Final answer:
Accrual accounting recognizes revenues when earned and expenses when incurred, while cash basis accounting does so when cash is exchanged. Financial statements are prepared using accrual accounting, which is important for calculating both accounting profit and economic profit.
Step-by-step explanation:
Under accrual accounting, revenues are recorded when earned and expenses are recorded with related revenues. Under cash basis accounting, revenues are recorded when cash is received and expenses are recorded when cash is paid out. Financial statements are prepared using accrual accounting. These distinctions are important to understand the difference between accounting profit, which is total revenue minus explicit costs, and economic profit, which includes both explicit and implicit costs.
Explicit costs refer to direct payments for resources like labor, materials, and utilities, while implicit costs represent opportunity costs of resources owned by the firm and used in production. For instance, the salary the owner could have earned working elsewhere is an implicit cost. Privately owned firms seek to earn profits where accounting profit considers only explicit costs, but economic profit includes both, affecting the actual success of a business economically.