Explicit vs Implicit CostComparison of Differences along with Examples

Written By:
Adiste Mae

Expenses affect the profitability of businesses.

In order for businesses to generate revenue, they can either increase their sales or cut their expenses.

When it comes to cost, there are two types that affect the ability of businesses to land a profit: Implicit Costs and Explicit Costs. 

Implicit vs. Explicit Costs

Businesses across different industries face both implicit and explicit costs in their day-to-day operations.

In differentiating between implicit and explicit costs, businesses will be able to determine the profitability of their business, as well as account for opportunity costs and economic profits. 

What are explicit costs?

Explicit costs refer to expenses that are incurred in the normal operations of the business and are shown in the general ledger.

This type of cost directly affects the profitability of the business.

It is also referred to as an accounting expense and appears in the Income Statement and Balance Sheet. 

Explicit costs are easily identifiable and quantifiable since there is always a payment of money involved. 

Common examples of explicit costs are the following:

• Salaries
• Rent / Lease Payments
• Raw Materials
• Utilities
• Other direct expenses

What are implicit costs?

Where explicit costs are quantifiable and easily identifiable, implicit costs are a little more complicated since they deal with intangible costs.

There is no exchange of cash when this cost is incurred and it is not recorded in the books of the company. 

Implicit costs are also referred to as opportunity costs – there is a loss of income even though there is no loss in profit.

Without the actual monetary transfer, implicit costs are the result of using an asset instead of acquiring or purchasing one. 

Here are common examples of implicit costs:

• Manager’s salary for work done in the early stages of the business and does not accept a salary. 
• Cost of hiring a new employee – the training hours devoted to training the new employee. 
• Payments that could have been earned for renting a property. 
• Cost of capital. 
• Temporary production downtime. 

Calculating Explicit Cost

To compute for a business explicit cost, simply get the total of the business expenses from the expenses posted on the general ledger.

They can include all the reported expenses – wages, rent, utilities, cost of goods sold, etc. 

When companies have their expenses recorded accurately and completely, it is easier for them to compute explicit costs. 

Example

ABC Company has reported the following information in their Income Statement:

Based on the information above, simply add all the expenses reported to get the explicit cost.

The total explicit cost, therefore, is $638,000.

Calculating Implicit Cost

Implicit Cost is an intangible cost and could not be easily computed because it does not involve the transfer of money.

This means that it would be difficult to come up with a standard formula to compute for implicit costs. 

However, in order to put a value on implicit costs, one must simply compute for the opportunity cost – the cost of choosing one option over the other. 

Example

For example, John has just opened his new business.

Because he has just started the operations, he has decided to not take any salary to help the business become more profitable.

Had he continued his work before, he would have been earning $50,000 a year. 

The implicit cost for this example is $50,000, which would have been considered an explicit cost if John had accepted a salary from his own company.