 In this module we are trying to understand what is the difference between the accounting mager of income and the economic mager of income because there are some technical differences. When we define income in according to the accounting terms or terminology or rules we define income in a different way as compared to the way we define income according to the principles of economics. It is important that when we are analyzing things then it is important to consider income from both perspectives from the accounting perspective as well as from the economics perspective because that is good to help you or equip you in order to analyze in a better way. So when we define what is meant by income or profits or earnings, so I would like to quote here the definition which was presented by John R. Hicks, a very famous economist. According to him, income is the amount of money that you will spend in a year but income will only be the amount that your wealth will be the same in the beginning of the year. For example, if you begin with in January 2010 or 2019 or 2020, in January, your wealth value is total 20 lakhs and you spent 6 lakhs in 2020 and by the end of 2020 you have the same amount of wealth equivalent to 20 lakhs but you have spent 600,000 rupees or 600,000 in that year so according to John R. Hicks, 600,000 will be your income. So your wealth will be unaltered and you will spend the money in a year or any time period or reference time period that is defined as your income. But when we define income from the economics perspective, we look at accounting, so the way you treat income or the way you treat earnings or the way you treat profits is something different from the way we treat income, earnings or profits, they can be used interchangeably in economics. So what is the problem there, what is the difference in accounting that all your unrealised gains or losses are not accounted for in accounting and why is that basically we have got certain principles which you book on the basis of accounting and those principles are known as generally accepted accounting principles which we abbreviate as GAAP. So when we are maintaining the books of account, we are consulting or following the principles that are in GAAP. So accordingly, you do not have the allowance or the permission to unrealise gains, the gains that you are expected to get, you have earned the money but you did not get it or the losses that you have got but you have not paid them yet, so we call these gains or losses unrealised gains or losses that you do not account for when you consider accounting profit or accounting earnings. One more thing is there, as we all know that when we calculate the profit, whether it is accounting profit or the economic profit, we have to consider various types of costs. So profit is basically the difference between total revenue and total cost. So we need to take into consideration what are the various types of costs which are considered in accounting profit. So when you calculate accounting profit, you have to account for explicit costs i.e. the payments which you have actually done and the realised costs and the realised expenses that you have incurred, the most important costs that we have to use to calculate the accounting profit, that would be the labour cost, like you have given wages to the workers, then the second type of cost which is considered in order to calculate the accounting profit is the inventory that it is needed for production, so the inventory that you have to use for production whatever expenses you have bear, that will be considered as your cost. Third is other than the different types of raw materials that are essential or necessary for the production, the raw materials that you have bought, you have to bear the expenses that will also be considered in your cost to calculate the accounting profit, then you will have to calculate the transportation cost, sales or marketing cost or production cost and all the overhead expenses. So the important thing to remember is that when we calculate the accounting cost or accounting profit, then we have to consider only those expenses or the revenues that you have actually received, i.e. explicit revenue is explicit cost, so you are going to consider only that part. So when you are going to calculate the accounting profit, then you are, as I just told you, that we mainly primarily only consider explicit cost, that is the basic difference between calculating accounting profit and economic profit, so what else we will consider in the economic profit that we will discuss in a few minutes, so explicit costs are mainly those specific amounts that any company, any other company or organization or supplier is actually paying or you have given the salary to the laborer, when you actually pay, then that will be considered for the calculation of your accounting profit and when we calculate the accounting profit, basically accounting profit or we will call it net income, it is reported over some time period, so generally either you report your net income or accounting profit on a quarterly basis or you report it on an annual basis and when we report net income or accounting profit, then it basically indicates any company's financial performance. Now coming towards economic profit, so in the economic profit, as I just told you that the treatment of the economic profit and the treatment of the accounting profit are technically different, our technical difference is about the concept of explicit cost or implicit cost, so when we are calculating the accounting profit which is the difference between the total revenue which you have earned and the difference between the total revenue and the explicit cost, if you are going to consider explicit cost as well as the implicit cost, you will account for it, then what you will calculate the profit, it would be considered as the economic profit, so that is the basic difference between the two concepts and it is important to take into account the net income or the accounting profit and at the same time we also calculate the economic profit, it can be that in some