Imputed costs are those costs that do not involve any cash outlay. For example interest on capital, it not an expense actually paid in monetary terms.
An imputed cost is also known as a hidden cost, implicit cost, or opportunity cost. The formal definition of opportunity cost is this: it is the value of the next best alternative forgone to pursue a particular activity. This is a concept that applies to individuals as well.
For example, let’s say you have a choice between two careers: medicine and arts. If you pursue medicine, you’ll make an annual salary of $50,000, but by pursuing arts, your annual salary would be $40,000. Therefore, if you pursue arts, your imputed cost or opportunity cost is $50,000. A firm doesn’t report these costs in its financial statements.
These costs are initially recorded as assets but subsequently treated as expenses. The main examples are the purchase of an intangible asset such as a patent, copyright, or any other similar intellectual property.
Capitalized cost is the aggregate of all costs incurred in connection with the acquisition or production of a long-term asset. Such costs generally include the purchase price of the asset, any costs of modifying the asset to get it into its intended condition and location, and any other costs necessary to get the asset ready for its intended use.
A company may capitalize on costs associated with the research and development of new products, technologies, or processes. The company may also capitalize on costs associated with constructing a new factory or expanding an existing one. The costs of natural resources that are extracted and used in the production process may also be capitalized.
The decision of whether to capitalize or expense a cost is made by Management and is generally based on matching principles. That is, the costs associated with acquiring or producing an asset should be matched against the revenues generated by the asset. For example, if a company builds a new factory, it would spread the cost of the factory over its useful life and match the expenses against the revenue generated by the factory.
How imputed costs and capitalised costs Differ
The difference between capitalised and imputed costs is not a question of the amount being paid by the owner but of the time spent and the opportunity cost of the employee or contractor.
The difference arises because imputed costs may be charged by an owner or a contractor as an expense against income. For example, an owner that hires an employee may be able to claim the full cost of that person’s wages from an accrual basis, but an accrual basis owner cannot claim the wages of its employee.
The difference between imputed and capitalised costs is the difference between the cost of an item and what it would cost to replace the item if it were broken or lost. For example, when you buy a new pair of shoes, the actual price of the shoes is the imputed cost. Imputed costs include the depreciation value on your shoes and any warranties.
On the other hand, when you buy a new pair of shoes, the price is the capitalised cost. Capitalised costs only include the depreciation value of your shoes and do not include any warranties.
Capitalised costs are used for calculating the depreciation of equipment, vehicles, and other capital items. For example, when you calculate the depreciation on your car, the cost of your car is capitalised. When you calculate the depreciation on your car, the cost of your car is capitalised cost.