Chapter 21: Problem 8

Which statement is true? (LO2) a) Accounting profits are greater than economic profits. b) Economic profits are greater than accounting profits. c) Accounting profits are equal to economic profits.

Short Answer

Expert verified

(b) Economic profits are less than accounting profits.

Step by step solution

Understand accounting profits

Accounting profits are the profits that a company reports on its financial statements. It is the difference between total revenues and accounting costs (explicit costs). It represents the money the company has made during a specific period, based solely on its revenues and costs. In simple terms, Accounting Profit = Total Revenue - Explicit Costs

Understand economic profits

Economic profits consider both explicit and implicit costs. Implicit costs are the opportunity costs associated with a firm's use of resources that it already owns. Economic profits provide a more comprehensive view of a firm's performance, taking into account not only the explicit costs but also the opportunity costs incurred in running a business. In simple terms, Economic Profit = Total Revenue - (Explicit Costs + Implicit Costs)

Compare accounting profits and economic profits

Comparing the equations of accounting profits and economic profits, we can see that: 1. Accounting Profit = Total Revenue - Explicit Costs 2. Economic Profit = Total Revenue - (Explicit Costs + Implicit Costs) From the above two equations, it is evident that economic profits take into account more costs (implicit costs) than accounting profits. This means that economic profit is generally lower than accounting profit.

Identify the correct statement

Based on our analysis, we can determine which statement is true. Since economic profits consider both explicit and implicit costs and are generally lower than accounting profits, the true statement is: (b) Economic profits are less than accounting profits.

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