Question

Suppose a company incurs the following costs:

Labor $800

Equipment $400

Materials $300

It owns the building, so it doesn’t have to pay the usual $900 in rent

(a) What is the total accounting cost?

(b) What is the total economic cost?

(c) How would accounting and economic costs change if the company sold the building and then leased it back?

Answer 1

Acccounting cost- It is known as explicit cost. Is is defined as the payments made to the outsiders for the production of a commodity. It is considered as out of pocket expenses. It reprsent any cost involved in the payment of cash or any tangible resource by a company. It is listed in books of ledger.

Example- Payment of raw material, wages to labourers, lease payments etc.

Accounting cost= Explicit cost

Economic cost- It includes both explicit and implicit cost.

Implicit cost is not recorded in books of ledger as there is no cash exchanges in the realization of implicit cost. It is estimated cost of self owned resources. It is also known as opportunity cost.

Example- Rent of own building, wages to enterpreneur, interset of own capital etc.

Economic cost= Explicit cost + Implicit cost

Answer a) Explicit cost in question

Labour= $800

Equipment= $400

Material= $300

Explict cost= $800 + $400 + $300 = $1500

Accounting cost = Explicit cost

So Accounting cost= $1500

Answer b) Explicit cost= $1500

Implicit cost= $900(rent of own building)

Economic cost= Explicit cost + Implicit cost

=$1500 + $900 = $2400

Answer c) Now the company sold the building and leased it back then

There is no implicit cost of the company because impicit cost is for self owned resources.

Explicit cost now equal to $1500 + $900 = $2400 so now accounting cost and economic cost become equal i.e. $2400 because now there is only explicit cost.