What Is Incurred in Accounting and Finance?

In accounting and finance, the term “incurred” describes when a cost or obligation arises, regardless of when the actual payment is made. This concept is fundamental for understanding how businesses track their financial performance and signifies the point at which a company takes on a financial responsibility. It allows for a clearer picture of economic events as they happen, rather than solely when cash changes hands.

Accrual Accounting Basics

The concept of “incurred” is a cornerstone of accrual basis accounting, the standard method used by most businesses. Accrual accounting dictates that revenues and expenses are recorded when they are earned or incurred, respectively, not when cash is received or paid. This differs significantly from the cash basis, which only recognizes transactions when money changes hands.

A central tenet of accrual accounting is the matching principle. This principle requires that expenses be recognized in the same accounting period as the revenues they helped generate. By matching expenses to the period of their related revenue, businesses can present a more accurate representation of their profitability over time. Recording expenses as they are incurred ensures this alignment.

Incurred Versus Paid

The distinction between an expense being “incurred” and being “paid” is important. An expense is incurred when the obligation to pay for a good or service arises, meaning the company has received the benefit or consumed the resource. This occurs even if the cash payment has not yet been processed. For instance, if a business uses electricity throughout December, the utility expense is incurred in December, even if the bill is not received and paid until January.

Conversely, an expense is “paid” only when the actual cash outflow occurs from the company’s cash reserves. The act of paying settles the previously incurred obligation. Therefore, an expense can be incurred in one accounting period and paid in a subsequent one. This highlights the difference between the economic event and the cash transaction.

Typical Incurred Expenses

Common business costs are recognized as incurred before the actual cash payment takes place. Rent expense, for example, is incurred as the period of occupancy passes. Similarly, utility expenses for services like electricity or water are incurred as they are consumed throughout the billing cycle.

Salaries and wages are incurred as employees perform their work, creating an obligation for the business to pay them. Interest expense is another example, as it accrues over time based on the amount of borrowed money. Supplies are considered an expense when they are consumed or used in operations.

Impact on Financial Reporting

Incurred expenses significantly impact a company’s financial statements. On the income statement, incurred expenses are deducted from revenues to arrive at net income for a specific period. This enables stakeholders to see the true profitability of the business by matching all costs to the period in which the associated revenues were generated.

On the balance sheet, expenses that have been incurred but not yet paid result in the creation of liabilities. These liabilities commonly appear as “Accounts Payable” for amounts owed to suppliers for goods or services received, or as “Accrued Expenses” for obligations like unpaid wages or utilities. These liabilities represent future obligations.