<p>In economics profit is simply defined as total revenue minus total costs or:</p>
<p><span class="math-container">$$\Pi = TR-TC$$</span></p>
<p>In your case if</p>
<blockquote>
<p>Pfizer makes \$100B in revenue, spends \$80B on business expenses doing so, then spends the remaining \$20B on research for a new drug.</p>
</blockquote>
<p>from economic perspective the profit would be:</p>
<p><span class="math-container">$$\Pi= TR -TC = {\\\$}100B - ({\\\$}80B+{\\\$}20B) = 0B$$</span></p>
<p>So from economic perspective the profit will be zero. (However, note the economic perspective is not necessary the same as an accounting perspective - I mention that since you reference reporting, but in this case accounting profit would also happen to be zero if <span class="math-container">$20B$</span> is on accounts treated as cost).</p>

CC BY-SA 4.0
2020-10-31T17:01:29.073Z
so if this is true shouldn't a good majority of companies be making near \$0 profit since companies tend to reinvest all their profits? If I wikipedia a company making billions in profit with no dividends, where is this money going?
Chubmaster25
CC BY-SA 4.0
2020-10-31T17:12:24.563Z
@Chubmaster25 in your example above the spending is happening at the same time but in reality in dynamic setting the situation might look more like this: $t=1$ Firm has revenue $100b$ and total cost $80b$ which gives firm $20b$ profit (in accounting this would be called retained earnings), then in period $t=2$ the $20b$ might be spend on research. If it is spend within the same period then the profits must be zero. Also, in many industries even if accounting profits are positive economic profits might be zero although in your particular simple example they would coincide.
1muflon1
CC BY-SA 4.0
2020-10-31T17:16:27.090Z
lastly going back to retained earnings, if you will look at the income statements of real life firms that is what you will find there if their total revenue was greater than all expenses (including the investment expenses and people would say that those retained earnings are 'reinvested'- although I am not an accountant and maybe in some situation investment spending now might be allowed under accounting rules to be recorded later - but economists would not make such distinction. Also economists would add also all the unobservable opportunity costs etc.)
1muflon1
CC BY-SA 4.0
2020-10-31T17:21:28.370Z
@Chubmaster25 I think based on your comments that you are probably more interested into accounting side of things - for that personal finance & money stack exchange is the correct place.
1muflon1
CC BY-SA 4.0
2020-10-31T23:51:01.613Z
I have to disagree with that. Profits are total revenues minus total _production_ costs, the costs of producing the product that was sold. Spending on R&D is an investment, it does not relate to the output that has been produced and sold.
Alecos Papadopoulos
CC BY-SA 4.0
2020-10-31T23:56:05.637Z
@AlecosPapadopoulos I thought that would be considered a cost. In endogenous growth models that explicitly model production of technology/R&D the R&D itself would be product. How would the investment expenditure then be modeled?
1muflon1
CC BY-SA 4.0
2020-11-01T00:06:53.207Z
@AlecosPapadopoulos for example, for some Pharma firm shouldn’t R&D expenditure be counted as a cost of producing the output? I mean I don’t want to argue, after your comment I am not entirely sure, and I come from macro not IO but I always thought this would be part of the  total cost function.
1muflon1
CC BY-SA 4.0
2020-11-01T00:42:38.523Z
@AlecosPapadopoulos I actually went and checked Tirole, theory of industrial organization ch 8 on pp 308 (if I am not misreading the passage) states that investments can be modeled as fixed respectively sunk cost that would be part of total cost function. In chapter 10 on pp 402-405 there is even a model of unpatented innovation/imitation models where research enters the problem through cost function in the profit function... is this then case/model dependent? To be honest now I am quite confused about this
1muflon1
CC BY-SA 4.0
2020-11-01T02:09:22.350Z
@1muflon1 I will look up Tirole and will get back on the matter. In any case, this approach would be the (very) long-term view of what cost is.
Alecos Papadopoulos
CC BY-SA 4.0
2020-11-04T02:25:23.873Z
National accounts is based on financial accounting, and investment is not  immediately expensed, rather it is depreciated. I don’t think it’s fair to characterize economics as ignoring the national accounting definitions.
Brian Romanchuk
CC BY-SA 4.0
2020-11-04T02:29:34.493Z
@BrianRomanchuk on national accounts investment is literary in the formula that is called the ‘expenditure approach’ to GDP, so by national accounts logic investment spending is expenditure. Also I am not an accountant but if I remember my basics of accounting from bachelor years the depreciation would be calculated once the investment is already made as an additional expense that lowers tax liability. In addition, as I read the question it is about micro not macro, I think it is fair to say that micro has completely different definitions of concepts such as cost, profit etc than an accounting
1muflon1
CC BY-SA 4.0
2020-11-04T02:36:01.350Z
The depreciation normally takes years, so the immediate expense is typically smaller than the cash expenditure in the current period. As such,   fixed investments don’t subtract from profits, so long as you remember the depreciation.
