January 29, 2022

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Meaning of Committed Cost in Costing key Explanations

Meaning of Committed Costs in Costing and key Explanations
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Committed costs are a type of cost in cost accounting. The word committed means such costs are budgeted on a particular project and cannot be reversed or reduced. In this article, let’s delve into it.

Meaning of Committed Cost

According to the cost accounting textbook by ATSWA, committed Costs are “costs that are expected to be incurred and for which resources have been earmarked or allocated as a result of a contractual agreement or an earlier decision to have the cost incurred.”

Committed cost means any cost that has been budgeted or predetermined to be used for a particular project or investment on which any changes may affect the business operation.

Key Explanations of Committed Costs

Committed costs must be earmarked by the entity’s owners or board of directors. Once they have decided to make such expenses or expenditures it cannot be reversed. For example, a lease agreement cannot be changed immediately. The lease term must be followed till the end of the lease period. If the business must end the lease agreement, it must have planned an alternate way to deal with it. Why?
Breaching the contract will affect the business’s daily operations.

Committed costs are included in the entity’s budget. Therefore, they are predetermined costs. The entity decides the amount it will spend on it yearly, including the maintenance costs involved. If a company pays for the rent of a building, it will also set aside money for maintaining the building.

Committed costs are also sunk costs. This is because the business has already agreed to pay for such a cost and this cannot be reversed. Therefore, sunk or past costs. It will require the owners or board of directors’ decision to change the costs. And in doing so, it must affect the business operation to some extent.

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For example, if the business decides to build its own office instead of using a rented one. After building the office, it will take at least two days to move to the new office. These days business operations will be affected. The company will lose sales on those days. Unless most of its businesses are done outside the office.

Examples of Committed cost

The following are some examples of Committed costs

  • Rent of office building
  • Lease of office plants and machinery
  • Salaries paid to staff
  • Pension contribution by employer
  • Depreciation of property, plants, and equipment
  • Insurance premium
  • Audit fees

Conclusion

Committed costs occur as a result of Management’s decision to incur the expenses or expenditure on a project or investment that the reversal will affect business operation. Examples of this cost are rent of office buildings and staff salaries.

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