What is an Implicit Cost?
Definition: An implicit cost refers to any opportunity cost that a firm incurs when its internal resources are used for a project but only when the project does not offer compensation for the committed resources. It is considered an opportunity cost because the company puts its resources into a non-paying activity, thereby foregoing a paying one.
A scenario where a company may incur an implicit cost is where it decides to use resources rather than leasing them or even selling them. For example, a company may use a building for its own activities and forego making a profit if it would have otherwise leased or rented out the building. Implicit costs are also known as notional costs, implied costs or imputed costs.
Why are Implicit Costs not Recorded as Expenses?
Implicit costs are not recorded in accounting books and for good reasons. The first major reason is that they are not easily quantifiable. They are also not recorded because they do not exactly represent and exchange of value. In other words, there is no money changing hands. Implicit costs are easily viewed as forgone revenue-generating opportunities. Think of it as seeing an opportunity but not taking advantage it it for whatever reason.
Implicit Cost Examples
A company may own buses which it uses to transport its employees instead of earning an income by using those busses in a public transport system where they would generate a consistent income. This means that the company forwent the revenue that it would have generated if it had chosen the second option.
Another example is a scenario where business owners have a big building with three floors in a prime area and they use it as their private residence. They forego the opportunity to rent out the building or part of it so they can earn some rental income. So instead of making the house an asset, it is a liability to them since they have to maintain it and pay utilities.
A company may also incur an implicit cost if it hires employees and covers the cost of training those employees. For example, employees that have already been working at the firm for some time might be tasked with training the new employees and are even paid extra. Meanwhile, the training does not necessarily result in added value to the company at that moment.The trainees only contribute to the company’s revenue when they start actively working at their respective positions in the company.
Implicit Costs vs Explicit Costs – What’s the Difference?
There is another type of cost that is usually pegged against implicit costs on the other end of the spectrum and it is known as explicit costs. The latter refers to the costs that a business incurs when running its operations, such as the cost of materials, rent, and even wages. There are notable differences between implicit costs and explicit costs.
- No payment is made for implicit costs while explicit costs occur when a transaction is made.
- Implicit costs do not represent any expenses that a firm incurs while explicit costs represent expenses that a company or business actually incurs in exchange for value. For example, salaries are paid in exchange for added value which brings in revenue.
- Implicit costs are not recorded in the accounting books while the explicit costs are recorded in the financial statements.
- Explicit costs are are the expenses that the business incurs. Implicit costs are simply the opportunity costs of not pursuing something.
- Explicit costs can be easily quantifiable but the same cannot be said for explicit costs since they cannot be easily accounted for.
A company or organization should be careful enough to consider implicit costs. Taking such costs into consideration may help the company to make better decisions about the allocation of its resources. Implicit costs are not necessarily something to be avoided. In fact, sometimes they contribute to a better future for the company. For example, the implicit cost of training new employees contributes to a more rounded and capable workforce.