Brian Romanchuk
CC BY-SA 4.0
2020-11-04T02:40:08.990Z
@BrianRomanchuk yes but in an microeconomic setting depreciation is not used in the same sense as in accounting. For example, in EU in many places you have to depreciate certain assets in certain number of years even if the asset is fine which has nothing to with what economists understand as depreciation. In addition buying let’s say machine would be in micro problem regarded purely as a cost you can see this regularly done across literature. See for example the IO textbook by Tirole. Also, you might be completely correct from an accounting perspective - but this is economics not accounting
1muflon1
CC BY-SA 4.0
2020-11-04T02:43:36.760Z
Macroeconomics is concerned with national accounting profits, and investment is not expensed.
Brian Romanchuk
CC BY-SA 4.0
2020-11-04T02:59:44.537Z
@BrianRomanchuk 1. this question clearly does not ask about GDP, GDP is widely known even among non-economist so if the question would be about it it would be referenced. 2. Even in macroeconomics you see profit functions such as $\Pi = p A L^{\alpha} K^{\beta} - wL-rK$ where capital investments clearly enter profit function as cost. You can see such models across macro literature, just have a look at any graduate textbook. 3. on national accounts (e.g. GDP) investment expenditure includes expenditure on purchase of new assets. Just have a look at NIPA Handbook of BEA.
1muflon1
CC BY-SA 4.0
2020-11-04T03:04:27.920Z
In fact if you want to get technical from national accounts perspective any distinction between income and expenditure is meaningless they are the same thing since anyone’s expenditure is someone else’s income. Hence in theory both income and expenditure approach to GDP has to yield the same result - even though in reality there will be discrepancies due to measurement errors and such
1muflon1
CC BY-SA 4.0
2020-11-04T03:17:13.673Z
Your answer does not aggregate correctly. If investment is an expense, that would hold across all firms, and so the national accounting definitions for profits would be different.
Brian Romanchuk
CC BY-SA 4.0
2020-11-04T03:24:35.843Z
@BrianRomanchuk 1. I dont understand at all what do you mean it would not aggregate properly again in *economics* a common definition of profit function would be  $\Pi = p A L^{\alpha} K^{\beta} - wL-rK$  - you can properly aggregate that by lets say summing profit over all $n$ firms $\sum \Pi_i$ and you can also completely properly aggregate costs e.g. $\sum TC = \sum (rK_i +wL_i)$ or just capital cost $\sum rK_i$- I dont see how that is not proper aggregation. 2. When talking about statistics and national accounts again BEA records new investment as expenditure when calculating GDP
1muflon1
CC BY-SA 4.0
2020-11-04T03:32:58.787Z
@BrianRomanchuk Furthermore, from Blanchard et al Macroeconomics an European Perspective. The chapter on composition of GDP - "Economists use investment to refer to the purchase of (new) capital goods, such as new machines (new) buildings or (new) houses...." this is leading textbook from one of the worlds most renown macroeconomists so I dont think that is wrong
1muflon1
CC BY-SA 4.0
2020-11-04T15:25:28.800Z
1) GDP has nothing to do with this. Statistical agencies calculate aggregate profits, based on accounting standards. Investment is not immediately expensed in those aggregates. 2) The question asks about “profit reporting,” not how some models in microeconomics calculate profits.
Brian Romanchuk
CC BY-SA 4.0
2020-11-04T15:37:34.197Z
1. But statistical agencies calculate both profits and other incomes and also expenses. The issue is that macroeconomically all income equals all expenses $\pi+r+i+w \equiv C+I+G$. Statistical offices clearly record spending on investment as expenses on the expenditure side (as the references provided above show) and on income side of national accounting this would be recorded through recording profits of companies that create the capital that other firms buy. 2. This question was actually originally not clear if it is about accounting  as Q in body and title dont match, as you can read in my
1muflon1
CC BY-SA 4.0
2020-11-04T15:37:36.420Z
3rd. comment I later told the user that this is all economics **not** accounting and recommended the user to go to personal finance and money stack for accounting info. You might not be aware of this but accounting discussions are considered off-topic on this site (see the [help center](https://economics.stackexchange.com/help/on-topic)). This is why I was abundantly clear that this answer is not from an accounting perspective and that accounting focused Q belong to other stacks
1muflon1
CC BY-SA 4.0
2020-10-31T16:56:54.463Z
2020-10-31T16:56:54.463Z
1muflon1
<p>From an accounting perspective, minimizing <em>taxable</em> profits is a generally a good thing. This is quite distinct from minimizing profit.</p>
<p>An investment is something you expect to generate money. In an error prior to intellectual property and R&amp;D, it typically referred to capital equipment--something you could sell, if necessary. An expense, in contrast, generates no residual value. The difference is simple when buying a tractor, still mostly simple when buying the plans for a tractor, but starts to get a bit odd when you talk about investing by researching how to build a tractor. Happily, accounting rules have long acomodated the problem of 'We paid way more for this asset than it was worth&quot;.</p>

