Accounting Terms

Accounting Profit

Accounting profit is also known as the net income for a company or the bottom line. It's the profit
after various costs and expenses are subtracted from total revenue or total sales as stipulated
by generally accepted accounting principles (GAAP). Those costs include:

Labor costs, such as wages

Inventory needed for production

Raw materials

Transportation costs

Sales and marketing costs

Production costs and overhead

Accounting profit is the amount of money left over after deducting the explicit costs of running the
business. Explicit costs are merely the specific amounts that a company pays for those costs in that
period – for example, wages. Typically, accounting profit or net income is reported on a quarterly
and annual basis and is used to measure the financial performance of a company.

Economic Profit

Economic profit is similar to accounting profit in that it deducts explicit costs from revenue.
However, economic profit also includes the opportunity costs for taking one action versus another in
the period. Economic profit is determined by economic principles, not by accounting principles.

Economic profit also uses implicit costs, which are typically the costs of a company's resources.
Examples of implicit costs include:

Company-owned buildings

Plant and equipment

Self-employment resources

Economic profit is the profit from producing goods and services while factoring in the
alternative uses of a company's resources.

For example, a company may choose Project A versus Project B. The profit from Project A after
deducting expenses and costs would be the accounting profit. The economic profit would
include the opportunity cost of choosing Project A versus Project B. In other words; economic profit
would consider how much more or less profit would have been generated - by using the company's
resources - had management chosen Project B.

Economic profit is more of a theoretical calculation based on alternative actions that could have
been taken, while accounting profit calculates what actually occurred and the measurable results for
the period.

What Is an Implicit Cost?

An implicit cost is any cost that has already occurred, but not necessarily
shown or reported as a separate expense. It represents an opportunity
cost that arises when a company uses internal resources toward a project
without any explicit compensation for the utilization of resources. This means
when a company allocates its resources, it always forgoes the ability to earn
money off the use of the resources elsewhere, so there's no exchange of
cash. Put simply, an implicit cost is comes from the use of an asset, rather
than renting or buying it.

Understanding Implicit Costs

Implicit costs are also referred to as imputed, implied, or notional costs. These
costs aren't easy to quantify. That's because businesses don’t necessarily
record implicit costs for accounting purposes as money does not change
hands.

These costs represent loss of potential income, but not of profits. A company
may choose to include these costs as the cost of doing business since they
represent possible sources of income.

Volume 0%

1:27
Implicit Cost
Examples of Implicit Costs
Examples of implicit costs include the loss of interest income on funds and the
depreciation of machinery for a capital project. They may also be intangible
coststhat are not easily accounted for, including when an owner allocates time
toward the maintenance of a company, rather than using those hours
elsewhere. In most cases, implicit costs are not recorded for accounting
purposes.

When a company hires a new employee, there are implicit costs to train that
employee. If a manager allocates eight hours of an existing employee's day to
teach this new team member, the implicit costs would be the existing
employee's hourly wage, multiplied by eight. This is because the hours could
have been allocated toward the employee's current role.

Another example of an implicit cost involves small business owners. But some
may decide to pass on taking that salary in the early stages of operations in
order to increase revenues and to cut down on costs. They give the business
their skill in lieu of a salary, which becomes an implicit cost.

In corporate finance decisions, implicit costs should always be considered

when coming to a decision on how to allocate company resources.

Key Takeaways
  An implicit cost is a cost that exists without the exchange of cash, and is
not recorded for accounting purposes.
 Implicit costs represent the loss of income but do not represent a loss of
profit.
 These costs are in contrast to explicit costs, which represent money
exchanged or the use of tangible resources by a company.
 Examples of implicit costs include a small business owner who may
forgo a salary in the early stages of operations to increase revenue.

[Important: Economists include both implicit and explicit costs when

factoring total economic profit.]

Difference Between Implicit and Explicit Costs

Implicit costs are technically not incurred and cannot be measured accurately
for accounting purposes. There are no cash exchanges in the realization of
implicit costs. But they are an important consideration because they help
managers make effective decisions for the company.

These expenses are a big contrast to explicit costs, the other broad
categorization of business expenses. They represent any costs involved in the
payment of cash or other tangible resource by a company. Rent, salary, and
other operating expenses are considered explicit costs. They are all recorded
within a company's financial statements.

The main difference between the two types of costs is that implicit costs are
opportunity costs, while explicit costs are expenses paid with a company's
own tangible assets. This makes implicit costs synonymous with imputed
costs, while explicit costs are considered out-of-pocket expenses. Implicit
costs are harder to measure than explicit ones, which makes implicit costs
more subjective. Implicit costs help managers calculate overall economic
profit, while explicit costs are used to calculate accounting profit and economic
profit.

What is Explicit Cost

An explicit cost is a cost that occurs, is easily identified, and is accounted for
in business documents or financial statements. It represents clear, obvious
cash outflows that reduce a business's bottom-line profitability. Examples of
explicit costs would be items such as wage expenses, rent, or lease costs; it is
easy to identify the sources of those cash outflows and the business
activities to which the expenses are attributed.

Volume 0%
Explicit Cost
BREAKING DOWN Explicit Cost
An explicit cost is an expense that has occurred and has a clearly defined
dollar amount. These expenses are incurred during business operations and
are actual out-of-pocket cash outlays, with their objective dollar amounts
subject to reporting.

Examples of Explicit Costs

Net income of a business reflects residual incomeremaining after all explicit
costs have been paid. Explicit costs are the only costs necessary to calculate
accounting profit. 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 that the company owns.

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.
Contrastingly, implicit or implied costs are not clearly defined, identified, or
reported as costs. They often deal with intangibles and are described as
opportunity costs. An example of an implicit cost is wasted time. While
management will utilize explicit costs when viewing business operations,
implicit costs are only utilized in decision-making or choosing between multiple
alternatives.

Opportunity Costs
Explicit costs are used in the computation of opportunity costs, the value of
the best alternative not accepted. Explicit cost is calculated by adding the
explicit and implicit costs of not performing an activity. For example, the
purchase of a vehicle by a business represents an explicit cost as the
equipment is actually purchased. An implicit cost is the greatest benefit that
could have resulted from the use of the funds. This cost could reflect a
different vehicle that could have been purchased or the benefit gained from
using the funds elsewhere.

Economic Profit
Explicit costs are also 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. These costs include all explicit and implicit costs.
Economic profit 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.
 Accelerated Depreciation
Accelerated depreciation is the allocation of a plant asset's cost in a faster manner than
the straight line depreciation. Compared to straight line depreciation, accelerated depreciation
will mean 1) more depreciation in the earlier years of an asset's life and 2) less depreciation in
the later years of the asset's life. [Note that the total amount of depreciation over the asset's life
will be the same regardless of the depreciation method used.] Hence, the difference between
accelerated depreciation and straight line depreciation is the timing of the depreciation

Definition of Capital Budgeting

Capital budgeting is a process used by companies for evaluating and ranking potential capital
expendituresor investments that are significant in amount. A few examples of capital expenditures
include:
 Purchase of new equipment
 Rebuilding existing equipment
 Purchasing delivery vehicles
 Constructing additions to buildings
Examples of Capital Budgeting Calculations
Capital budgeting usually involves the following calculations for each project:

 Future accounting profit by period

 Future cash flows by period
 Present value of the cash flows by discounting them with an appropriate interest rate
 The number of years it takes for a project's cash flow to pay back the initial cash investment
 An assessment of risk along with the urgency of the project
.