What is Implicit and Explicit cost? How are they Different?

The majority of people associate cost with the price they paid for something. Cost, on the other hand, is defined by economists as the number of resources used to create a good or service. The time it takes to complete a task, for example, is a cost. There is also an opportunity cost, which is the cost of passing up the best alternative.

 

If two opportunities are mutually exclusive, a person can only take advantage of one of them. Giving up an opportunity is the cost of something, and an explicit cost is one that involves monetary payment. 

 

Implicit cost is an opportunity cost that arises from the allocation of resources for a specific purpose and cannot be easily assigned a monetary value. Let's look at both explicit and implicit costs in more depth.

 

(Also Read - Cost Benefit Analysis)

 

 

Implicit and Explicit Cost

 

What is Implicit Cost?

 

An implicit cost is defined as a cost that has already been incurred but has not been explicitly expressed or reported as a separate expense. It reflects the value of an opportunity created when a company uses internal capital for a project with no clear reimbursement for resource usage.

 

When you use the word implicit, you're implying something without actually saying it. This holds true for both explicit and implicit costs. You may incur an implicit cost without recording it in your ledger as a separate expense. As a result, implicit costs may be more difficult to quantify than other types of costs.

 

They frequently represent a loss of revenue rather than a loss of profit. They also assist business executives in making the best decisions for their companies based on profit and market conditions. Implied, imputed, and notional costs are other names for implicit costs. 
 

 

What is Explicit cost?

 

Explicit costs are ordinary business costs that appear in the general ledger and have a direct impact on a company's profitability. A traditional business expense is what some people refer to as an explicit cost. It depicts a money transaction or the application of a tangible resource.

 

The term explicit refers to something that is stated explicitly or in great detail. This is the only accounting cost that is required to calculate profit, and it has a direct impact on a company's bottom line. 

 

Explicit costs have clearly defined dollar amounts that flow through to the income statement. Explicit costs include wages, lease payments, utilities, raw materials, and other direct expenses.

 

(Also Read - Revenue Deficit)

 

 

Examples of Implicit and Explicit Cost
 

Because of the relationship between implicit and explicit costs, both calculations are required when calculating accounting profit and economic profit for a company. 

 

When calculating total accounting profit, explicit costs are typically considered first, followed by implied costs of business operations such as salary reductions, increased working hours, or other resources that could be used to generate revenue but aren't.

 

Implicit Cost Examples

 

Unlike explicit costs, which have a fixed value, implicit costs are not always so straightforward. If you spend 5 hours playing video games, for example, you will not be able to study during that time. 

 

The hidden cost is the time spent studying that could have been spent elsewhere. Although the value is not always monetarily quantifiable, it is still considered a cost.

 

1.   The cost of training a new employee is hidden in the fact that those seven hours could have been spent on other tasks.

 

2.   Going to university entails an implicit cost in the form of money that could have been earned during that time.

 

3.   When a company uses its capital, it forgoes the interest it could have earned in interest.

 

4.   Maintenance requires the company to halt production for a period of time, which may result in lower output or dissatisfied customers.

 

Explicit Cost Examples

 

An explicit cost is a monetary amount that is made by the company in a clear and visible manner. It has a distinct monetary value that can be seen in the financial balance sheet of the company. Here are some examples of Explicit Cost:

 

1. Taxes and legal fees

 

2. For the land that the company is using, rent or other mortgage payments are required.

 

3. Costs of advertising and marketing

 

4. Wages, bonuses, commissions, and other forms of employee compensation.

 

5. Employee benefits such as healthcare, a staff restaurant, or a staff gym that are not paid directly to the employee.

 

6. Supplies required by the company in order to supply its output to customers.

 

7. Electricity, water, and internet service are examples of utilities that are required to keep a business running.

 

8. Businesses buy equipment to increase the efficiency of their production and output.

 

(Also Read - Pricing Strategies)

 

 

How to calculate the Implicit Cost?