CC BY-SA 4.0
2020-11-04T00:25:54.310Z
2020-11-04T00:25:54.310Z
Mox
<p>The matching principle of accounting makes efforts to match revenue to related expenses during a period. This means cash outlays during a period are either capitalized to an asset account or deducted from revenue in the profit and loss statement using a current expense account.</p>
<p>This video covers the basic concepts of capitalization versus expense:</p>
<p><a href="https://www.youtube.com/watch?v=LThBs6X_M04" rel="nofollow noreferrer">https://www.youtube.com/watch?v=LThBs6X_M04</a></p>
<p>The matching principle means the capitalized cost of a long lived asset should be spread over its useful life using accounting methods relating to depreciation, depletion, or amortization.</p>
<p>In general an outlay that can be treated as an expense reduces profit in the same period whereas the outlays to put capitalized assets into service do not reduce profit in the same period.</p>

CC BY-SA 4.0
2020-11-04T01:21:15.747Z
2020-11-04T01:21:15.747Z
SystemTheory
<p>As I understand it, in a company, profit will be invested, either into capital assets or into projects.</p>
<p>How do you distinguish between an expense, and reinvesting profits back into company projects?</p>
<p>For instance, if Pfizer makes \$100B in revenue, spends \$80B on business expenses doing so, then spends the remaining \$20B on research for a new drug, would they have made \$20B in profit? or \$0?</p>

<finance>
How do you differentiate between a business expense and an investment for the purpose of profit reporting?
Chubmaster25
# How do you differentiate between a business expense and an investment for the purpose of profit reporting?

(Asked by: username_0 on 2020-10-31)

As I understand it, in a company, profit will be invested, either into capital assets or into projects.

How do you distinguish between an expense, and reinvesting profits back into company projects?

For instance, if Pfizer makes \$100B in revenue, spends \$80B on business expenses doing so, then spends the remaining \$20B on research for a new drug, would they have made \$20B in profit? or \$0?

**Tags:** finance


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## 3 answers

### Answer by username_1 on 2020-10-31. Score: 2

In economics profit is simply defined as total revenue minus total costs or:

$$\Pi = TR-TC$$

In your case if

> Pfizer makes \$100B in revenue, spends \$80B on business expenses doing so, then spends the remaining \$20B on research for a new drug.

from economic perspective the profit would be:

$$\Pi= TR -TC = {\\\$}100B - ({\\\$}80B+{\\\$}20B) = 0B$$

So from economic perspective the profit will be zero. (However, note the economic perspective is not necessary the same as an accounting perspective - I mention that since you reference reporting, but in this case accounting profit would also happen to be zero if $20B$ is on accounts treated as cost).

