Accounting profit and economic profit is difference because of many reasons including the principles that use for calculation the profits, the usages as well as the requirements. Accounting profit is calculated by using the accounting principle and respect to accounting standard.It is used to present in entity financial statements, reporting to government related body, board of directors as well as any other official use.
However, economic profit is calculated by using the economic principle. Economic profit is sometime called Economic Value Added profit and the way how we calculate this profit is by making adjustment to accounting profit.
For example, marketing, promotion and research expenses are consider as operating expenses under accounting principle to calculate accounting profit. However, in calculation of economic profit, these expenses need to add back to profit and net assets.
This profit is normally use for management decision making, investment appraisal as well as performance appraisal. The formula and calculation is explain below. The following are the key points that make accounting profits difference from economic profits:
Accounting profit is reporting in the entity’s statements of financial transactions or income statements. The preparation of this statement as well as others financial statements are based on accounting standard that allow by relevance authority. There are two major accounting standards that use by most of entities. They are US GAAP and IFRS. US GAAP is normally use by entity that register in US or the subsidiary companies that their parent companies are in US.
However, IFRS is the global accounting standards that use and accept by majority countries in the wold. Others accounting profit is use local standard to prepared.
Accounting profit or financial statements are prepared based on the requirement of local authority, board of director, and shareholders of the companies. These financial statements are required to have an audit annually in most cases. But sometime, audit of financial statements are performed quarterly as per requirement. Accounting profit is generally prepared monthly, quarterly and annually.
Accounting profit as well as financial statements are used by local authority ; for example, to assess whether the entity had fulfill its tax obligation or not. These reports use also use by entity’s bankers, shareholders, board of directors, employees, customers, suppliers (creditors), as well as stock exchange.
- Accounting profit or loss = Total Revenue – Cost of Goods Sold = Gross Profit
- Net Operating Profit After Tax = Gross Profit – Operating Expenses – Interest Expenses – Tax Expenses
- Use economic principle: economic profits use economic principle to calculate. This is the main reason that make it different from account profit. The cost like marketing expenses normally deduct from the calculation in the accounting profit. However, the economic profit, these like of cost will benefit to the entity in the future and it normally not deduct. Economic profit is sometime called Economic Value Added (EVA).
- Time Frame: Based on management decision.
- Adjustment to accounting profit is required to get economic profit.
- Use for economic decision: The calculation this kind of profit is not required by law; however, most of decision making are made by using the variable economic profit calculation. Value added to the entity or the shareholders is the key principle of
- Economic Profits = Net Operating Profit After Tax ( NOPAT) – (WACC * Net Assets
- Net Operating Profit After Tax: This is the figure from accounting profit. NOPAT could be found in the income statement of entity or it might take from the specific project that being assess.
- WACC: This is the Weigh Averages Cost of Capital. You might need to find if it is not provided.
- Net Assets: Net Assets refer to the assets or fund that used to support the specific project. In other words, Net Assets are the capital employed for the project.