Updated July 17, 2023
Definition of Incurred Cost
Any expenses or payment till it is discharged is considered as incurred cost like use of credit card till the payment to bank is done is considered as incurred cost and it is used in accrual system of accounting which determine that the expense should be recorded at the right time of accrual.
Explanation
Any obligation for payment is termed as incurred cost. Goods received till payment is termed as incurred cost. Incurred cost is the obligation till payment. In short, the expenses which is liability till payment is the incurred expenses. For example, electricity bill of one month is to be paid in next month so the expense for the month till its payment is the incurred electricity expenses. Till the paymentit is considered as current liability according to accrual system of accounting. In case of purchase of asset or property on credit or on instalment till the complete discharge of liability it becomes the incurred cost. Prepaid expenses from beginning of the year is considered as incurred cost as the organization will use it throughout the year. The expense is to be treated as incurred expense on due and on payment it becomes the paid expenses.
Examples of Incurred Cost
- A has the credit card the limit of which is $ 5000 per quarter. Mr. A used the full limit. The bill for one quarter is to be paid by the last date of first month of next quarter. Like credit limit used for Apr- June, the bill is to be paid by the 31st of July. So, the liability of credit card expenses till its payment is called as incurred expenses.
- ABC Ltd. is the manufacturing company. The company earn very well. The organization has made provision for tax for the income earned for the year. So, the provision for tax is also termed as incurred expenses till the tax expenses are paid by the ABC Ltd.
- M/s. ABC & Co. files the case against one of the dealers for non-payment of the dues. The organization appoint lawyer to fight the case on behalf of M/s. ABC & Co. and the fees of lawyer is $ 1,500, which is to be paid after the completion of the case. So, the legal expenses of $ 1,500 becomes the incurred expenses till it is paid to the lawyer on the completion of the case.
- XYZ Ltd. purchases the goods from MNP Ltd. on 10.02.2019 on credit of 2 months for $ 7,000. The payment for the goods is due on 10.04.2019 i.e. after 2 months. The goods received and payment due becomes the incurred expenses till 10.04.2019 i.e. till the payment for goods and after the payment is made, the expense is called as paid expenses or discharged expenses.
Types of Incurred Cost
Different Types is explained as under:
- Manufacturing or Direct Cost: Manufacturing or direct cost includes purchase of goods on credit, payment due to the labourers, power and fuel expenses due for payment etc. manufacturing cost forms the part of cost of goods sold.
- Operating Cost: Operating cost refers to the normal expenses due for payment like rent for one month is due till it is paid in next month. Operating expenses include manufacturing as well as other expenses like sales and distribution expenses, interest expenses, administration expenses, repairs and maintenance etc. operating cost also includes the fixed as well as variable costs. Examples of fixed expenses are rent, insurance, salaries etc. whereas example of variable cost Is selling and distribution cost, repairs cost etc.
- Capital Cost: Capital cost include the asset purchased. Till the payment of full amount, the remaining payable amount of asset becomes the incurred cost.
- Sunk Cost: Sunk cost includes the irrecoverable cost like rent due or paid, interest paid etc. for example the loan taken is the liability and at the end of term loan has to be repaid with interest. So, loan repayment till the last instalment is the incurred expense.
Incurred Cost Analysis
Analysis of this includes the planning of cost incurred so as to maintain the proper liquidity and management of cash. The following are the results of analysis of incurred cost:
- Analysis of incurred cost helps the organization to manage the expenses well and to be paid on time.
- This analysis helps the organization in strategic decisions.
- It enables the better management of the cash flow.
- It helps in cash budget preparations.
- The company can be better managed through the analysis of incurred cost.
Uses of Incurred Cost
This concept is used in some of the following areas:
- It is mostly used in retail business, where the most of the sales and purchases is done on the credit basis.
- This concept is also useful in real estate industry where the payment of asset purchased is done in parts.
- The concept of incurred cost is also used in insurance companies where claim admitted and accepted becomes the incurred cost till the settlement of the claim.
Advantages
Some of the advantages are:
- With this concept, the cash flow can be better managed.
- It helps in managerial and long-term investment planning.
- Due to this concept the organization can gets the time for payment of the due expenses and prevent itself from liquidity crunches.
- This concepts help managing the recurring operating expenses like salaries, rent, interest etc.
Disadvantages
Some of the disadvantages are:
- Because of this concept the system becomes more complex it requires recording of very large number of expenses thereby making it complex and lengthy.
- Incurred concept is not suitable for small businesses where most of the transactions are done in cash.
- The cost results in much liability on the organization.
Conclusion
Incurred cost is the concept through which the cost till it is discharged is treated as the incurred cost like in case of purchase of goods till the payment to the creditor the cost becomes the incurred cost and after payment it becomes the paid cost. The concept also helps the management in decision making and planning of cash flow etc. but at the same time the application of concept becomes complex and the segregation consumes too much time and efforts.
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