Problems in profit measurement, Microeconomics

Accounting profit equals revenue minus all explicit costs, and economic. One profit is defined it should not be difficult to measure the profit of a firm for a given period. But two questions complicate the task of the measuring profit:

1.    Which of the two concepts of profit be used for the measuring profit, and

2.    What costs should be and what should not be included in the implicit and explicit cost? The answer of the first question is that the use of a profit concept depends on the purpose of the measuring profit. Accounting concept of profit is used when the purpose to be used is to produce a profit figure to for

3.    The shareholders to inform them of progress of the firm, financiers and creditors who would be interested in the firm's progress. The managers to access their own performance, and what costs should be and what should not be included for measuring accounting profit for these profit. It must how ever be noted that accounting

4.    Profit may present an exaggeration on actual profit (or less) if it is based on arbitrary allocation of revenues and costs to a given accounting period. On the other hand, if the objective is to measure true profit, the concept of economic profit should be used. However true profitability of any investment or business cannot be determined until the ownership of that investment or business cannot ne be has been fully terminated. But then life is a corporation is eternal. Therefore true profit can be measured only in terms of the maximum amount that can be distributed in (dividends theoretically from now to the further) without impairing the real capital. To estimate income then a forecast of all future changes in demand, changes in production process, cash outlays to operate the business, cash revenues and price changes. This concept of the business income is, however an ideal and hence is of little practical use. Nevertheless it serves as a guide to income measurement even from business man point of view. If follows from the above discussion that, for all practical purposes, profits have to be measured on the basis of accounting concept. But measuring even the accounting profit is not any easy task. The main problem is to decide as to what should not be included in to the cost. One might feel that profit and loss account and balance sheet of the firms provide all the necessary data to measure accounting profit. There are however three specific items of cost and revenue which pose conceptual problems. These items are:

1.    Depreciation

2.    Capital gains and losses, and economist

3.    Current vs. Historical costs. Measurement problems side for two reasons.

4.    Economist view on these items differs from that of accountants, and

5.    There is more than one accepts method of treating these items. We discuss below the problems related to these items in detail.

Posted Date: 8/4/2012 7:39:58 AM | Location : United States







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