Notional cost
A notional cost is an imputed charge used in management accounting that involves no actual cash payment — such as notional rent on company-owned premises or notional interest on equity capital — introduced to improve comparability.
See it move
Division A rents its premises and pays €120,000 in market rent each year, a real cash cost. Division B occupies a group-owned building and records €0 rent, because no external transaction exists. Charging Division B a notional rent of €120,000 removes that accidental advantage, so the two divisions are compared on operating performance rather than on who happens to own the building.
The formula
Variables
- capital employed in the division or project — typically net assets or total assets allocated to the unit (€)
- required rate of return applied as the notional cost of capital, often the organisation's weighted average cost of capital (decimal)
The most common notional cost in management accounting; it is the charge deducted from divisional profit to arrive at residual income. Notional interest involves no cash outflow and is not recognised in financial accounting — it appears only in internal management reports.
Check yourself
Two divisions are being compared in an internal management report. Division X occupies premises that the group owns outright and pays no rent. Division Y leases equivalent premises at market rate for €90,000 per year. To place both managers on equal footing, the group charges Division X €90,000 for its premises in the internal report only; no cash changes hands and the charge does not appear in the group's external financial statements. What type of cost is the €90,000 charge to Division X?