What is the difference between accounting and economic cost?
Answer:
We are going to divide this answer into two parts: an accountant's calculation of a retailer's fiscal year, and then an economist's explanation of costs for the year.
A. The Accountant's Calculation
Cindy Wong owns a sports equipment and services shop in West Edmonton. For her fiscal year 2002, Cindy has revenue of $410,000. Her expenses are as follows:
| Inventory expense … | $120,000 |
| Wages expense …. | $90,000 |
| Tax expense …. | $39,000 |
| Utilities expense …. | $25,000 |
| Interest expense …. | 10,000 |
| Miscellaneous expense …. | $5,000 |
| Total expenses | $289,000 |
Cindy's accountant would recognize only these explicit costs—the company's actual costs for its inputs of production, or service in this case—and therefore declare Cindy's after-tax profit to be $121,000.
B. The Economist's Calculation
Economists would disagree on the accountant's calculation of after-tax profit. They focus not just on explicit costs, but also on those costs that are implicit, meaning the opportunity costs of nonpurchases. The economist wants to look, as well, at the total opportunity costs of a business investment. It makes sense to look at what is being sacrificed, as well as what is being expensed.
What has Cindy sacrificed in order to make this seeming profit of $121,000? There are at least three items to consider:
- normal profit;
- interest on the capital investment, since the capital could have been invested elsewhere, for example, in stock; and
- amortization on capital equipment—Cindy has a computerized cash register system.
Let's assume that Cindy is well educated and trained, in fact, she is trained as an investment broker. She could earn $60,000 annually as a broker.
Cindy has invested $100,000 capital in her business. In a well-chosen Canadian stock, she could have earned $8,000 during the year. Cindy's accountant has recommended that she amortize the cash register over three years. The amortization expense for this year is 30 percent of an original cost of $30,000, which means a $9,000 amortization expense. Total implicit costs are, therefore, $77,000. An economist considers the following equation: profit = revenue minus accounting cost minus implicit costs.
The economist would scale down the profit of Cindy's Sports Shop to be $44,000 ($410,000 - 289,000 - 77,000 = $44,000).