> **Comments:**
> **username_0**: so if this is true shouldn't a good majority of companies be making near \$0 profit since companies tend to reinvest all their profits? If I wikipedia a company making billions in profit with no dividends, where is this money going?  
> **username_1**: @username_0 in your example above the spending is happening at the same time but in reality in dynamic setting the situation might look more like this: $t=1$ Firm has revenue $100b$ and total cost $80b$ which gives firm $20b$ profit (in accounting this would be called retained earnings), then in period $t=2$ the $20b$ might be spend on research. If it is spend within the same period then the profits must be zero. Also, in many industries even if accounting profits are positive economic profits might be zero although in your particular simple example they would coincide.  
> **username_1**: lastly going back to retained earnings, if you will look at the income statements of real life firms that is what you will find there if their total revenue was greater than all expenses (including the investment expenses and people would say that those retained earnings are 'reinvested'- although I am not an accountant and maybe in some situation investment spending now might be allowed under accounting rules to be recorded later - but economists would not make such distinction. Also economists would add also all the unobservable opportunity costs etc.)  
> **username_1**: @username_0 I think based on your comments that you are probably more interested into accounting side of things - for that personal finance & money stack exchange is the correct place.  
> **username_2**: I have to disagree with that. Profits are total revenues minus total _production_ costs, the costs of producing the product that was sold. Spending on R&D is an investment, it does not relate to the output that has been produced and sold.  
> **username_1**: @username_2 I thought that would be considered a cost. In endogenous growth models that explicitly model production of technology/R&D the R&D itself would be product. How would the investment expenditure then be modeled?  
> **username_1**: @username_2 for example, for some Pharma firm shouldn’t R&D expenditure be counted as a cost of producing the output? I mean I don’t want to argue, after your comment I am not entirely sure, and I come from macro not IO but I always thought this would be part of the  total cost function.  
> **username_1**: @username_2 I actually went and checked Tirole, theory of industrial organization ch 8 on pp 308 (if I am not misreading the passage) states that investments can be modeled as fixed respectively sunk cost that would be part of total cost function. In chapter 10 on pp 402-405 there is even a model of unpatented innovation/imitation models where research enters the problem through cost function in the profit function... is this then case/model dependent? To be honest now I am quite confused about this  
> **username_2**: @username_1 I will look up Tirole and will get back on the matter. In any case, this approach would be the (very) long-term view of what cost is.  
> **username_3**: National accounts is based on financial accounting, and investment is not  immediately expensed, rather it is depreciated. I don’t think it’s fair to characterize economics as ignoring the national accounting definitions.  
> **username_1**: @username_3 on national accounts investment is literary in the formula that is called the ‘expenditure approach’ to GDP, so by national accounts logic investment spending is expenditure. Also I am not an accountant but if I remember my basics of accounting from bachelor years the depreciation would be calculated once the investment is already made as an additional expense that lowers tax liability. In addition, as I read the question it is about micro not macro, I think it is fair to say that micro has completely different definitions of concepts such as cost, profit etc than an accounting  
> **username_3**: The depreciation normally takes years, so the immediate expense is typically smaller than the cash expenditure in the current period. As such,   fixed investments don’t subtract from profits, so long as you remember the depreciation.  
> **username_1**: @username_3 yes but in an microeconomic setting depreciation is not used in the same sense as in accounting. For example, in EU in many places you have to depreciate certain assets in certain number of years even if the asset is fine which has nothing to with what economists understand as depreciation. In addition buying let’s say machine would be in micro problem regarded purely as a cost you can see this regularly done across literature. See for example the IO textbook by Tirole. Also, you might be completely correct from an accounting perspective - but this is economics not accounting  
> **username_3**: Macroeconomics is concerned with national accounting profits, and investment is not expensed.  
