Case Study: How is he doing?

It seems like Mr. Mohr has made a profit out of his restaurant and novelty business according to his income statement, but the fact is that he lost $72,500 last year.

The $103,000 salary he made when he worked in the corporate should be considered as opportunity costs that he decided to run his own business. Although opportunity costs are not generally considered by accountants in financial statements, they should be considered by managers. Opportunity costs increase the cost of doing business, and thus should be recovered as a portion of the overhead expense charged to every job. Ignoring opportunity costs may lead managers overestimate their profits. Though the business is owned by Mr. Mohr, he still works as a manager of the business, therefore, his salary should be considered as part of the expenses, just as the salaries paid to other employees.

Mr. Mohr owns the building in which his business operates, and pays no rent for the space. But this does not mean that the cost for the building is zero. Instead, the business owner must consider the opportunity cost associated with reserving the building for its current use. Perhaps the building could have been rented out to another company. The foregone money from these alternative uses of the property is an opportunity cost of using the office space, and thus should be considered in calculations of the business' expenses.

As for the interest of $44,600 on the invested capital, it is evident that the return which Mr. Mohr receives is due to the factors of production that he himself owns and uses in the business. The return to his capital invested is really interest, as truly as if it were to be paid to another person who owned the capital instead of to the owner himself. In estimating net profits, therefore, it should be deducted from gross profits interest on capital invested by