Which situation describes a company experiencing an accounting loss? Click or tap a choice to answer the question. Total revenue is more than total cost. The explicit costs are higher than the implicit costs. The total cost includes only the implicit costs. The explicit costs are higher than total revenue
The Correct Answer and Explanation is:
Correct Answer: The explicit costs are higher than total revenue.
Explanation
A company is said to be experiencing an accounting loss when its explicit costs exceed its total revenue. To understand why, we must distinguish between key financial concepts:
- Total Revenue is the total amount of money a company earns from selling its goods or services.
- Explicit Costs are the direct, out-of-pocket expenses necessary to run the business, such as wages, rent, utilities, raw materials, and other operational expenses.
- Implicit Costs, on the other hand, represent the opportunity costs of using resources that the company already owns, such as the owner’s time or the use of company-owned buildings.
Accounting profit is calculated by subtracting explicit costs from total revenue:Accounting Profit=Total Revenue−Explicit Costs\text{Accounting Profit} = \text{Total Revenue} – \text{Explicit Costs}Accounting Profit=Total Revenue−Explicit Costs
If the explicit costs are greater than total revenue, the result is a negative number, which is referred to as an accounting loss.
Let’s consider an example: A bakery earns $80,000 in revenue in a year but pays $100,000 in explicit costs (for ingredients, rent, and salaries). Its accounting profit would be:80,000−100,000=−20,00080,000 – 100,000 = -20,00080,000−100,000=−20,000
This means the bakery has an accounting loss of $20,000.
It’s important to note that accounting losses are different from economic losses, which include both explicit and implicit costs. Accounting focuses only on actual cash flow, which is why it uses only explicit costs in its calculations.
Therefore, among the provided choices, the situation that correctly describes a company experiencing an accounting loss is:
“The explicit costs are higher than total revenue.”
