Definition: An implicit cost is an opportunity cost of using a firm’s internal resources that isn’t reported as separate, distinct expense. In fact, these costs do not explicitly state the cost of using these resources for a project.
What Does Implicit Cost Mean?
What is the definition of implicit cost? Implicit costs are costs on which the firm waives any opportunity of earning a profit from the use of its internal resources by third parties, such as the rent that a firm would earn if it leased out a building that it owns instead of using it for its own operations.
They are also costs that the firm cannot account for, such as the depreciation of equipment or the cost of hiring an employee. For this reason, they are not recorded on any financial statement. These costs are generally hard to quantify since there is no physical exchange of cash or transaction directly related to them; however, some businesses single out these as costs of potential sources of income.
Let’s look at an example.
Example
A manufacturing company owns a building, which is used for its own operations instead of renting out to another firm. The company has a net profit of $25,000 per month, and the opportunity cost of rent is $10,000. The actual economic profit of the manufacturing company is $25,000 – $10,000 = $15,000 per month.
Because the firm uses its own resources, it does not earn income on these assets, and it cannot report any explicit costs for using the building for its own operations. In doing so, the company waives a potential income of $10,000 per month.
If the company earned $13,000 from the rent with a net income was $10,000 per month, it would face a loss of $10,000 – $13,000 = – $3,000. This means that the asset is underutilized, and the company should rent out the building to earn an additional profit per month instead of using it for its operations.
Summary Definition
Define Implicit Cost: Implicit costs are unrecognized costs that a firm realizes when it uses its assets and resources for one project over another.
