Incurred costs, also known as actual costs, are expenses that a business has already committed to or paid for. These costs have been realized, and thus, are non-refundable regardless of the outcome or future decisions.
Incurred costs can be either fixed or variable and can include a wide range of expenses. For example:
- Salaries: Once the pay period is over, the business has incurred the cost of its employees’ wages.
- Utilities: Once the billing period is over, the business has incurred the cost of electricity, water, heating, and other utilities used during that period.
- Materials and Supplies: Once the materials have been used or the supplies consumed in the production process, the business has incurred these costs.
Incurred costs are an important concept in accounting and budgeting as they represent the actual expenditure of the business, which is necessary for accurate financial reporting and profitability analysis. It’s also essential to understand that incurred costs are different from committed costs. Committed costs are future costs that a company has committed to pay, while incurred costs are expenses that have already been used or paid.
Example of an Incurred Cost
Suppose that you own a bakery. Every day, you need to purchase flour, sugar, butter, and other ingredients to make your baked goods. The cost of these ingredients is considered an incurred cost because you’ve already paid for them and you can’t return them once they’ve been used in the production process.
Let’s say that in the month of January, you’ve spent the following amounts:
- Flour: $1,000
- Sugar: $500
- Butter: $800
- Rent for the bakery premises: $2,000
- Wages for your employees: $3,000
- Utilities (electricity, water, gas): $200
These costs have all been incurred – you’ve used the ingredients in your baking, the rent for the month has been paid, your employees have worked their hours, and you’ve used the utilities. All these costs amount to a total of $7,500 in incurred costs for the month of January.
No matter how many items you sell, or what profits you make, these costs have already been paid out and can’t be recovered, making them “incurred costs”. They are the base expenses that you need to cover with your revenues in order to turn a profit.