by Megha Sharma(@megha0111) on 8th October 2016
Accounting is about following rules and having a monotonous way of solving a problem. Economics is much dynamic in nature which makes economists farsighted and cautious.
Economists and accountants treat costs and profit differently. To understand the quandary of economists and accountants, it is essential to know about the cost, profit, and revenue.
Cost is not just the amount spent to produce something. In fact, it is much more than that. The amount one spends in producing something is what a person gives up to get it. The cost of producing an item does include all those things that a producer must have forgone to produce that item. This is the opportunity cost of producing an item, which cannot be handled loosely.
If a child buys a chocolate for Rs. 10, that Rs. 10 is an opportunity cost as he can no longer use that 10 rupees to buy something else. Or in other words, he lost the opportunity to buy something else from that 10 rupees.
Revenue is the total amount that a producer earns after the sale of the outputs (quantities of the output). The revenue covers the cost of production when a firm makes a profit. After covering the cost of production, the extra revenue is termed as the profit.
So, we define the profit as total revenue minus the total cost. That is Profit= Total revenue – Total cost.
Economists divide the total cost into implicit and explicit costs. An explicit cost is a monetary cost. An implicit cost is an opportunity cost incurred by a firm. There is no such implicit cost that accountants take into consideration. They consider only the explicit costs because they see this cost as flowing in and out of the firm.
The accountants mostly have to keep track of the money that flows in and out of the firm. And hence they consider just the explicit costs and ignores the implicit costs.
This is how an economist and an accountant calculates the total cost. The economist considers both explicit and implicit cost while the accountant focuses only on explicit cost.
Now, since there is a difference in the consideration of costs between the two, there has to be a distinction between the economic and accounting profit.
The accounting profit includes only the explicit cost. While the economic profit takes into account both implicit and explicit cost. This is the reason why accounting profit is much higher than the economist profit. Economist calculates the profit as the firm’s total revenue minus all the cost including explicit as well as implicit. While an accountant’s profit is a measure of total revenue minus only the explicit cost. And as a result, Accounting profit is much higher than the economic profit.
The following scenario depicts the situation clearly.
Reema, a resident in Bangalore, is planning to open a bakery. She is dubious about her decision because she would have to give up her present job of teaching. She presently earns Rs. 500 per day. She decides to seek suggestions from her two friends Sanjay, who teaches economics and Tanya, a chartered accountant. The response she gets from both of them makes her more daunting and dubious.
When Reema loses the opportunity of earning Rs. 500 per day, Tanya does not consider this amount as a cost of Reema’s bakery business but Sanjay does. This is because an accountant of a firm only considers the monetary value that flows out of a business for the cost. Whereas an economist will definitely count the forgone opportunities as a cost because it will affect the future decisions in the business.
What if Reema’s teaching wages increases from Rs. 500 per day to Rs. 1000 per day? Maybe then she realises that the bakery business is costlier and calls off the business in order to resume her previous job.
Similarly, the profit that Sanjay will measure for her will be lesser than Tanya’s calculated profit of Reema’s business. it is because Sanjay has also deducted the opportunity cost(the teaching job) that Reema is giving up to start the business while Tanya does not consider it at all. This makes a dilemma for Reema to continue her job or to start a new business.
These are the aspects in which the amount of cost and profit differs when seen through the angles of an economist and an accountant.
Accountants and Economists are mutually exclusives. The latter can explain well the behaviour of a firm considering the future and past consequences while the former are good at following a set of principles to solve a problem. The relationship between the two is complex yet important.
Featured image source: Google images.
Megha Sharma is pursuing M.A in public policy @Mount carmel college in Bangalore.