30,000 economic loss ($120,000 - $100,000 - $50,000).
While accounting profit outlines tangible expenses and actual performance results, economic profit measures theoretical alternative actions and opportunity benefits, primarily aiding management decisions.
Accounting Profit vs. Underlying Profit
Organisations occasionally present accounting profit alongside their subjective profit interpretations, such as underlying profit. This widely-used measure often excludes one-time charges or irregular occurrences emphasized by management as a critical focus point for investors, aiming to neutralize random earnings-affecting events. Irregular gains or losses, like restructuring costs or property dealings, are generally omitted as they aren’t consistent reflections of standard operating expenses.
Inspiring Example of Accounting Profit
Company A, a Widget manufacturer consistently transforming the industry, sold widgets for $5. In January’s breakthrough, it sold 2,000 widgets generating $10,000 monthly revenue – the first figure in the income statement.
After subtracting the $2,000 Cost of Goods Sold (COGS) ($1 per widget), the gross revenue totals $8,000 ($10,000 - $2,000).
Operational costs deduction next, like $5,000 employee expenses, determines the $3,000 operating profit ($8,000 - $5,000).
Thereafter, non-operating expenses evaluation happens, including $1,000 monthly asset depreciation and corporate taxes at 35%, concluding the inspiring accounting profit of $650, calculated as follows:
[ EBT ($1,000) - Taxes ($1,000 \* 0.35) ]
This demonstration highlights Company A’s productivity leaps and strategic operations management.
Related Terms: Economic Profit, Net Income, Implicit Costs, Revenue, Expenses.
