OPPORTUNITY%20COST

1
OPPORTUNITY COST

• FUNDAMENTAL COST PRINCIPLE IN ECONOMICS
• MEASURES COSTS IN TERMS OF OPPORTUNITIES FOREGONE
  (i.e. THE NEXT BEST OPPORTUNITY)
• LEADS TO NOTION OF IMPLICIT COST
• ACCOUNTANCY MEASURES EXPLICIT COSTS
• ECONOMICS MEASURES BOTH EXPLICIT AND IMPLICIT
  COSTS

2
IMPLICIT COSTS

• Implicit costs apply to factors of production
• - in small businesses where owner is principal
  worker, labour may no
• be properly costed
• - land such as office space also has an
  opportunity cost
• - owner capital has an opportunity cost as the
  interest rate foregone on
• investment
• - enterprise has an opportunity cost which in
  economics is measured
• as normal profits
• So from this perspective normal profits
  represents a legitimate cost of
• business

3
ACCOUNTANCY MEASUREMENTS

• Historic Cost Accounting
• - based on original cost values
• Current Cost Accounting
• - based on replacement values
• Historic cost still dominates accountancy
  profession
• - not suitable in times of inflation

4
CREATIVE ACCOUNTING

• CAPITALISATION OF COSTS
• BRAND ACCOUNTING
• CHANGES IN DEPRECIATION POLICY
• CONVERTIBLE AND PUT OPTIONS
• PENSION FUND SURPLUS
• CURRENCY MISMATCHING

• PRE-ACQUISITION WRITE DOWN
• DISPOSALS
• DEFERRED CONSIDERATION
• EXTRAORDINARY AND EXCEPTIONAL ITEMS
• OFF BALANCE SHEET FINANCE
• CONTINGENT LIABILITIES

5
DEPRECIATION AND STOCKS

• IN ACCOUNTING, DEPRECIATION IS BASED ON THE
  HISTORIC COST VALUE OF AN ASSET
• IN ECONOMICS, DEPRECIATION IS BASED ON THE
  EXPECTED FUTURE EARNING POWER OF AN ASSET

• ACCOUNTANCY TENDS TO USE EITHER THE LIFO OR THE
  FIFO METHODS OF VALUING STOCKS
• NEITHER METHOD WILL BE ACCURATE IN TIMES OF
  INFLATION
• ECONOMICS WOULD SUGGEST A SYSTEM OF CONSTANT COST
  (RATHER THAN CURRENT VALUES) AS MORE APPROPRIATE

6
GOODWILL AND EXTERNALITIES

• GOODWILL CONCEPT MUCH WIDER IN ECONOMICS THAN
  ACCOUNTING

• EXTERNAL ECONOMIES OF SCALE
• EXTERNAL DISECONOMIES OF SCALE
• Tend to be ignored in terms of conventional
  accounting

IN ECONOMICS A TECHNIQUE CALLED COST BENEFIT
ANALYSIS IS USED
7
PROFITS

• Profits as a residual
• Normal and supernormal profits
• Economic rent and monopoly profits
• Reward for innovation and risk
• Profit as exploitation
• NEED FOR LIMITATION ON PROFITS

8
MEASUREMENT OF PROFITS

• ABSOLUTE
• GROSS PROFITS (BEFORE TAX)
• NET PROFITS (AFTER TAX)
• NET PROFITS (AFTER INTEREST DEEDUCTIONS)
• DISTRIBUTED AND UNDISTRIBUTED PROFITS
• SOCIAL PROFITS
• RELATIVE
• PROFITS AS OF CAPITAL EMPLOYED
• PROFITS AS OF SHAREHOLDERS' EQUITY
• PROFITS AS OF GROSS TURNOVER