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    Calculating Accounting and Economic Profits - Sound Devices Inc.

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    At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year in order to start his own business, Sounds Devices, Inc. The new company builds, installs, and maintains custom audio equipment for businesses that require high-quality audio systems. A partial income statement for Sound Devices, Inc., is show below:

    Revenue from sales of product and services: $970,000
    Operating costs and expenses:
    Cost of products and services sold: $355,000
    Selling expenses: $155,000
    Administrative expenses: $45,000
    Total operating costs and expenses: $555,000
    Income from operations: $415,000
    Interest expenses (bank loan): $45,000
    Legal expenses to start business: $28,000
    Income taxes: $165,000
    Net income: $177,000

    To get started, the owner of Sound Devices spent $100,000 on his personal savings to pay for some of the capital equipment used in the business. In 2010, the owner of Sound Devices could have earned a 15 percent return by investing in stocks of other new businesses with risk levels similar to the risk level at Sound Devices.

    1. What is total explicit cost in 2007?

    2. What is total implicit cost in 2007?

    3. What is total economic cost in 2007?

    4. What is accounting profit in 2007

    5. What is economic profit in 2007?

    6. Based on your answers to the previous questions, evaluate the owner's decision to leave his job to start Sound Devices.

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    Solution Preview

    1) What is total explicit cost in 2007?

    Explicit costs are costs for which actual payments are made.

    Total operating costs and expenses = $555,000
    Interest paid = $45000
    Legal expanses = $28000
    Income taxes = $165000
    Total explicit costs = Total operating costs and expenses+ Interest paid+ Legal expanses +Income taxes
    = 555000+45000+28000+165000
    = ...

    Solution Summary

    Solution describes the steps to calculate implicit cost, explicit cost, accounting profit and economic profit in the given case.