What is a Committed Cost?

A committed cost is an investment that a business entity has already made and cannot recover by any means, as well as obligations already made that the business cannot get out of. You should be aware of which costs are committed costs when reviewing company expenditures for possible cutbacks or asset sales.

There is usually a long-term legal agreement associated with a committed cost, such as a 10-year lease commitment. Or, a power plant has entered into a 20-year commitment to buy diesel fuel for its generators. It can be exceedingly difficult to break out of these contractual arrangements, at least without paying a hefty penalty.

Examples of Committed Costs

Here are several examples of committed costs, which demonstrate how these costs can appear in several places within a business:

Asset purchase. A company buys a machine for $40,000 and also issues a purchase order to pay for a maintenance contract for $2,000 in each of the next three years. All $46,000 is a committed cost, because the company has already bought the machine and has a legal obligation to pay for the maintenance.
Employment contract. A company enters into a five-year contract with a well-known engineering manager, who agrees to a $200,000 salary through this period in exchange for working on new product designs for the company. The contract is quite difficult to break, so it can be considered a committed cost.
Leasing arrangement. A company enters into a multi-year property lease agreement. This is a committed cost for the full term of the lease, since it is extremely difficult to terminate a lease agreement.
Loan agreement. A company enters into a five-year loan agreement with a local lender, under which it is obligated to make monthly $10,000 payments to the lender. Since the company has an obligation to repay the loan, and the loan amounts are fixed, this can be considered a committed cost.

In the preceding examples, the purchase of assets, long-term hiring of employees, and borrowing arrangements are all committed costs. You should recognize these arrangements when developing the annual budget, to ensure that they are included in the obligations of the business.