Question

If firm is making an Accounting profit, which of the following should be deducted from its revenue?

• A. Its explicit costs only.
• B. Its explicit costs plus depreciation.
• C. Its implicit costs only.
• D. Its explicit costs and its implicit costs.

Hint:

- Accounting Profit = Total Revenue - Explicit Costs.
- Economic Profit = Accounting Profit - Implicit Costs.
Economic profit is always less than or equal to accounting profit.

Answer 1

The Correct Option is A

Step 1: Understanding the Concept:
In microeconomics and accounting, profits are defined differently depending on whether implicit costs are taken into consideration.
Accounting profit focuses purely on book-keeping and monetary transactions, whereas economic profit includes non-monetary opportunity costs.

Step 2: Detailed Explanation:
Let us look at the mathematical definitions of these terms:
- Accounting Profit:
This is calculated by deducting only the out-of-pocket, direct monetary costs of running the business from the total revenue.
These direct, out-of-pocket expenses are called explicit costs.
\[ \text{Accounting Profit} = \text{Total Revenue} - \text{Explicit Costs} \]
Therefore, only explicit costs are deducted from revenue to determine accounting profit.
- Economic Profit:
This is calculated by deducting both explicit costs and implicit costs (the opportunity costs of resources owned by the firm, such as the owner's time or self-owned land).
\[ \text{Economic Profit} = \text{Total Revenue} - (\text{Explicit Costs} + \text{Implicit Costs}) \]
- Depreciation:
While depreciation is deducted in formal accounting, it is categorized as an explicit/accounting cost over time; however, the fundamental definition of accounting profit distinguishes itself from economic profit solely by the exclusion of implicit costs.

Step 3: Final Answer:
To find the accounting profit, only explicit costs should be deducted from the revenue (Option A).