Imputed cost refers to the earnings or revenue that one has to forgo for using an asset instead of using it to generate revenue.
It is a cost that is not actually incurred by a person or business as an expense, but just a hypothetical cost.
It is thus, more commonly known as opportunity cost, implied cost, or implicit cost.
Imputed costs are a factor of concern in high level management where strategic decisions need to be made concerning the direction a company should move towards.
When deciding where to allocated capital senior executives have to weigh up all their options and come to a decision of what is best for the business. Having information on all the options can assist them in deciding on an investment that minimizes the imputed costs.
If a project would enable the company to rake in 5% returns, and a fixed deposit can easily enable it to earn 5% or more, then it makes financial sense to put the money in the bank.
There would be little to no work involved, and the company records the same amount of earnings.
These high level decisions are why higher management need to consider imputed costs when making decisions.
However, middle and lower management usually don’t have imputed cost as a factor when running operations.
This is because their focus would be on the actual explicit cost that operations have to contend with for the smooth running of the business.
For example, a manufacturing company with a fully owned and fully paid up factory and sales office in different locations might be occupying both premises for no practical reason. If it is to move the staff in the sales office into the factory, then the office property can be rented out for rental income or even sold for sales proceeds. The fact that they currently occupy both premises means that there is imputed cost that is the potential revenue and profits from renting out the commercial office instead of occupying it.
Imputed cost is not just applicable to companies. It can theoretically be applied to people as well.
An administrative clerk for example, might be getting a salary of 2,000 a month from working in a logistics service operator. But he decided to take 2 year off to pursue a full time Bachelor’s degree course so that he can climb the career ladder faster than he currently is. By giving up his job to pursue his studies, the imputed costs that he incurs would be $48,000 ($2,000 x 24 months) in those two years.
However, it must be noted that upon graduating, he might command a $3,000 per month salary. If everything stays constant, he would need to work for 4 full years before making up for the imputed cost of $48,000 during those 2 years of academic pursuit. This don’t even factor in the course fees he paid.
Having said that, one must be reminded that imputed costs, or opportunity costs, are hypothetical and is present in every decision people make.
So no matter what kind of choice managers make there would always be imputed costs involved.
At it’s most useful, it is a way for managers to determine the various comparable alternatives of a decision.
