“A woman opens and operates a pet store. She likes her work, even though she left a job paying her an annual salary of $70,000 to start the store two years ago. At that time, she borrowed and invested $25,000 in cages, aquariums, shelving and other fixtures. For the most recent year, her revenue was $120,000, with cash operating expenses of $50,000. Wanda does not pay herself any salary. the accounting profit and economic profit of her pet store were:” $63,000 for Accounting Profit and ($7,000) for Economic Loss is the correct answer. The explanation says “The $25,000 investment in fixtures is accounted for by the depreciation.” Why on earth would the $25,000 investment be included in depreciation? Doesn’t that constitute a cash outflow? -Richard
I just looked at this question … I thought of the $25K as a sunk cost - therefore not included in accounting income (since it was started many many yrs ago) and it’s not an economic cost here (only her loss annual salary of $70K)
It is a cash out flow, but the assets that she invested in are long term: cages, aquariums, shelving and fixtures are all what she would be using in the following years after the cash outflow, thus the 25,000 increases her capital assets account. then, depreciation that you calculate from the 25,000 would decrease out accounting income, which i’m guessing is the 7,000
when I read this i initially assumed acct and econ profit in the current year…but you guys have assumed since she started the business… how did everyone get the $7000 in dep from the $25000?
i didn’t, but i’m assuming that either the answers were in comparison easy to pick out that it was 120-50 - (depreciation amount) vs higher than (120-50) 70 (b/c otherwise it doesnt take depreciation into account when it should’ve) or lower than 55 (120-50-25) b/c then it’s reduced the profit more than the whole investment. the econ profit and acct profit i assumed was only for this year as well. she started the store 2 years ago, so first assumption was that the long term investment would still be in use, therefore the depreciation of it would reduce this year’s profit of 120-50 by a factor of 25,000