What is Explicit Cost?

Explicit costs are those costs recorded in the accounting records of a business. As such, they have a distinct paper trail that is easy to identify and record. The profitability of a business is determined after all explicit costs have been subtracted from revenues. Explicit costs are included in the formulation of a firm’s annual budget, on the assumption that they will be incurred again in the future.

Presentation of Explicit Costs

Most explicit costs are period costs, and so will flow through the income statement. Other costs may not be consumed at once, and so will be presented in a firm’s balance sheet until they are consumed. For example, the cost to acquire merchandise may be capitalized into the inventory line item that appears on the balance sheet, and will later be charged to expense when the merchandise is sold.

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Examples of Explicit Costs

Several examples of explicit costs are as follows:

Compensation expense. This is the cost incurred to pay all employees, and includes payroll taxes and the cost of benefits. This is a massive explicit cost in services businesses.
Cost of goods sold. This may be the largest explicit cost, since it includes all direct labor, direct materials, and factory overhead costs associated with the production of goods.
Depreciation expense. This is considered an explicit cost, since it relates to the ongoing cost of a set of fixed assets.
Rent expense. This can be a major explicit cost, especially for retail businesses that rent many store locations.
Utilities expense. The cost of utilities can be substantial in cases where a business needs to cool or heat its premises, or where employees are using many phone lines to conduct business.

Explicit Costs vs. Implicit Costs

Implicit costs are not clearly defined, and so are not included in a company’s accounting records. They are considered to be more of an opportunity cost, which is the value of an activity that was not pursued. For example, the time spent developing a new product could have been spent revising the design of an existing one.

Explicit costs are included in the calculation of a firm’s profitability, while implicit costs are only considered as part of a decision-making process, when management is choosing between alternative actions.