This article will help you to learn about the difference between Economic cost and Accounting cost.
Difference between Economic Cost and Accounting Cost
An economist thinks of cost differently from an accountant, who is concerned with the financial statements.
Accountants tend to take a retrospective look at a firm’s finances as they have to keep track of assets and liabilities and evaluate past performance.
Accounting costs include actual expenses and depreciation expenses for capital equipment, which are determine for tax purposes.
Economists, on the other hand, take a forward-looking view of the firm. They are concerned with what costs are expected to be in the future, and how the firm would be able to rearrange its resources to lower its costs and improve its profitability. They must, thus, be concerned with opportunity costs.
For example, consider a firm that owns a building, and, therefore, pays no rent for office space. Does this mean that the cost of office space is zero for the firm? Though an accountant might treat this cost as zero, an economist would consider the rent that the firm could have earned by leasing the office space to another company.
This foregone rent is an opportunity cost of utilizing the office space and should be included as part of the economic cost of doing business.
Accountants and economists both include actual outlays, called explicit costs, in their calculations. Explicit costs include wages, salaries, etc. For accountants, explicit costs are important because they involve direct payments by a company. These costs are relevant for the economists because the costs of wages and materials represent money that could have been usefully spent elsewhere.
Explicit costs involve opportunity cost as well; for example, wages are the opportunity costs for labour inputs purchased in a competitive market.
Let us look at how economic costs can differ from accounting costs in the treatment of wages and depreciation. For example, consider an owner who manages his own firm but chooses not to pay himself a salary, the business none the less incurs an opportunity cost because the owner could have earned a competitive salary by working elsewhere.
Accountants and economists also treat depreciation differently. When estimating the future profitability of a business, an economist is concerned with the capital cost of plant and machinery. This involves not only the explicit cost of buying and running the machinery, but also cost associated with wear and tear.
Accountants use tax rules to determine allowable depreciation in their cost and profit calculations. But these depreciation allowances need not reflect the actual wear and tear on the equipment.