In accounting, a cost is incurred when a business has used up resources or become obligated to pay for them, whether or not any cash has changed hands. An electricity bill is incurred as the power is consumed, wages are incurred as employees work, and interest is incurred as time passes on a loan. Under the accrual basis of accounting, expenses are recorded in the period they are incurred, not the period in which they are paid.
"Incurred" is the cost-side partner of earned on the revenue side. Together they underpin the matching principle, which aims to report each period's revenues alongside the costs of earning them. An expense that has been incurred but not yet paid or recorded at the end of a period is an accrued expense.
Incurred costs in plain terms
If you eat at a restaurant and the bill has not yet arrived, you still owe for the meal. The cost was incurred the moment you ate, not when you finally pay. Businesses think about their costs the same way.
A shop that runs its heating all through December owes for that heating in December, even if the bill does not come until January. Counting the cost in December, when the heat was used, gives a truer picture of what December really cost to run. Waiting for the bill would push the cost into the wrong month.
Recording costs as they are incurred
When a supplier's invoice arrives promptly, the incurred cost is recorded when the invoice is entered, usually with a credit to accounts payable. When the period ends before an invoice arrives, the business records an adjusting entry to capture the cost.
Suppose a print shop used $1,800 of electricity in December, but the utility bills it in mid-January. On December 31 the shop debits Utilities Expense $1,800 and credits Accrued Liabilities $1,800. When the bill is paid in January, it debits Accrued Liabilities and credits Cash, so no expense falls into January. Similarly, if employees earn $6,000 in the last three days of December and are paid on January 3, the $6,000 is recorded as wages expense and accrued payroll in December.
Incurred versus paid
A cost can be incurred before, at the same time as, or after it is paid:
- Incurred before payment. Utilities, wages and interest are commonly incurred first and paid later, creating an accrued liability.
- Paid before incurred. Insurance premiums and rent paid in advance are recorded as prepaid expenses and become expenses only as the cover or rental period passes.
- Incurred and paid together. A cash purchase of supplies used immediately is incurred and paid at the same time.
A payment, or a commitment to pay, is an expenditure; recognizing the cost in the income statement is a separate question about when it was incurred and when it should be expensed.
Incurred costs that are not expensed immediately
Incurring a cost does not always mean expensing it at once. Costs incurred to buy or make inventory are inventoriable costs: they are held as an asset and expensed as cost of goods sold when the goods are sold. Costs incurred to acquire equipment are capitalized and expensed through depreciation. Only period costs, such as selling and administrative costs, are expensed in the period incurred.
Losses may also be incurred before the amount is certain. A probable loss from a lawsuit that can be reasonably estimated is recognized as a loss contingency when incurred, even if payment is years away. Similarly, under the current credit loss rules, lenders record expected losses rather than waiting for a loss to be incurred, a notable change from earlier "incurred loss" accounting.
Incurred for tax purposes
For US federal income tax, an accrual-method taxpayer generally deducts an expense in the year in which all events have occurred that fix the liability, its amount can be determined with reasonable accuracy, and economic performance has occurred, such as delivery of the goods or services. These rules, applied by the Internal Revenue Service, are stricter in some cases than financial reporting; for example, many estimated reserves accrued in the books cannot be deducted until paid. A cash-method taxpayer, by contrast, generally deducts expenses when paid, not when incurred. The difference between book and tax timing is one of the main sources of deferred taxes, and it means a business may record an incurred cost in its accounts in one year while claiming the deduction in another.