What is Explicit Cost?
An explicit cost is a cost that occurs, is easily identified, and is accounted for in the general ledger or financial statements. It represents clear, obvious cash outflow that reduces a company's bottom-line profitability. Examples of explicit costs would be items such as wage expenses, rent, or lease payments. It is easy to identify the sources of those cash outflows and the business activities to which the expenses are attributed.
Understanding Explicit Cost
Net income of a business reflects residual income remaining after all explicit costs have been paid. Explicit costs are the only costs necessary to calculate accounting profit. An explicit cost is an expense that occurs during business operations and has a clearly defined dollar amount. They are recorded in a company's general ledger and flow through to the expenses listed on a company's income statement.
Explicit and implicit costs are both utilized in the calculation of economic profit. Economic profit is the total return a company receives based on all costs incurred to attain that revenue, and it is utilized for long-term decision-making. Economic profit is used extensively to determine whether a business should enter or exit a market or industry.
Explicit Costs vs. Implicit Costs
Explicit costs, also known as accounting costs, involve tangible assets and monetary transactions and result in real business opportunities. Explicit costs are easy to identify, record, and audit because of their paper trail. Expenses relating to advertising, supplies, utilities, inventory, and purchased equipment are examples of explicit costs. Although the depreciation of an asset is not an activity that can be tangibly traced, depreciation expense is an explicit cost because it relates to the cost of the underlying asset owned by the company.
In contrast, implicit or implied costs are not clearly defined, identified, or reported as expenses. They often deal with intangibles and are described as opportunity costs, the value of the best alternative not accepted. An example of an implicit cost is wasted time, or time spent on one activity that could better be spent on another. While management will utilize explicit costs when viewing business operations, implicit costs are only calculated in decision-making or choosing between multiple alternatives.