Implicit Cost

What is the implicit cost?

Implicit cost can be simply defined as the indirect cost incurred by a company which is not reported directly in the accounts of the company. It usually includes the opportunity cost which are non-monetary in nature. Such expenses arise when a company utilised its own internal resources and assets to perform business activities. No extra cost is needed for such activities as the company already owns the resources that are needed.

Implicit cost can also be defined by other terms such as notional cost, implied costs, and imputed costs. On the contrary, a company also experiences explicit costs under which all the monetary expenses fall. It is the money utilised by a company to additionally buy resources and provide service to the customers.

 

Summary

• Implicit cost can be simply defined as the indirect cost incurred by a company which is not reported directly in the accounts of the company.
• It is a crucial factor that draws the difference between economic profit, business profit, or accounting profit.
• The major difference between implicit and explicit cost is that implicit cost is the price paid for losing opportunity to earn more profit whereas explicit cost is the investment made by a company to earn revenue.

Frequently Asked Questions (FAQs)

How can the concept of implicit cost be explained?

The expenses born by a company indirectly and without any cash transaction are known as implicit cost. These expenses are difficult to account as there is no money transaction happen and hence they do not make it to the accounts book of a company. Implicit cost also represents the cost of an opportunity or a potential loss. Opportunity cost is simply the cost paid by a company when it chooses one option over other option. The potential profit that could have been earned by choosing the other option is the cost paid for not choosing it. The charge incurred could be due to choosing its own resources rather than outsourcing it. For instance, a company could earn more money if they rented their building rather that just utilising it for their own business work.

Implicit cost is considered a source of income hence, companies may also consider it as a cost of carrying out business activities. The professional economists and accountants do include implicit cost of a company to calculate the total economic profit made by the company.

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Why is implicit cost significant?

The implicit cost is extremely important for every business organisation even though these are not direct expenditure and are not recorded in the accounting books and cash flow statements of the organisations. However, they play a big role in determining the profitability of a company. Implicit cost is a crucial factor that draws the difference between economic profit, business profit, or accounting profit. The difference between accounting profit and economic profit are:

• Accounting profits

Accounting profits are recognised by the profit that can be seen at the bottom of the accounting books. It is also reflected in the financial statements of the company. The accounting profit is calculated by subtracting the total expenses from the total income of the company. However, accounting profit only records the monetary expenses or inflow of cash. For example, let us assume that a company’s net income is $100,000 and its total expenditure is $70,000.

Accounting profit = $(100,000 - 70,000) = $30,000

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• Economic profits

On the other hand, the economic profit considers both the explicit cost and implicit cost. Thus, a company might show a net profitability in its financial statements but does not necessarily mean that the company has earned revenue. There could be a huge amount of implicit cost experienced by the company which might reduce the overall profitability of the company. Let us take the example of the same company again. Let us assume that the total income is $100,000; total expenditure is $70,000; and the implicit cost is $50,000.

Economic profit = ($100,000 - $70,000 - $50,000) = -$20,000

However, it is not necessarily the case in every situation. Implicit cost is not always a profit reduction factor of a company. If a company can reduce its implicit cost then it might surely gain a positive economic profit.

What is the difference between implicit cost and explicit cost?

Implicit cost is the non-technical price paid by the company which cannot be measured accurately through the accounting process. There is no cash flow or transaction happening in implicit cost. It is just the price paid by a company for utilising its own resources and assets for business purpose rather than outsourcing.

Explicit costs on the other hand are the expenses that are technically made by the company for its business purpose. These costs are easily measurable for accounting. There is a cash flow and transaction happening in the case of explicit cost. It is basically the cost paid by a company for manufacturing, buying raw materials, paying bills, paying its employees, etc.

The major difference between implicit and explicit cost is that implicit cost is the price paid for losing opportunity to earn more profit whereas explicit cost is the investment made by a company to earn revenue. Moreover, the explicit cost is easy to measure and account whereas implicit cost cannot be measured.

Examples of implicit cost

Let us assume that a company has 100 workers working in the manufacturing unit. It takes approximately 30 days for 100 workers to manufacture 1000 unit of a particular product. It is an example of implicit cost as if there were 500 workers working in the same manufacturing unit, the company could have produced a greater number of products within 30 days.