Explicit Vs Implicit Cost

Meaning of Explicit Cost

Costs resulting in an immediate outflow of cash from the business are termed explicit costs. These costs are incurred during the production process or the regular course of action of the business. Explicit costs are incurred due to the utilization of factors of production such as capital, land, labor, etc. These costs are paid in the form of rest, electricity bills, salary, wages, materials, and other overhead miscellaneous expenses.

Explicit costs are easy to recognize and keep track of. They are recorded when they arise and are calculated in terms of cash. Keeping a record of explicit costs is very important as it helps in calculating profits, cost controlling, decision making, etc.

Meaning of Implicit Cost

Implicit cost is also known as economic cost and does not require an outflow of cash from the business. Implicit cost is the value of the sacrifice made by the company at the time of conducting some other action. The cost arises when the asset is utilized as a factor of production instead of renting it out.

Implicit costs cannot be easily measured as they are not incurred in monetary terms. Only an estimate for these can be prepared. These costs are not reported or recorded in the books of accounts. Implicit cost is determined as they assist in the decision-making process regarding the replacement of any asset. These costs impact the performance and profitability of the company. Examples of implicit costs are the salary of the proprietor and interest in the owner’s capital.

Explicit Cost Vs Implicit Cost

After gaining insight into both types of costs,i.e., explicit and implicit costs, let’s look at the explicit cost vs implicit cost.

Explicit Cost Vs Implicit Cost

The following are the differences between explicit cost and implicit cost:

Meaning

Explicit costs occur when the company pays for the usage of its factors of production. Implicit costs arise when the company uses resources belonging to the owner, such as capital and inventory.

Alternatively known as

Explicit cost is also referred to as out-of-pocket costs. At the same time, the implicit cost is referred to as imputed or opportunity cost.

Determining Costs

Explicit costs can be determined easily. However, implicit cost does not have a track and cannot be determined precisely.

Estimation of Cost

Explicit cost is actually incurred; thus, its measurement is objective in nature. As opposed to implicit cost that occurs indirectly, thereby making the measurement subjective in nature.

Calculation of Profit

Explicit cost assists in calculating both accounting profit as well as economic profit. At the same time, implicit costs help in calculating only economic profit.

Recording and Reporting

On a regular basis, the management does recording and reporting of explicit costs. However, implicit costs are not recorded or reported to the management of the company.

Cash

Explicit cost requires an outflow of cash from the entity. While implicit costs do not require an outflow of cash.

Uses

Economists take into consideration both explicit and implicit costs. Whereas accountants use only implicit costs.

Conclusion

Implicit and explicit costs relate to a firm’s opportunity, costs, and cash expenditures. A business may incur explicit costs from a variety of sources, as opposed to implicit costs, which are difficult to quantify. However, the company endures both the cost and conducts decisions, considering both costs.

To know more about the different types of costs, refer to the article Types of costs and their basis of classification.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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