What is Imputed cost?

Imputed cost mostly termed as opportunity cost or implicit cost is a more technical aspect of economic theory (economic problem).

According to economic theory due to scarce resources investor cannot fulfill all what he wants and thus has to pick and chose among alternatives and investor will choose the alternative that gives the maximum return. And right here in the selection lies the concept of imputed cost.

When one alternative is preferred over the other i.e. if one option is selected then it automatically means that all the other options are dropped. In other words to enjoy the benefits of one alternative the benefits of other alternatives are foregone.

The benefits that are sacrificed act as a hidden cost of selecting one alternative. For example, a business own a building that is used as a warehouse. Alternative use of the building could have been that it is rented out and thus rental incomes. Thus imputed cost of using building as a warehouse is rentals sacrificed.

Another example can be that entity is already producing an item called “Sporty” on which it earns a profit of $5/unit.

Another order is received to produce “Athlety” that require same labour force that is currently working on Sporty.

Currently there is no spare labour available and if new order is accepted then Sporty’s production will stop that means the profit of $5/unit have to be sacrificed. Therefore, the imputed cost of accepting a new order is $5/unit.

Another good example of imputed cost is inflation or time value of money where money loses its value over a long period of time.

As these costs are not actual cash outflows therefore, such costs are not accounted for in entity’s accounting system and often no effort is made to trace such costs if management decides to evaluate alternatives without considering imputed costs or lacks resources to collect necessary information. However, cost and management accountants give due importance to this concept under the name¬†relevant cost.¬†However, not all imputed costs are relevant costs in a given situation.

Important application of imputed cost in economics, accounting and business studies is calculation of economic profit to get better information for decision making purposes instead of relying on nominal profit. Economic profit calculation considers both explicit and implicit costs whereas nominal profit is calculated using explicit cost alone.