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What Is an Implied Cost?

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  • Written By: Terry Masters
  • Edited By: Shereen Skola
  • Last Modified Date: 30 June 2014
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Implied cost, also termed "implicit cost," refers to the opportunity cost a business incurs by holding an asset for its own use, rather than allowing the asset to generate income for the business in the marketplace. Opportunity cost, or hidden cost, is the concept of what might have been when allocating resources among various uses. The concept is applicable to individuals, as well as businesses.

Perhaps the easiest way of understanding implied cost in a business context is to think of it from an individual perspective first. An individual usually has a choice regarding how to spend his time. Take, for example, a person who chooses to leave a paying job to go back to school full time. The true cost of his chosen endeavor is not just the tuition he must pay. There is also an implied cost associate with lost opportunity.

In this example, the student's opportunity cost is the amount of money he would have made if he had continued to work at a job, instead of going back to school. This cost is hidden from casual computation because most people do not bother to determine how much they could have been making if they had directed their time differently. The true cost to the student in the example of going back to school is the actual cost of the tuition plus the implied cost of his missed income.

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Businesses also incur opportunity costs when they choose to use resources one way, rather than another way. A common example of implied cost in a business context occurs when a business owns and occupies its own facilities. In most instances, a company feels it is doing a great job by occupying space that it own. It doesn't have to pay rent, and once the building is paid off, it seems like a big expense has come off of the company's books.

The only benefit the company gets out of its own occupation of the building is the rent abatement. If the company was renting a facility, however, it could deduct the expense against income on its taxes. Even though the cost to the business of occupying the building seems to be zero, there is an implied cost that is equal to the missed tax savings that result because the business is not paying rent.

It is important in business to recognize the implied cost of transactions and to take that cost into account when making decisions. In the rent example, for instance, the company would have to compare the bottom line figures of the cost of occupying the building without paying rent with the cost of paying rent somewhere else, taking the expense deduction and leasing out the building to someone else. Only by taking the implied cost into account can a company figure out which decision results in the most after-tax income.

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