Explicit Cost vs. Implicit Cost

The main difference between explicit cost and the implicit cost is that in explicit cost firm directly bears the cost or expenses. Whereas, the implicit cost is the opportunity cost equal to the amount that a company must sacrifice to use those factor of productions for which it already owns.

Comparison Chart

Basis Explicit Cost Implicit Cost
Definition It stands for those direct expenses that are paid by the firm and are recorded in books of account These stands for those theoretical expenses that go unrecognized by the accounting system as these belong to the owner himself
Nature of Profit Economic Profit, Accounting Profit Economic Profit
Entry Recorded in books of account Unrecognized by accounting system
Other Name Out of pocket cost Imputed cost, implied cost, notional cost
Occurrence Actual Implied
Profitability Reduced Increased
Nature of Cost Monetary cost Opportunity cost
Money Actual money No actual money
Examples Wages, salaries, cost of raw materials, power charges, etc. No rent or other charges as everything is in owner’s hands and he is utilizing it in business. If he gave it to somebody, he would have earned some profit.

What is Explicit Cost?

In economics, the explicit cost is defined as the cost of making of actual payments in the process of production. These are the direct payments made by the firms or entrepreneurs in the course of making business transactions. In other words, the explicit cost can be said to the cost that represents cash outflows from a business and reduces its overall profit as well.

Suppose if a company doesn’t expend cash on given factors of production, those factors are not explicit costs for business transaction purposes. It can be variable or fixed depending on how to change with the change of company output. Common examples of explicit costs are salary and wages, payments of rent, the cost of raw materials, repair and maintenance charges and all those costs that require the outflow of cash. These are easier to trace because these are recorded in the books of account as compared to the implicit cost that is not recognized by the accounting system.

What is Implicit Cost?

As opposed to explicit cost, implicit cost or implied cost is an opportunity cost equal to the cost that a firm must give up to use factors of production which are neither purchases nor hires. It can be understood as if a person has a plot and he utilizes it for business purposes rather than acquiring another on rent. If he has not that plot, then he must have pay for the plot as rent.

On the other hand, by giving a personal plot for business purposes, he has sacrificed the profit in the shape of rent of the plot as well. For the same reasons, the implicit cost is said to be a cost where there is no actual flow of cash at all and has no effect on profitability as well. In the case of company or business, the implicit cost is the cost of the capital which the own may have earned if he had invested somewhere else. The implicit cost falls in economic cost only and has no relation with accounting cost at all.

Key Differences

  1. While calculating accounting profit, only explicit costs are taking into consideration, and the implicit cost has no value at all.
  2. The electricity bills, wages, salaries and other direct expenses paid by the firm are common examples of explicit cost while the labor of the owner who works for the company but doesn’t draw a salary is examples of implicit cost.
  3. Explicit cost requires an outlay of money while implicit cost does not require a cash outlay.
  4. As explicit cost takes into consideration of what is paid by the firm, so the profitability is decreased. Whereas, there is not a visible outflow of cash, so profitability increased or shown more than actual.
  5. The capital amount increased in the case of explicit because of what is invested in the part of business. However, in the case of implicit cost, investment has no effect on the capital because the thing belongs to the entrepreneur, not the business.
  6. Explicit costs are easier to trace because these are recorded in the books of account as compared to the implicit cost that is not recognized by the accounting system.
  7. Implicit cost is used by accountants only while economists take into consideration both explicit costs and implicit costs.
  8. Estimation of cost of explicit cost always remains objective whereas implicit cost delivers the subjective estimation of cost.
  9. The another name of the implicit cost is imputed cost while explicit costs are known as the out-of-pocket
  10. An explicit cost is always recorded and reported to the management while the implicit cost is neither recorded properly, however, is reported to the management of the company for decision-making

Video Explanation

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