16 October 2013
An implicit cost is a cost that has occurred but it is not initially shown or reported as a separate cost. On the other hand, an explicit cost is one that has occurred and is clearly reported as a separate cost. Below are some examples to illustrate the difference between an implicit cost and an explicit cost.
16 October 2013
Lets assume that a company gives a promissory note for $10,000 to someone in exchange for a unique used machine for which the fair value is not known. The note will come due in three years and it does not specify any interest. Due to the companys weak financial position it will have to pay a high interest rate if it were to borrow money. In this example, there is no explicit interest cost. However, due to the issuers financial difficulty and the seller having to wait three years to collect the money, there has to be some interest cost. In other words, there is some interest and it is implicit. To properly record the note and the machine, the accountant must determine the amount of the interest, which is known as imputing the interest. In effect the accountant must convert the implicit interest to explicit interest. This is done by discounting the $10,000 by using the interest rate that the issuer of the note would have to pay to another lender. If the rate is 12% per year, the interest that was implicit in the note is $2,880 and the principal portion of the note is the remaining $7,120.
16 October 2013
Explicit Costs: 1. involve immediate cash payment. 2. Actually incurred; can b objectively measured. 3. Are recorded in Books of A/cs 4. Purpose- Accounting, Reporting, Cost control & decision Making. 5. Also known as Out of Pocket costs. 6. Examples: Salaries, Wages, Advertisements etc
Implicit Costs: 1. Doesnt involve cash payment. 2. Not Actually incurred; have to be estimated. 3. Are Not recorded in Books of A/cs 4. Purpose- decision Making like asset replacement, make/buy etc. 5. Also known as Imputed/Notional costs. 6. Examples: Interest on own Capital,Depreciation, rent of owned premises, salary of proprietor etc.
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