What Are Unrecoverable Expenses in a Business?

by Forest Time, Demand Media

Unrecoverable expenses, sometimes referred to as sunk costs, are monies spent on a commodity or service that cannot be refunded or resold. Because the fear of losing money due to unrecoverable expenses sometimes prevents entrepreneurs from starting a small business, they are considered to be a barrier to entry into the market. They may also represent a barrier to exit for companies that do not wish to admit defeat in a venture in which they already are invested heavily. In such cases, emotional attachment to unrecoverable costs may have the unfortunate effect of causing entrepreneurs to make bad investment decisions, a phenomenon known as the sunk cost fallacy.

Plant, Equipment and Labor

If you buy the building where your company operates, it is not necessarily an unrecoverable expense because you may be able to sell it if your business goes under. If you rent the building, that money represents an unrecoverable cost unless you are able to recover a portion of the rent by subletting. All utility costs incurred in the course of business are also unrecoverable.
Similarly, money you've invested in equipment commonly used by other businesses may be a recoverable expense. However, specialized equipment that is not in demand and would be difficult to sell may represent an unrecoverable expense. All money expended on labor, both direct and indirect, is unrecoverable. You cannot withhold payment to workers for hours worked just because your business fails.

Advertising and R&D

Money spent on market research and advertising is usually unrecoverable. A business cannot recoup money spent on advertising just because an advertising campaign turns out to be unprofitable. Money spent on advertising space may be recoverable if a company manages to resell it or obtain a refund before the space is used, but once an advertisement airs, the money spent developing and airing it is a sunk cost that cannot be recovered.
Money spent on researching and developing new product lines is another example of an unrecoverable expense. Regardless of whether the new product is a wild success or an abject failure, a business cannot simply recoup the cost of R&D.

Licensing and Insurance

Overhead costs of operating a business, such as obtaining appropriate licenses and insurance, are unrecoverable. Licenses and insurance are non-transferable and cannot be sold to other companies. A business can cancel an insurance policy and let a license expire if it fails, but it cannot recover the sunk costs already spent on years of licensing and insurance.

The Sunk Cost Fallacy

The sunk cost fallacy applies when a business considers unrecoverable expenses as a factor in future business decisions. This type of thinking is fallacious because unrecoverable expenses are by definition gone regardless of future decisions. For example, assume you have just spent money to become licensed to drive a big rig but then find you can make twice as much money delivering pizza. If you decide to drive a truck simply because you have already invested money in the idea, you will end up losing money. This is why entrepreneurs should not consider already unrecoverable expenses when making investments.

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