 

Implicit cost is the opportunity cost incurred when a company performs resource allocation to one decision over another. It's difficult to give an implicit cost calculation a standard formula because it can involve a variety of situations.

 

Examine the costs associated with an opportunity to determine your implicit or opportunity cost of a situation. A day spent training a new employee, for example, means another employee misses out on sales and commissions. For the employee/trainer, the opportunity cost (aka commission and other pay) is an implicit cost.

 

Example,

 

Assume you're a new business owner who has only been in operation for a few years. You decide not to take a salary for the first two years to help pay for startup costs. Your annual salary would have been Rs 400,000.

 

Because you haven't been paid in two years, your decision has an implicit cost of Rs 800,000. (400,000 X 2). If you had been paid that salary, it would have been a clear cost. 

 

How to calculate the Explicit Cost?

 

Calculating explicit costs is simple as long as you know your business expenses. To calculate explicit costs, add up all of your business expenses on the general ledger. This could include things like insurance, rent, equipment, supplies, and the cost of goods sold, among other things.

 

Keep in mind that costs differ from one company to the next. As a result, calculating explicit costs does not have a one-size-fits-all formula. It is, however, relatively simple to calculate if you have a list of your business expenses on hand.

 

Example,

 

Let's say your company's total costs for the period are 1 lakh in cost of goods sold, 10,000 in rent, 2000 in supplies, 25000 in insurance, 10 lakhs in employee wages, and 5000 in utility costs. Add up all of your expenses to get your total explicit costs:

 

100000+10000+2000+25000+1000000+5000 = Explicit Costs

 

For the period, your explicit costs total Rs 1,142,000. You can use this amount to find financial information for your company by plugging it into other formulas, such as accounting or economic profit formulas.

 

(Also Read - Cost of Production)

 

 

Difference between Implicit and Explicit Cost

 

We’ve listed some key differences between Implicit and Explicit Cost below : 

 

1. The idea behind explicit cost is that "cash outflow equals cost incurrence." Implicit cost is based on the idea that "if the inputs had been diverted for another purpose, they would have generated some revenue."

 

2. Explicit Cost is easy to calculate, but Implicit Cost is difficult to calculate because there is no paper trail.

 

3. Explicit Cost is measured objectively because it is directly incurred, whereas Implicit Cost is measured subjectively because it is incurred indirectly.

 

4. Both accounting and economic profit can be calculated with the help of explicit costs. Implicit Cost, on the other hand, aids in the calculation of only economic profit.

 

5. Explicit costs are kept track of and reported to management. The implicit cost, on the other hand, is neither recorded nor reported to the company's management.

 

6. An entity incurs an explicit cost when it must pay for the use of production factors. Implicit cost is the cost incurred when an entity uses the owner's resources such as capital inventory and so on.

 

7. Implicit or imputed costs are terms used to describe costs that are not explicitly stated. Out-of-pocket costs is another name of explicit cost.

 

8. Explicit costs are simple to calculate because they involve a cash transaction between two parties. Implicit costs, on the other hand, are difficult to quantify. They are difficult to evaluate because there is no real exchange of money. They are also subjective as a result of this.

 

9. Both accounting profit and economic profit are calculated using explicit costs. Accounting profit = Revenue – Cost of doing business (explicit). 

 

Only economic profit can be calculated with the help of implicit costs. Revenue – Cost of doing business – Opportunity cost = Economic profit (implicit)

 

10. To calculate profit, all explicit costs are recorded in the books of account. Despite the fact that implicit costs are not separately recorded in financial statements, managers frequently consider them when making critical cost-related decisions.

 

(Also Read - Cash Flow Analysis)

 

Explicit cost refers to a business owner's cash expenditures, whereas implicit cost occurs when a business owner applies his already available resources to a specific job rather than using them for his own purposes.

 

There is an implied cost of losing a potential income on the resources used, even though there is no cash payment. While a business owner bears the explicit cost directly, he bears the implicit cost indirectly