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.

Characteristics of a Committed Cost

The key characteristics of a committed cost are as follows:

Long-term nature. Committed costs are typically tied to long-term obligations or investments, such as the purchase of equipment, lease agreements, or salary contracts for key personnel. They cannot be easily altered in the short term.
Fixed in nature. Committed costs do not vary with the level of production or sales activity in the short term, making them a subset of fixed costs.
Difficult to eliminate. Even during periods of reduced activity or financial downturns, committed costs remain, as they are tied to obligations that are not easily renegotiable or cancelable.
Significant impact on profits. Since committed costs are fixed, they must be covered regardless of revenue levels, which can impact profitability during low-revenue periods.
Predictable. Committed costs are predictable and accounted for in budgets, as they arise from planned commitments.

In summary, committed costs represent long-term financial obligations and are fixed in nature, making them critical for operational continuity but challenging to adjust in the short term.

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.