An organization’s costs include all the expenses it incurs when converting raw materials into finished products. Actual expenditure on inputs and the owner’s imputed value of the input is included in the cost. The former is known as an explicit cost and the latter as an implicit cost. The firm should be able to differentiate between the two terms as a failure to do so can have disastrous results.
Explicit Cost vs Implicit Cost
The main difference between Explicit Cost and Implicit Cost is that An explicit cost is a direct payment made to another party in the course of operating a business, whereas an implicit cost is what a firm must forego to use a factor of production that it already owns.
Explicit cost is the actual money expenditure on inputs or payments made to outside for hiring their factor services. It involves actual money payment on buying and hiring inputs. Paying wages to employees, paying rent on land, purchasing raw materials are examples of these expenses.
Implicit cost is the estimated value of the inputs supplied by the owner or cost of self-supplied factors. It involves the input value of a factor owned by the firm. There is no money involved. Some examples include interest on capital, rent or own land, the salary of the entrepreneur, etc.
Comparison Table Between Explicit Cost and Implicit Cost
| Parameters of Comparison | Explicit Cost | Implicit Cost |
| Definition | Explicit cost is the cost an organization pays directly to the market to acquire goods and services necessary for production. | Implicit cost is a cost that does not have a monetary value. They are instead inputs that a company owns. |
| Alternative name | Explicit cost is also known as Out Pocket costs. | Implicit cost is also known as Imputed cost or Opportunity cost. |
| Records | Explicit cost is neatly defined in the books. | Implicit cost is not recorded in the books. |
| Consideration | Explicit cost is considered to calculate both the accounting and the economic profit. | Implicit cost is considered only to calculate the economic profit. |
| Estimation | The estimation of an explicit cost is objective. | The estimation of an implicit cost is subjective. |
| Tracking | Explicit costs can be tracked easily in the market. | Implicit costs cannot be tracked that easily in the market. |
| Example | Rent, wages, salaries, advertisement, etc. | Owners salary, owners rent, owner’s capital interest, etc. |
What is an Explicit Cost?
Explicit costs consist of actual payments for inputs or payments made to outside parties as factoring services. Explicit costs include actual payments for inputs such as purchasing and hiring. These expenses include paying wages to employees, paying rent on land, and purchasing raw materials.
Explicit cost is also known as Out Pocket costs. Explicit cost is neatly defined in the books. Explicit cost is considered to calculate both the accounting and the economic profit. The estimation of an explicit cost is objective. Explicit costs can be tracked easily in the market.
Explicit costs occur during the production process or generally throughout the business. Payments in explicit costs are made to outsiders during the running of the business. The payments demonstrate that the business has exchanged funds.
To be able to keep track of the explicit costs, firms must record and observe theThis enables the firm to understand its profit margin.de. Furthermore, the number of explicit costs spent can help businesses make critical decisions regarding cost-cutting, lowering the quality of expensive products, or production control.
What is an Implicit Cost?
An implicit cost is the estimated value of inputs provided by the owner or factors that are self-supplied. This involves input values of factors owned by the firm. It is not a financial transaction. There are many examples, such as interest in the capital, rent on the land, and the salary of the entrepreneur.
Implicit cost is also known as Imputed cost or Opportunity cost. Implicit cost is not recorded in the books. Implicit cost is considered only to calculate the economic profit. The estimation of an implicit cost is subjective. Implicit costs cannot be tracked that easily in the market.
There are no actual monetary transactions involved in implicit costs. The company is sacrificing something that already belongs to them to keep the production process going. An implicit cost is a cost associated with an asset that is used by the company itself instead of being leased out.
Keeping track of implicit costs is difficult because they are not incurred by the organization. Implicit costs have a significant impact on a company’s profitability. Implicit costs also have an impact on the performance of a business.
Main Differences Between Explicit Cost and Implicit Cost
- Explicit cost is the costs an organization pays directly to the market for goods and services necessary for production. Therefore, it is also known as Out Pocket costs, while implicit cost has no monetary value. It is instead all the inputs that a company owns, therefore Implicit cost is also known as Imputed cost or Opportunity cost.
- Explicit cost is nicely reflected in the books, whereas implicit cost does not appear in the books.
- Explicit cost is used to calculate both the accounting and economic profit, whereas implicit cost is only used to calculate the economic profit.
- Explicit cost is measured objectively, whereas implicit cost is measured subjectively.
- It is easier to track explicit cost in the market, whereas implicit cost is more challenging.
Conclusion
Explicit and implicit costs are both necessary for a company to remain profitable. A cost that is directly paid to an outsider is called an explicit cost. An implicit cost is one incurred by the company itself. They are not in any way more significant than each other. A company needs to keep track of both types of costs to maximize its profits and minimize its expenditures.
References
- https://www.jstor.org/stable/3664969
- https://pubs.aeaweb.org/doi/pdf/10.1257/aer.99.2.424