Incurred and paid expenses can be tricky to differentiate, depending on how you record them in your personal budget. Whether you put a purchase on a credit card or use cash, you’ve incurred the expense and have paid for it, even if you still owe the credit card company for the purchase. Sound confusing? As long as you define what a paid expense is consistently in your personal budget, you’ll reduce the chances that you end up with a cash shortfall or an excess you could have applied to a 401(k) match or other investment opportunity.
Incurred expenses are those you have agreed to and are obligated to pay. They might include a purchase or loan. When recording incurred expenses in a budget, include those you have already paid and those for which you used credit. For example, if you bought a new couch in January and paid cash, you incurred that expense when you ordered the couch. If you purchased a new computer in February and put it on a credit card, you incurred the expense in February, even if you won't pay the credit card company until later. If you bought a car with a loan, you have incurred the expense of the loan, including the down payment, monthly payments, interest and turn-in fees. Part of this incurred expense -- the down payment -- has been paid, while the rest is still due. Some business people define incurred expense as any money you owe but have not yet paid. It’s up to you how you want to define an incurred expense, but you must be consistent as you update your budget.
What constitutes a paid expense is also tricky to define. If you buy groceries using plastic, the store is paid when the credit card charge goes through. You don’t owe the grocery store any money and won’t receive a bill from them because you paid them with your card. Since you have not paid the credit card company for this purchase, however, it’s an incurred, but not paid, expense in your budget.
Recording Incurred Expenses
When you create a personal budget, don’t fall into the trap many inexperienced budgeters do -- “double paying” an expense on paper. Say you buy $300 worth of groceries in March. Rookie budgeters will record that as a $300 expense in March because that was when it was incurred, then also record the eventual $300 paid toward card payment as an expense. If you don’t pay your balance every month, but enter your monthly credit card payment into your budget as a paid expense, you will eventually “pay” for your groceries twice. Either record the groceries as an expense in the month they are due and do not record the $300 credit card payment later, or record only the credit card payment when it is paid.
Effects of Incurred Expenses
When you incur debt, this affects your ability to get future loans or credit, the interest rate you’ll receive and your credit score. The more credit you use, the lower your score will go, unless you have charged only a small amount. If you pay off an incurred expense, such as a car or student loan, you might actually hurt your credit score. These types of loans, called installment loans, show creditors that you are able to make regular payments. If you have no installment loans, your score will decrease, so think twice about paying off an installment loan early if you can’t afford to lower your credit score.
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