Applied Problems

Chapter 1: Applied Problem 1

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, Sound 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 shown below:

2010
Revenues
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 cost and expenses $555,000
Income from operations $415,000
Interest expense (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 of 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.

a. What are the total explicit, total implicit, and total economic cost in 2010?
b. What is accounting profit in 2010?
c. What is economic profit in 2010?
d. Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices.

Answers

a) Explicit costs are defined as monetary opportunity costs of using market-supplied resources (Thomas & Maurice, 2011, p. 15).

Total explicit costs = $555,000 + 45,000 + 28,000 + 165,000
= $793,000
Implicit costs are defined as nonmonetary opportunity costs of using owner-supplied resources (Thomas & Maurice, 2011, p. 15).
Total implicit costs = ($100,000 * 15%) + 175,000
= $15,000 + 175,000
= $190,000
**The $100,000 *