Incurred costs are those that a company has incurred during a particular period. These costs can include both direct and indirect costs. Direct costs can be directly attributed to the production of a particular good or service. Indirect costs are not directly attributable to the production of a particular good or service but have been incurred by the company.
The concept of incurred costs is important in both accounting and financial analysis. In accounting, incurred costs are used to calculate various ratios, such as the gross profit margin and the operating expenses ratio.
Did You Know? An incurred cost in accrual accounting is the moment in time when a resource or asset is consumed and an expense is recorded.
Overview: Incurred Cost
Incurred value is a cost that a company becomes accountable for in exchange for ingesting or otherwise benefiting from the use of an asset. It is based on the amassed accounting idea of expense reputation. Incurred fee is an expense for the agency and is generally recorded at the debit facet of the income statement.
Examples Of Incurred Costs
One example of Incurred costs is a company's inventory. A company's inventory is considered an Incurred cost because it has been purchased before selling. The company has spent money on inventory, which is an Incurred cost. If the company does not sell the inventory, the Incurred cost will become an expense.
Another example of Incurred costs is a company's accounts receivable. Accounts receivable are considered Incurred costs because they represent money owed to the company. The company has incurred the service or product cost, so the accounts receivable is an Incurred cost. If the customer does not pay the company for the service or product, the Incurred cost will become an expense.
A company incurs the cost of office supplies when it purchases them. The company has yet to use the office supplies, but it has Incurred the cost because it has paid for them.
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Reasons To Keep Track Of Incurred Costs
1. Incurred costs are necessary to track because they represent the actual costs of goods and services that have been purchased. This information is essential for financial reporting and decision-making purposes.
2. It can be used to assess a company's or project's performance. For example, if total costs are increasing but revenues are not growing at the same pace, this could be a sign that the project is not being managed efficiently.
3. Incurred costs help to negotiate better prices from suppliers. If a company knows how much it typically spends on a particular item, it can use this information to negotiate a lower price from the supplier.
10 Types Of Incurred Costs
Incurred costs can be used to decide on future projects. If a company is considering a new project, it can use incurred costs from similar projects to estimate the likely cost of the new project. This information can help the company decide whether or not to proceed with the project.
1. Direct costs
These are the costs directly related to the production of goods or services. Direct costs include raw materials, direct labour, and manufacturing overhead. Direct expenses incurred in conversion of raw materials within finished goods.
2. Indirect costs:
These costs are not directly related to the production of goods or services but are necessary for the operation of the business. Indirect costs are the expenses that are incurred for smooth functioning of business activities. Examples of indirect costs include rent, utilities, and administrative expenses.
3. Variable costs:
These are the costs that vary concerning the level of production. Examples of variable costs include raw materials and direct labour. It refers to expenditure in selling finished goods in the market.
4. Fixed costs:
These are the costs that remain constant regardless of the level of production. Examples of fixed costs include rent and utilities.
5. Capital costs
Cost incurred for purchase of capital assets is capital costs. These are the costs associated with the acquisition or expansion of fixed assets. Examples of capital costs include machinery, equipment, and buildings.
6. Operating costs
These are the costs associated with the day-to-day operation of the business. Examples of operating costs include administrative expenses and selling expenses.
7. Start-up costs
These are the costs incurred when starting a new business. Examples of start-up costs include research and development expenses, legal and accounting fees, and marketing expenses.
8. Expansion costs
These are the costs associated with expanding the business. Examples of expansion costs include advertising and promotion, new product development, and market research.
9. Exit costs
These are the costs associated with discontinuing the operation of the business. Examples of exit costs include lease termination fees, asset disposal, and employee severance payments.
10. Sunk costs
These costs have been incurred and cannot be recovered. Examples of sunk costs include research and development expenses, advertising expenses, and bad debts.
Sunk costs are important because they can represent a significant portion of the total cost of production. By understanding the sunk costs, businesses can better control their overall costs and improve their profitability.
Also Read: What is Accounting Cycle: Definition and Steps in the Accounting Cycle Process.
Advantages of Incurred costs
There are several advantages to be gained from incurring costs:
1. Discouraging Unwanted Behavior
Costs can be used as a means of discouraging unwanted behaviour. For example, if a company wants to discourage smoking among its employees, it could impose a cost on smoking, such as a surcharge on health insurance premiums for smokers.
2. Encouraging Desired Behavior
Costs can be used to encourage desired behaviour. For example, a company might discount health insurance premiums for employees who quit smoking.
3. Finance Desired Activities
Costs can be used to finance desired activities. For example, a company might use the money it saves from imposing a smoking surcharge to finance a wellness program for all employees.
4. Changes In Priorities
Costs can be used to signal a change in priorities. For example, a company that suddenly starts charging for parking might be signalling a new emphasis on environmental sustainability.
5. Creation Of Competitive Advantage
Costs can be used to create a competitive advantage. For example, a company that incurs costs to develop a more efficient production process could gain a competitive advantage over its rivals.
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Disadvantages of Incurred Costs
The five disadvantages of incurred costs are:
1. Difficult To Trace
They can be difficult to track and manage: Incurred costs can be difficult to track and manage because they often involve multiple invoices from different vendors. This can make it challenging to determine which costs are truly incurred and which are not.
2. Expenses for Large Project
They can be significant expenses as incurred costs can be significant, particularly if they are associated with a large project. This can impact a company's bottom line and make it difficult to meet financial goals.
3. Complexity For Financial Reporting
They can add complexity to financial reporting as incurred costs can add complexity. This is because these costs must be allocated to the appropriate accounting period. This can be a challenge for companies, especially with multiple projects underway.
4. Impact Cash Flow
Incurred costs can impact cash flow because they are often paid for upfront. This can put a strain on a company's working capital and make it difficult to meet other financial obligations.
5. Tax Consequences
Incurred costs can create tax consequences. This is because these costs are often tax-deductible. This can impact a company's tax liability and should be considered when making financial decisions.
Conclusion
In conclusion, it is important to keep track of incurred costs because they represent the actual costs of goods and services that have been purchased. This information is important for financial reporting and decision-making purposes. Incurred costs can be used to assess the performance of a company or project, negotiate better prices from suppliers, and make decisions about future projects.
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