Students often find themselves in the first few days of class understanding the idea of opportunity cost.  Inevitably, this leads to the discussion of implicit costs observed by a firm and how accountants and economics track these costs.

Most often, students have a hard time grasping the real world implications of accounting for these costs using GAAP and theoretical economic ideas.  In 2003, the WSJ published a small article from the eyes of an accountant Robert L Bartley in order to shed some light on how accountants view the differences.

Using GAAP, earnings per share (EPS) are supposed to measure the profit of a company.  As Frank Knight (a very famous economist) wrote, it was the income to the proprietor.  Granted, there are some more subtle nuances identified by economist throughout history, which we acknowledge and teach today but the the identification of economic and accounting profit needn’t be so muddy says Knight.  It is really about perspective.  Economists are concerned about the dynamic nature of production while the accountant is interested in proprietorship.

As the article states, “Knight warned that ‘economic profit cannot be carried to theoretical completeness’ because it is difficult to quantify.”

If you’re new to some of this language, here is a nice breakdown of some the terms and how economists have come to understand them.