Cost Recovery Method

Cost Recovery Method is a method of accounting used to recognize revenue for a project or product based on the costs incurred to complete the project or manufacture the product. Under this method, revenue is recognized only after all costs associated with the project or product have been recovered.

The cost recovery method is commonly used in industries where costs can be accurately tracked and are a significant factor in determining the price of the product or service. This method is often used by companies that provide custom products or services, such as engineering or construction firms.

One advantage of the cost recovery method is that it ensures that the company is able to recover all of its costs associated with a project or product before recognizing any revenue. This can help to mitigate the risk of revenue recognition problems, such as those that can arise from incomplete or inaccurate cost estimates.

However, one disadvantage of the cost recovery method is that it can result in delayed recognition of revenue, which can affect cash flow and profitability. In addition, the cost recovery method can be more complex and time-consuming to implement than other revenue recognition methods.

To illustrate some key concepts of the cost recovery method, consider the following example:

Example: An engineering firm is hired to design and build a custom manufacturing facility for a client. The cost of materials, labor, and overhead for the project is estimated to be $10 million. Under the cost recovery method, the firm will recognize revenue only after it has recovered all of its costs associated with the project.

If the firm incurs additional costs during the course of the project, such as due to unforeseen delays or changes in project scope, the amount of revenue that can be recognized will be reduced until those additional costs are recovered.

In this case, the cost recovery method ensures that the engineering firm is able to recover all of its costs associated with the project before recognizing any revenue. However, if the project takes longer than anticipated, the delay in revenue recognition may affect the firm's cash flow and profitability.

In conclusion, the cost recovery method is a method of accounting used to recognize revenue for a project or product based on the costs incurred to complete the project or manufacture the product. While the cost recovery method can ensure that all costs associated with a project or product are recovered before recognizing any revenue, it can also result in delayed recognition of revenue and be more complex and time-consuming to implement than other revenue recognition methods.

See Also

• Revenue Recognition - The principle governing how revenue is recorded and disclosed; cost recovery is a specific method of revenue recognition.
• Installment Sales Method - Another revenue recognition method for accounting, similar to cost recovery but with key differences.
• Accrual Accounting - An accounting method where revenue and expenses are recorded when they are earned or incurred, contrasted with the cash basis which is often associated with the cost recovery method.
• Cash Flow - The inflow and outflow of cash in a business, directly related to revenue recognition methods like cost recovery.
• Income Statement - One of the core financial statements in accounting, where the effects of the cost recovery method would be reflected.
• Generally Accepted Accounting Principles (GAAP) - The accepted set of accounting procedures, principles, and standards; provides guidelines on methods like cost recovery.
• Accounts Receivable - Money owed to a company by its customers, directly affected by the company's choice of revenue recognition method such as cost recovery.