Also referred to as illusory profits. Occurs because accountants use past costs rather than replacement costs. For example, in computing the cost of goods sold accountants often use the FIFO cost flow assumption. This results in the oldest costs being matched with sales. Economists prefer that the replacement cost of the inventory be matched with sales. The difference in profits from using FIFO instead of the replacement cost is referred to as phantom or illusory profits. Similarly, accountants depreciate the original cost of buildings and equipment. Economists prefer that the replacement cost be depreciated. With inflation the accounting profits are higher than the economists would report using replacement cost.
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