When operating a business, it’s critical to track the factors that impact the bottom line. Two of these factors are accounting costs and economic costs. What are they and why are they important?
The difference between accounting costs and economic costs is something all accounting majors learn in an accounting degree program. They can help organizational leaders better manage both short-term and long-term strategies.
What are Accounting Costs?
Accounting costs measure the monetary value of taking an action. They are the explicit costs involved with the business.
For example, if a company wants to open a satellite office in a new market, they must make investments, such as new hires, computer equipment, software systems, rent, and inventory. If the total spent on all these areas is $700,000, then that is the accounting cost.
Accounting costs are sometimes referred to as “hard costs.” They are easily tracked and include dollar amounts spent in typical areas such as payroll, equipment, production, and leases.
What are Economic Costs?
Economic costs, also known as opportunity costs, look at the potential difference between taking one action over another. They measure both the explicit and implicit costs of following a strategy.
In the example above, a company spent $700,000 to open a new satellite office at location A. But what if:
- They opened a satellite office at location B?
- They bought the office location, but leased it to another company?
- They did not open the new office, but instead put more money into the main location?
The total of the accounting costs, plus the differences in costs between choosing the other options instead of option A, is the economic cost. Economic costs include both the explicit and implicit costs of an action.
Another example is if a company has an asset — an orange grove, for example — and uses an economic cost analysis to determine if it would be better to maintain and harvest the orange grove or lease it to another company to do the work. Finding the differences in costs between the two options is the benefit of using an economics cost analysis.
Accounting Costs vs. Economic Costs
Accounting costs are essential to any business. Every business owner must know the exact amount of money coming in and going out. Accounting costs are reported on official company ledgers.
Economic costs are important for determining long-range business strategy. For accountants who work in this area, software is increasingly important to determine the total economic costs of different options. Economic costs are critical to determining if there are lost opportunities for revenue that organizations miss by choosing one strategy over another. At its simplest level, it’s a way of determining how to use a company’s cash and resources to create the biggest profit.
While accounting costs are crucial to tracking hard costs for a business, economic costs are vital to determining the best future direction for an organization.
