COST INCURRED: FEATURES AND EXAMPLES - DUDAS - 2025

The cost incurred is, at an accounting level, an expense that was incurred during the commercial activities of the business, and that is recorded as a liability in the company's balance sheet until it is downloaded or paid. Therefore, it is a cost for which a company has been made responsible.

It is a concept of accrual accounting, in which an entity records a cost at the time a resource or asset is consumed and is recorded as an expense.

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In other words, it occurs when a company uses an asset or becomes liable for the use of an asset in the manufacture of a product. These assets are no longer a resource and an expense, even if you have not yet received an invoice from a vendor as documentation of the cost.

Costs incurred may include direct production costs and indirect costs as overheads. Allowing too many unpaid costs to accumulate can be dangerous because it can make it harder to meet all the payments.

characteristics

The accrual accounting concept requires companies to record costs when they are incurred, rather than when they are paid. In this way, the company's expenses are recorded in the same period as the income related to those expenses.

This concept is called the principle of agreement. Generally accepted accounting principles require that the principle of consistency be used in all financial statements, to present a consistent picture of the company's activities.

For example, a manufacturing operation uses a significant amount of electricity during the month of January, after which the electric company bills $ 25,000 for electricity consumption. The company receives the invoice in February and then pays it in March.

However, the company incurs the cost of electricity in January. Therefore, you must book this expense in January.

If the company were using a cash accounting basis, the incurred cost concept would not be applied, because the cost would not be recorded until the invoice was paid in March. This would generate a delay of two months in the recognition of the cost.

Cost owed

An incurred cost is the cost that the business owes when receiving goods or services. It generally refers to the cost that has not yet been paid.

For example, if a business receives $ 10,000 worth of goods from a supplier who expects payment for the next month, the business has incurred an expense of $ 10,000.

Product cost of a retailer

It is the cost paid to a supplier, plus any other costs that are necessary for the product to be available and ready for sale.

For example, if a retailer pays their supplier $ 40 and then pays $ 10 to have it delivered to their warehouse, the retailer's product cost is $ 50.

Cost of a manufacturer's product

This cost includes the cost of raw materials, plus the costs of converting the raw materials into the product. It is classified into three groups:

- Raw materials used in the product.

- Direct labor used to make the product.

- General manufacturing costs incurred to make the product.

Since general manufacturing costs are indirect costs, they must be allocated to manufactured products in order to comply with accounting standards.

Inventory cost and cost of merchandise sold

Product costs are also known as inventory costs, because they are used to value products in inventory.

When the goods are sold, the costs of the product are removed from the inventory, appearing in the income statement as cost of merchandise sold.

Expenses not included in the cost of the product

Selling, general, and administrative expenses of a business are not product costs. Rather, they are reported as expenses in the income statement for the accounting period in which they occurred.

Examples

-Example 1

To illustrate, let's say a new retail store opens on September 1, and the utility company will read your electric meter on the last day of each month. During September, the retailer incurred the cost of the electricity it used during September.

Under accrual accounting, the retailer must report a liability on September 30 for the amount owed to the utility company at that time.

In its September income statement, the retailer must report the cost of electricity, which is equal to the cost of electricity used during September.

The fact that the utility company does not bill the retailer until October and allows the retailer not to make the payment until November is not relevant in accrual accounting.

The principle of agreement requires that the costs incurred in September correspond to the income of the same month.

-Example 2

Sarah is the accountant for Sedlex Company and has to determine what costs were already incurred in July, based on the following information:

- Machinery, useful life: 1 year, cost $ 300,000.

- Rent: prepaid at the beginning of the year the annual total of $ 12,000.

- The company receives its telephone bill on the 15th of each month and it has always been $ 75.

- Supply inventory, originally $ 30, at the end of the month is only half of its original amount.

As can be seen, these costs are incurred when they are consumed or the company is responsible for them. Thus, they are recorded as expenses in this period.

The costs that were incurred as an expense during the July period are detailed below.

Depreciation: $ 25,000

All the months that they have benefited from the use of the machinery must also share in its cost. The depreciation expense in July is $ 25,000, which is the total cost divided by its useful life in months ($ 300,000 / 12).

Rent: $ 1,000

The prepaid rent at the beginning of the year becomes a cost incurred as the company uses the benefits on it. That's the total for the year divided by the number of months ($ 12,000 / 12).

Phone: $ 75

Even if the company has not yet received the statement, it should be responsible for the communication costs, since it has used this resource during the month.

Supplies: $ 15

The cost incurred for supplies only includes the used portion of the supplies. The other half is still an asset at the end of the month.

References

1. Harold Averkamp (2019). What is cost incurred? Accounting Coach. Taken from: accountingcoach.com.
2. Harold Averkamp (2019). What is a product cost? Accounting Coach. Taken from: accountingcoach.com.
3. My Accounting Course (2019). What is an Incurred Cost? Taken from: myaccountingcourse.com.
4. Steven Bragg (2018). Cost incurred. Accounting Tools. Taken from: accountingtools.com.
5. Gregory Hamel (2019). Difference Between Incurred Expenses & Paid Expenses. Small Business - Chron. Taken from: smallbusiness.chron.com.