ACCOUNTANCY

Explicit Cost and Implicit Cost, Understand the Difference!

The following is an explanation of what explicit and implicit costs are, complete with examples and the differences between them. Read more on the Mekari Journal Blog!

Every company or organization definitely needs money to carry out production and operational activities.

These costs are divided into two types, namely explicit costs and implicit costs.

By knowing how much it costs, companies can be more effective in budget planning and financial management.

Definition of Explicit Cost 

Explicit costs are types of costs incurred by companies or businesses in carrying out operational activities or production processes.

These costs are also known as real costs and are directly related to various expenses that arise in the production process.

Explicit costs can determine the value of profit and loss so that it has a direct impact on company profitability.

Some examples of explicit costs are the costs of labor, inventory, rent, utilities, mortgages, production, and the company’s production machinery.

Understanding Implicit Costs

Implicit costs are unexpected costs or expenses that are not recorded in the company’s financial or cash records.

These costs are also referred to as invisible costs because they are not issued in the form of cash where there is no process of exchanging money or other forms of transactions.

In addition, these costs can also be in the form of opportunity costs that are utilized in the internal resources of a company.

Implicit costs are not shown in the financial statements or are generally reported as separate costs.

Implicit costs consist of several examples, such as the depreciation of company property prices, depreciation of tools/machinery, savings, and expenses that do not involve financial transactions.

Example of Explicit Cost

The following is an explanation of what explicit and implicit costs are, complete with examples and the differences between them

The following is a further explanation of some examples of explicit costs:

  • Employee salary

Companies need human resources in carrying out production activities.

For example, for the operation of tools, manual production of goods, as well as other tasks related to the company’s operational activities.

These workers and employees will receive a salary or wages, whether it is given on a daily, weekly or monthly basis.

Salaries or wages of employees that are issued regularly by the company are an example of explicit costs because they are always recorded in the company’s financial statements.

  • Production cost

Expenditures used during the production process.

Examples are the purchase of production raw materials, the purchase of additional materials, the purchase of tools, and so on.

  • Location Fee

Another example of explicit costs is budgeted expenditures for location costs, such as renting a building, renovating, purchasing equipment, or building a warehouse/factory.

  • Marketing Fee

To market the finished product, the company must market it to potential consumers.

The costs incurred for marketing can be in the form of advertising, digital promotion, and others.

Example of Implicit Cost

The following are some examples of implicit costs:

  • Employee training

Companies can provide training to employees to improve other skills.

This training is carried out during working hours so that employees cannot do their work during working hours.

It cannot be measured in money so it is an example of an implicit cost.

  • Asset Value Depreciation

The company has various assets that are used in the production process, such as buildings and equipment used which will experience depreciation in value.

The depreciation of this asset value will affect the production process.

However, this was not written in the financial statements because there were no financial transactions taking place.

  • Property Use

Holding various internal events such as seminars, training, or other events using company property can reduce building rental costs.

This can indeed save rental costs, but this method can also reduce company income because the company cannot rent out buildings or rooms for profit.

Difference Between Explicit and Implicit Cost 

Difference Between Explicit and Implicit Cost

Explicit costs have differences from implicit costs that can be seen based on:

Shape

Explicit costs are material (have a value that can be measured in money) so they can be calculated clearly.

While implicit costs are not material or only approximate, so they are more difficult to calculate.

Incident

Explicit costs are actually incurred where a payment transaction occurs.

In contrast, implicit costs are only the implications of an event, not a cost that is actually incurred due to the payment process.

Properties

Explicit costs are objective because they show a clear value based on the company’s transaction records.

On the other hand, implicit costs are subjective because they are only estimates or estimates.

This is also the reason why calculating explicit costs is easier to do than implicit ones.

Recording in Financial Statements

The difference between explicit and implicit costs is in the process of recording in the financial statements.

Explicit costs must be recorded in the general ledger and reflected in the company’s income statement.

Meanwhile, implicit costs are not recorded and included in the financial statements.

These costs are usually recorded in a separate report because they do not have a direct impact on the company’s profitability.

Impact on Profit/Profit

Explicit costs have a direct impact on the company’s net income which will later be reduced to revenue and form profit in accounting.

Meanwhile, implicit costs, this does not have an impact on profits, but only show the level of economic profit.

Function

The final difference between explicit and implicit costs is the functionality and benefits to the business.

Explicit costs are calculated to determine the accounting net income obtained by the company and to measure how efficiently the management manages the company’s cash outflows.

While the implicit cost serves to determine the value of the economic benefits of the business.

The goal is for management to better evaluate the business strategy and see the true potential or opportunity costs.

Difference Explicit Cost Implicit Cost
Shape form Intangible
Incident Actual Implications
Properties Objective Subjective
Recording in financial statements Yes Not
Impact on profit Yes Not
Function Counting profit Calculating economic profit

How to Calculate Explicit Cost

The way to calculate explicit costs is quite easy, you just need to break down the fixed costs and variable costs that the company incurs to operate and add them up.

Notice the example below:

For example, suppose your coffee shop business incurs the following expenses in May 2022:

Kiosk rental fee Rp 5.000.000
Employee Salary (3 0rang) Rp 7.500.000
Utility costs (internet, electricity, water) Rp 1.500.000
Raw material cost Rp 10.000.000
Transportation costs Rp 500.000
Marketing fee Rp 1.000.000
Miscellaneous expense Rp 700.000

 

The total explicit costs you incur for your coffee shop business in May 2022 are:

IDR 5,000,000 + IDR 7,500,000 + IDR 1,500,000 + IDR 10,000,000 + IDR 500,000 + IDR 1,000,000 + IDR 700,000

= Rp 26.200.000

For example, the income from sales in that month is IDR 45,000,000, then the profit you get is: 

IDR 45,000,000 – IDR 26,200,000

= Rp 18.800.000

For more, you can see an example case to know the implicit costing:

After one year of opening a business, your business is growing and has reached a profit of IDR 30,000,000 per month.

You then decide to open a new branch.

Incidentally, you own a private shophouse and decide to use it to open a new branch.

If rented out, this shophouse can bring in an income of IDR 7,000,000 per month.

This is what is called an implicit cost, where if you want to calculate the actual economic profit value from your business, you can do it by:

Economic profit = Profit – Implicit cost

= 30.000.000 – 7.000.000

= Rp 23.000.000

Monitor your Company’s Operating Costs with the Mekari Journal Finance Application

By understanding the difference between explicit and implicit costs, management or business owners can find out the value of accounting profit as well as actual economic profit so that it will be more helpful in evaluating business profitability and determining strategies for utilizing the company’s internal resources.

For that, you can use the Mekari Journal finance application to monitor the costs that arise so that you can make more appropriate decisions to cut unnecessary expenses.

With the Journal Expense & Budget feature, you can create automatic monthly budgets to control operating costs to maintain cash flow.

In addition, the Journal application is also equipped with various payment options so that costs can be recorded in full or categorized as debt.

Well, above is an explanation of what explicit and implicit costs are complete with examples, how to calculate them, and the differences between them.

Hope the above information is useful for you!

 

Related Articles

Leave a Reply

Your email address will not be published.

Back to top button