Question

Rodriguez operates a variety store with an annual revenue of $480,000. Each year he pays $25,000 in rent for the store, $15,000 in business taxes, and $350,000 on products to sell. He estimates he could put $50,000 he has invested in the store into his friend's restaurant's business instead and earn an annual 20% profit on his funds. He also estimates that he could earn a total annual wage of $70,000 if he works somewhere other than the store. (1.25%) a. calculate the total explicit costs and total implicit costs of running the variety store b. what is the accounting profit of the variety store? c. what is the economic profit? d. In what way is the economic profit superior to accounting profit as an indicator of the overall performance of this business? Given the advantages of economic profit as a performance indicator, explain why the concept of economic profit is not often used in accounting?

Answer 1

a. The total explicit costs of running the variety store are $390,000, while the total implicit cost is $50,000. b. The accounting profit of the variety store is $90,000. c. The economic profit is $40,000. d. Economic profit is a superior indicator of overall performance, but it is not often used in accounting due to subjective estimations of implicit costs.

Step-by-step explanation:

a. Total explicit costs can be calculated by adding up all the costs that are incurred and directly paid for running the variety store. This includes rent ($25,000), business taxes ($15,000), and product costs ($350,000), which equals $390,000 in total explicit costs. Total implicit costs, on the other hand, refer to the opportunity cost of using the funds invested in the store elsewhere. In this case, the implicit cost is $50,000, which represents the potential profit that could be earned if the funds were invested in the friend's restaurant.

b. To calculate accounting profit, subtract the explicit costs from the annual revenue. Accounting profit = $480,000 - $390,000 = $90,000.

c. Economic profit takes into account both explicit and implicit costs. It is calculated by subtracting the total explicit and implicit costs from the annual revenue. Economic profit = $480,000 - ($390,000 + $50,000) = $40,000.

d. Economic profit is superior to accounting profit as an indicator of overall performance because it considers the opportunity cost of using resources elsewhere. It provides a more comprehensive view of the true profitability of the business, taking into account both explicit and implicit costs.

The concept of economic profit is not often used in accounting because it involves subjective estimations of implicit costs, which can vary from person to person. Accounting profit focuses on the actual costs incurred and is more objective and standardized.