The difference between implicit and explicit costs
/What are Implicit Costs?
An implicit cost is any cost that is not reported as a separately identifiable cost. It is an opportunity cost, which means that resources are being used that could have been directed elsewhere. The amount of this cost is the foregone ability to earn money from the funds in some other activity. Thus, an implicit cost is associated with how an asset is used. Since there is no exchange of cash, it is impossible to record an implicit cost in the accounting records. Nonetheless, managers should consider implicit costs when deciding how to use existing funds.
What are Explicit Costs?
An explicit cost is any cost that is reported as a separate cost. Explicit costs are tracked within the accounting records, because they involve the payment of cash to third parties. Examples of explicit costs are compensation, rent, and utility costs. All of these costs appear in a firm’s income statement as expenses.
Comparing Implicit Costs and Explicit Costs
One difference between implicit and explicit costs is that a company only makes cash payments for explicit costs; it does not do so for implicit costs. Another difference is that it is quite easy to measure the amount of explicit costs, since there is a specific payment associated with each one. It is very difficult to measure implicit costs, since their amounts are highly subjective. A final difference is that a company only creates a formal record of explicit costs; it does not do so for implicit costs.
Example of Implicit and Explicit Costs
Emilio works in a plumbing business that he owns, which is organized as a corporation. In the most recent year of operation, he is paid a salary of $60,000. The $60,000 is an explicit cost that appears on the company’s income statement. At the beginning of that year, Emilio chose not to accept a salary of $70,000 to work for a rival plumbing company. When considering this implicit cost, he is losing $10,000 by continuing to work for his own company.