company, you can see the accounting profit, in terms of accounting profit, when you calculate the implicit cost or the economic profit, there are chances that you will see losses instead of profit, so this is important that you consider the economic profit along with the accounting profit, so when we calculate the economic profit, basically we have to consider the opportunity cost, so to consider the opportunity cost, to calculate the implicit cost, we have to consider the opportunity cost because on the basis of the opportunity cost, you can calculate the implicit cost, now you must be thinking how the implicit cost will be calculated and what is the opportunity cost, so the opportunity cost is the value of that which you have foregoed to do one thing, for example you have set up your own business or you haven't come and for that you have spared a room for your home where you have set up your office, so now along with that you have hired a manager or you have hired any individual, when by the end of a year or by the end of every month, when a month passes, then you are paying the salary and suppose that salary is 30,000 rupees per month, but the room was an extra room for your house which you have converted into your office and you have to use it, so when we calculate the accounting profit, then the cost which you have considered that would be that 30,000 per month which you have hired your employee, you paid 30,000 rupees per month, so that will be considered as your explicit cost and the accounting profit which you have earned, from that revenue this 30,000 multiplied by 12 total cost will be minus, this is your accounting profit, but when you calculate the economic profit, then you will not only have to consider the cost of the employee's 30,000 a month, but the room which you had set up your office, you will consider the rent on the market rate that if I don't use this room as my office, and put it on the rent, then the area of your room, how much will be the rent of that room, you will account for it and you will get its opportunity cost, that how much I have incurred, don't put this room on the rent, so that amount which you have foregone instead of giving your room on rent and taking it or considering it as your office, that will be, that has to be accounted for because instead of making that room as your office, if you had given it on the rent, then you would have done that, suppose you had done that 50,000 a month, you could have earned it, so if you had converted the room into your office, you had foregone that 50,000 a month, so this is how we use the concept of opportunity cost and we consider opportunity cost cost, you are told that you have done implicitly the cost of beer, it was not spent from your pocket, 50,000, but you have incurred it, so when we calculate the economic profit, then you will consider total revenue and then when you have to consider the cost, to take out C from R, to take out net difference, how much profit did I get from my profit, according to the principles, then you will include explicit cost in the cost, but you will have to include implicit cost also, and then the total cost defined which is a sum of explicit and implicit cost and considering this as implicit cost, when you will minus the cost from revenue and take out the total profit, then that will give you a more realistic picture, so therefore in order to make a better analysis of how your business is doing, how it is performing financially, it is essential not to only consider the economic profit whereas it is important to equally important to consider and calculate the economic profit's value also, so that is, this is why it is important and one more thing is there that when we follow, when we construct or when we calculate the accounting profit, for that we use the accounting principles, but to calculate the economic profit, we follow the principles of economics and the principles of economics say that the amount that you have forgo, to perform any economic activity, you have to consider the value that you have lost when you will be calculating the total profit which your entity, your firm, your company has earned over a certain time period and again it is important to note down that whenever we will be calculating accounting profit or economic profit, you have to consider that time period, so generally it is considered to be a year, but on a quarterly or monthly basis, or by annual, you can calculate it by doing it twice or six months a year now when we take into account the implicit cost, so in the economic profit, we consider the implicit cost, like I just gave you an example of using your own house, for your office, similarly if a company has bought that building itself in which they have made their own manufacturing unit or in which they have their office and they are not on rent and they are owned by the company itself then again you will have to consider the opportunity cost, the implicit cost you will calculate because if this is the building of your office, you would have taken that loan, then you would have to pay the cost and or whatever your building is, your asset you would have given it on rent, so you had to earn that rent which you are forgo, so it is important to consider these types of implicit costs, another example is that plant and equipment you have bought, so you did not have to take it on rent, so again if you had given it on rent or on rent, then you would have earned some money and we will consider that and treat that as the implicit cost, next if you are working for yourself in your company then if you are not working in your own company, then you would have to buy the level of your qualification and experience, so you would have to spend a lot of money on that or if you are working in your organization instead of working in any other organization then how much money you have forgo, to run your business, so that is again the opportunity cost will be applied and implicit cost, you have made another beer, so these are the different forms of implicit cost that are to be considered in order to calculate the economic profit