A cost incurred refers to an expense that a company has recognized and recorded in its financial records. These costs are recognized in the accounting period in which they occur and are expected to benefit the company’s future operations.
Costs incurred could be a result of various business activities, such as purchasing goods or services, paying salaries to employees, spending on marketing and advertising, investing in new equipment, paying rent for premises, or other operational costs.
The concept of cost incurred is crucial to the accrual basis of accounting. In accrual accounting, expenses are recognized when they are incurred (i.e., when goods or services are received), not necessarily when they are paid. This method provides a more accurate picture of a company’s financial health and performance by matching revenues with the costs incurred to generate those revenues within the same accounting period.
For example, if a company purchases raw materials on credit in December, uses them to manufacture products in January, and pays the supplier in February, the cost would be recognized and recorded as an expense in December when the cost was incurred. This is because the company received the raw materials in December, which represents an economic sacrifice (a cost incurred), regardless of when the payment was made.
Example of a Cost Incurred
Let’s consider a fictional company called “TechRise,” which is a technology startup.
- On January 15, TechRise hires a developer and agrees to pay them a monthly salary of $5,000. The developer starts work immediately. By the end of January, TechRise has incurred a cost of $5,000 for the developer’s salary, even if it pays the salary in February.
- On January 20, TechRise orders new computer equipment on credit for $10,000, which is delivered immediately. The supplier sends an invoice with payment due in 30 days. Even though TechRise hasn’t yet paid the bill, it has incurred a cost of $10,000 in January when it received the computer equipment.
- On January 25, TechRise launches a new advertising campaign for which it had pre-paid $2,000 in December. The cost for this advertising campaign was incurred in December when the payment was made.
So, by the end of January, TechRise has incurred costs of $5,000 (salary) + $10,000 (computer equipment) = $15,000. The advertising cost was incurred in December, so it’s not included in the January total.
This concept of recognizing costs when they are incurred (not necessarily when cash is paid) is a fundamental part of accrual accounting, which matches revenues with the costs incurred to generate those revenues in the same accounting period. This gives a more accurate picture of TechRise’s financial performance for January.