Explicit Cost

Explicit costs are the culmination of all direct and indirect expenses recorded in a company’s ledger. It includes expenses that impact the profitability of a business—raw material, wages, rent, administrative charges, and sales expenses.

They are mentioned in the financial statements of a firm. They are tangible costs—actual cash payments are made. These expenses must result in a cash outflow—depreciation and amortization cannot be considered.

• Explicit cost refers to a tangible expense that leads to a cash outflow and is recorded in a company's books of accounts. It is also reffered to as explicit expense.
• Explicit expenses are computed by aggregating all the business expenditures. It is an important element in audits and accounting.
• It is the opposite of implicit cost; a non-tangible expense—also known as opportunity cost.
• Accountants focus on explicit expenses for cost management and strategic planning.

Explicit costs, also known as explicit expenses, are the real expenses incurred by a company. Explicit expenses are recorded in the company's financial statements. It includes all the direct and indirect costs spent on a company's business operations. For an expense to be considered, an "actual cost," it must fulfill three conditions:

1. The expense should be made in cash—there should be a cash outflow;
2. It should be a tangible cost;
3. The expense should appear on the firm's financial statements.

For example, when a company buys an advertisement space in a newspaper, it pays the newspaper agency in cash. This transaction is an actual expense that is recorded in the company's income statement and general ledger. Thus, advertisement expenses are considered explicit expenses. However, when managers invest time in training subordinates, the cost is intangible—there is no cash outflow. Therefore, training is not an explicit expense.

There is no specific formula for computing the explicit cost. It is the aggregate of all the business expenses that leads to cash outflow. We can say that:

Explicit Costs = Cash outflows recorded in the company's financial statements

These direct and indirect expenses include the following:

• Equipment and machinery purchased for the production of goods and services;
• Salary, wages, commission, bonus, and other monetary compensation paid to employees;
• Other allowances, benefits, and reimbursements—travel, food, accommodation, business trips, and healthcare expenses;
• Rent or lease paid for the property;
• Mortgage payments;
• Electricity, internet, water bills, and other utility expenses;
• Taxes and legal charges;
• Advertisement, sales, and marketing expenses.

Let's take a practical example:

The accounting department of Kingsman Tailors wants to find the total explicit expenses for the year 2021.

The details of various costs for 2021 are as follows:

1. Raw material consumption worth $108000,
2. Advertisement expense of $14000,
3. Electricity expense of $9000,
4. Office rent amounting to $10000,
5. Factory rent paid to the owner of Kingsman Tailors - $15000,
6. Purchase of new equipment worth $67,000,
7. Office staff salary amounting to $35,000,
8. Factory worker wages aggregated to $40,000.

Solution:

Explicit Cost = Raw material + Advertisement + Electricity bill + Office rent + Equipment + Salary + Wages

Explicit Cost = 108000 + 14000 + 9000 + 10000 + 67000 + 35000 + 40000 = $283,000

Thus, the total explicit expense for the year 2021 is $283.000. In the above calculation, we have excluded the factory rent since it is never paid—the factory belongs to the owner of Kingsman Tailors.

Explicit Cost serves the following purposes:

1. Facilitates Profit Computation: Every company ascertains two kinds of profit—the accounting profit and the economic profit. Accounting profit considers both implicit and explicit expenses. However, economic profit considers only explicit expenses.
2. Helps in Cost Management: During cost management, finance departments focus on explicit expenses.
3. Supports Corporate Strategic Planning: Companies consider explicit expenses for planning long-term profitability.

Comparing explicit costs vs. implicit costs, they are very different. The former refers to cash or monetary expense incurred by a business—an "out of pocket" expense or cost. The latter is an opportunity cost that is not incurred by the company but implied.

Explicit expenses are shown on the organization's general ledger and income statements. These expenses can be audited and used to determine a firm's accounting and economic profits.

On the contrary, implicit costs are not mentioned in a company's financial statements—nor is it audited. Implicit costs are only used for computing the economic profits of a business. 

Rent, interest on the loan, freight charges, employee compensation, and taxes are examples of explicit expenses. On the other hand, interests on the owner's capital and rent of the owner's building are implicit costs.

This article has been a guide to explicit costs and its meaning. Here we discuss formula, example, calculation, and explicit costs vs. implicit costs. You may learn more about Corporate finance from the following article -

• Option Explicit in VBA
• Capitalization Cost
• Average Cost vs Marginal Cost
• Accounting Profit