What is accounting profit (concise definition)
Accounting profit is the net income that a company reports after subtracting all recorded, or explicit, costs from its total revenue for a reporting period. Explicit costs are actual cash outlays and other measurable charges recorded in the financial statements—examples include cost of goods sold (COGS), wages, interest, depreciation, and taxes. Accounting profit is calculated under applicable accounting standards (for example, U.S. GAAP or IFRS) and is the number that typically appears as “net income” on the income statement.
Key terms (brief definitions)
– Revenue: Money earned from selling goods or services.
– Explicit cost: A measurable expense paid or payable in money (COGS, rent, salaries, interest, taxes).
– Implicit cost: An opportunity cost not recorded in accounting books (for example, foregone salary if the owner works in the business).
– EBITDA: Earnings before interest, taxes, depreciation, and amortization. A measure of operating cash profitability.
– EBIT (operating profit): Earnings before interest and taxes; equals EBITDA minus depreciation and amortization.
– EBT: Earnings before taxes.
– Net income (accounting profit): EBT minus tax expense; the bottom-line profit reported on the income statement.
– Underlying profit: A company-adjusted profit measure that removes one-off or unusual items to show recurring earnings.
How accounting profit is used (short)
Accounting profit is widely reported and monitored because it measures actual, recorded performance for a period. It is used for financial reporting, tax filings, dividend decisions, and to communicate performance to investors and creditors. It does not, however, account for opportunity costs; those belong to economic profit analysis.
Accounting profit versus economic profit (concise comparison)
– Accounting profit = Total revenue − explicit costs (measurable and recorded).
– Economic profit = Total revenue − explicit costs − implicit costs (opportunity costs).
Economic profit is a theoretical concept used for decision-making and assessing whether resources are earning more than their next-best use. Accounting profit tells you what actually happened in monetary terms for the reporting period.
Accounting profit versus underlying profit
Underlying profit is an adjusted, often management-reported, measure that excludes items considered non-recurring or atypical (for example, large restructuring charges or gains/losses on asset sales). The intent is to present a clearer view of recurring operating performance. Because it is adjusted by management, underlying profit is not a standardized GAAP/IFRS metric and requires scrutiny of the adjustments made.
Checklist: steps to compute accounting profit from an income statement
1. Start with total revenue (sales) for the period.
2. Subtract cost of goods sold (COGS) to get gross profit.
3. Subtract operating (recurring) expenses (wages, rent, utilities, marketing) to compute EBITDA if depreciation/amortization are excluded, or operating profit (EBIT) if depreciation/amortization are included.
4. Subtract depreciation and amortization (non-cash but recorded) to move from EBITDA to EBIT if necessary.
5. Subtract interest expense (non-operating financing cost) to arrive at earnings before taxes (EBT).
6. Apply income taxes to compute tax expense.
7. Subtract tax expense from EBT to obtain net income (accounting profit).
Worked numeric example (consistent and corrected)
Assumptions:
– Company sells widgets for $5 each.
– Sold 2,000 widgets in the month.
– Production cost per widget (COGS): $1.
– Monthly recurring operating expense (cash wage overhead): $5,000.
– Monthly straight-line depreciation: $1,000.
– No interest expense (no debt).
– Corporate tax rate: 35%.
Step-by-step calculation:
1. Revenue = 2,000 widgets × $5 = $10,000.
2. COGS = 2,000 × $1 = $2,000. Gross profit = $10,000 − $2,000 = $8,000.
3. Recurring operating expense = $5,000. EBITDA = Gross profit − operating expense = $8,000 − $5,000 = $3,000.
(Here EBITDA equals operating cash profit because depreciation is accounted separately.)
4. Subtract depreciation: EBIT = EBITDA − depreciation = $3,000 − $1,000 = $2,000.
5. No interest, so EBT = $2,000.
6. Taxes = 35% × $2,000 = $700.
7. Accounting profit (net income) = EBT − taxes = $2,000 − $700 = $1,300.
So the company’s accounting profit for the month is $1,300. If you wanted economic profit, you would also subtract implicit costs (e.g., forgone salary) from this result.
Practical notes and assumptions
– Depreciation and amortization are non-cash expenses but reduce accounting profit because they allocate past capital expenditures over useful lives.
– Different accounting standards (GAAP vs IFRS) and management choices (useful life, impairment recognition, classification of items) can affect reported accounting profit.
– Underlying profit adjustments are useful for analysis but require transparency—examine what’s been removed or added back.
Quick checklist for reading reported profit figures
– Identify whether the number is GAAP/IFRS net income or an adjusted metric (e.g., underlying profit, EBITDA).
– Check for one-off items or large non-recurring gains/losses in the notes.
– Confirm whether depreciation, interest, and taxes were included or excluded.
– Reconcile the top line (revenue) to the income statement and notes if you need to validate calculations.
Sources for further reading
– Investopedia — Accounting Profit: https://www.investopedia.com/terms/a/accountingprofit.asp
– Financial Accounting Standards Board (FASB): https://www.fasb.org
– IFRS Foundation (International Financial Reporting Standards): https://www.ifrs.org
– U.S. Securities and Exchange Commission — How to read a 10‑K: https://www.sec.gov/fast-answers/answersform10khtm.html
– Internal Revenue Service (IRS) — Corporation taxes: https://www.irs.gov/businesses/small-businesses-self-employed/corporation-taxes
Educational disclaimer
This explainer is for educational purposes and does not constitute personalized investment, tax, or accounting advice. For decisions affecting your finances or business reporting, consult a qualified accountant, tax professional, or financial advisor.