> **username_1**: @username_3 1. this question clearly does not ask about GDP, GDP is widely known even among non-economist so if the question would be about it it would be referenced. 2. Even in macroeconomics you see profit functions such as $\Pi = p A L^{\alpha} K^{\beta} - wL-rK$ where capital investments clearly enter profit function as cost. You can see such models across macro literature, just have a look at any graduate textbook. 3. on national accounts (e.g. GDP) investment expenditure includes expenditure on purchase of new assets. Just have a look at NIPA Handbook of BEA.  
> **username_1**: In fact if you want to get technical from national accounts perspective any distinction between income and expenditure is meaningless they are the same thing since anyone’s expenditure is someone else’s income. Hence in theory both income and expenditure approach to GDP has to yield the same result - even though in reality there will be discrepancies due to measurement errors and such  
> **username_3**: Your answer does not aggregate correctly. If investment is an expense, that would hold across all firms, and so the national accounting definitions for profits would be different.  
> **username_1**: @username_3 1. I dont understand at all what do you mean it would not aggregate properly again in *economics* a common definition of profit function would be  $\Pi = p A L^{\alpha} K^{\beta} - wL-rK$  - you can properly aggregate that by lets say summing profit over all $n$ firms $\sum \Pi_i$ and you can also completely properly aggregate costs e.g. $\sum TC = \sum (rK_i +wL_i)$ or just capital cost $\sum rK_i$- I dont see how that is not proper aggregation. 2. When talking about statistics and national accounts again BEA records new investment as expenditure when calculating GDP  
> **username_1**: @username_3 Furthermore, from Blanchard et al Macroeconomics an European Perspective. The chapter on composition of GDP - "Economists use investment to refer to the purchase of (new) capital goods, such as new machines (new) buildings or (new) houses...." this is leading textbook from one of the worlds most renown macroeconomists so I dont think that is wrong  
> **username_3**: 1) GDP has nothing to do with this. Statistical agencies calculate aggregate profits, based on accounting standards. Investment is not immediately expensed in those aggregates. 2) The question asks about “profit reporting,” not how some models in microeconomics calculate profits.  
> **username_1**: 1. But statistical agencies calculate both profits and other incomes and also expenses. The issue is that macroeconomically all income equals all expenses $\pi+r+i+w \equiv C+I+G$. Statistical offices clearly record spending on investment as expenses on the expenditure side (as the references provided above show) and on income side of national accounting this would be recorded through recording profits of companies that create the capital that other firms buy. 2. This question was actually originally not clear if it is about accounting  as Q in body and title dont match, as you can read in my  
> **username_1**: 3rd. comment I later told the user that this is all economics **not** accounting and recommended the user to go to personal finance and money stack for accounting info. You might not be aware of this but accounting discussions are considered off-topic on this site (see the [help center](https://economics.stackexchange.com/help/on-topic)). This is why I was abundantly clear that this answer is not from an accounting perspective and that accounting focused Q belong to other stacks  

---

### Answer by username_4 on 2020-11-04. Score: 0

From an accounting perspective, minimizing *taxable* profits is a generally a good thing. This is quite distinct from minimizing profit.

An investment is something you expect to generate money. In an error prior to intellectual property and R&D, it typically referred to capital equipment--something you could sell, if necessary. An expense, in contrast, generates no residual value. The difference is simple when buying a tractor, still mostly simple when buying the plans for a tractor, but starts to get a bit odd when you talk about investing by researching how to build a tractor. Happily, accounting rules have long acomodated the problem of 'We paid way more for this asset than it was worth".


---

### Answer by username_5 on 2020-11-04. Score: 0

The matching principle of accounting makes efforts to match revenue to related expenses during a period. This means cash outlays during a period are either capitalized to an asset account or deducted from revenue in the profit and loss statement using a current expense account.

This video covers the basic concepts of capitalization versus expense:

<https://www.youtube.com/watch?v=LThBs6X_M04>

The matching principle means the capitalized cost of a long lived asset should be spread over its useful life using accounting methods relating to depreciation, depletion, or amortization.

In general an outlay that can be treated as an expense reduces profit in the same period whereas the outlays to put capitalized assets into service do not reduce profit in the same period.


---

