Incurred is an accounting term that means that all transactions, regardless of their nature, must be recorded when they occur. It means that an accountant must recognize and record the transaction on the date when it occurred rather than on the date when the transaction was actually paid.
Incurred losses refer to the value of losses that an insurance company incurs during a given period. The losses represent the profits that the company will not earn during the year because the money is used to pay policyholders.
This may occur through payments of new and old claims, revaluation of claims already captured in the accounting records, as well as changes in loss reserves. The sources of incurred losses are explained in detail below:
1. Policyholder claims
A policyholder makes a claim for compensation when he/she suffers a loss on the insured loss or event. For example, if the policyholder purchased flood insurance coverage for his business and floods cause damage to the business, the insurance company will be required to compensate the policyholder.
Insurance companies maintain a reserve to settle claims on losses that they underwrite. The amount made as compensation for losses incurred is recognized as a loss because the money goes out of the company’s account to the policyholder’s account. Therefore, the payments made to claimants cease to be recognized as assets in the company’s balance sheet.
2. Re-evaluation of claims
Re-evaluation of claims involves reviewing all the claims currently being processed to determine if their value is higher or lower than the amount recorded initially. Before paying any claims, an insurance company must first investigate the claims to verify if the loss actually occurred and that it is not a fraudulent process.
Once the company is satisfied that the claim is genuine, it then determines the accuracy of the recorded value. If the newly determined value of a claim is actually higher than the recorded claim, the company will be forced to pay a higher amount than it had planned. The excess claim paid is a loss to the insurer since it exceeds the amount recorded in the books.
3. Change to loss reserves
The law requires insurance companies to maintain an adequate reserve from which it will make payments of old claims, as well as the new claims anticipated in the next period. The standard level of reserves varies from 8% to 12% of the annual revenues, depending on the state laws.
The loss reserves may also be based on a forecast of losses that the insurer anticipates during a given period, which means that the forecast may be correct, excessive, or fall short of the actual claims during a given period. If the actual losses exceed the reserve, the insurer will be required to get additional funds to top up the reserve. The change in the reserve amount will be a loss to the company because it was not anticipated.
An incurred expense is a cost that a business incurs when it purchases goods or services on credit. The purchase may be made either through a credit card or a billing arrangement with the seller of the goods. Most companies buy raw materials in bulk from manufacturers and wholesalers on credit, with an agreement to pay at a later date.
The transaction is recorded in accounts payable since it is a cost that the business needs to pay in the future. For example, if Company XYZ purchases goods worth $1,000 on credit, the company will have an incurred expense of $1,000.
Incurred Expense vs. Paid Expense
An incurred expense becomes a paid expense once the business has paid the cost it owed the supplier of the goods or services. Most of the time, incurred expenses are paid immediately after they are incurred, while at other times, they may take several years before they are paid.
For example, a painter may be paid for the service after it has been performed, and the incurred expense changes to a paid expense. Another example would be when a business enters into a lease agreement to rent office space for a period of two years. The business incurs the expense when it completes each of the agreed rent periods.
Thank you for reading CFI’s guide to Incurred. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
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