Accounting profit definition
/What is Accounting Profit?
Accounting profit is the profit of a business that includes all revenue and expense items mandated under an accounting framework. This profit figure is used in an organization's financial statements, and is commonly used to evaluate its performance. Examples of accounting frameworks are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). These frameworks mandate the use of accrual basis accounting in deriving the accounting profit figure. Thus, if total recorded revenues exceed total recorded expenses, the remainder is an accounting profit. Conversely, if total recorded revenues are less than total recorded expenses, the remainder is an accounting loss.
Example of Accounting Profit
ABC International records $100,000 of revenues in its most recent reporting period through the issuance of customer invoices, and also accrues an additional $20,000 of revenue, as per IFRS standards, resulting in $120,000 of revenue. ABC also records $85,000 of expenses in the same period through the recordation of supplier invoices and wage payments to employees, and also accrues an additional $25,000 of expenses, as per IFRS standards, resulting in $110,000 of expenses. The result is:
$120,000 Revenue per IFRS - $110,000 per IFRS = $10,000 Accounting profit
Why Is Accounting Profit Important?
Accounting profit is one of the primary sources of information used by investors, because it includes all required reporting of both revenues and expenses. Thus, it includes the entire cost of goods sold, as well as all selling, general and administrative expenses, financing costs, and realized gains and losses. Because of its comprehensiveness, accounting profit is a more reliable indicator of overall results than the gross profit or operating profit figures.
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Accounting Profit vs. Economic Profit
Accounting profit is revenues minus the expenses mandated by an accounting framework, while economic profit is revenues minus the opportunity costs of the assets being used. Opportunity costs are the profits lost when one alternative is selected over another. This means that deriving economic profit requires an analysis of the alternatives that could have been acted upon, rather than the decision actually taken. In short, the key difference between the two concepts is that economic profit is reviewed while making a decision, while accounting profit reveals the outcome of the decision that was made.
How to Calculate Accounting Profit
The accounting profit equation is revenue minus all expenses. The formula is as follows:
Revenue per GAAP or IFRS - Expenses per GAAP or IFRS = Accounting profit/loss
More specifically, the generally categories of revenues and expenses are included in the following accounting profit formula:
Net revenue - Cost of goods sold - Operating expenses - Nonoperating expenses - Taxes = Accounting profit/loss
The concept does not include opportunity cost, which would be included in the more comprehensive (and theoretical) economic profit concept.
Accounting Profit vs. Gross Profit
Accounting profit is revenues minus all expenses, while gross profit is revenues minus just the cost of goods sold. The key differences between accounting profit and gross profit are as follows:
Presentation. The gross profit figure can be found higher in the income statement, as a calculated number inserted after the cost of goods sold. If the reporting entity is a retailer, then the gross profit figure can be found after the cost of merchandise sold. Conversely, accounting profit is located at the bottom of the income statement.
Expenses included. The gross profit figure only includes the costs of production, whereas accounting profit includes all expenses incurred by the organization. Thus, accounting profit is a more comprehensive measure.
Use as a performance metric. Accounting profit is used to examine the ability of an entire business to earn a profit, while the gross profit figure is more restricted in its scope - it is only intended to determine whether the price points charged and the production costs incurred are resulting in a reasonable profit before selling, general and administrative expenses are also deducted.
Terms Similar to Accounting Profit
Terms similar to accounting profit include financial profit and bookkeeping profit.