Cost Recovery Method

 Cost recovery method is a method used when there is an extremely high probability of uncollectible payments. There is no profit is recognized until cash collections exceed the seller’s cost of the merchandise sold. Cost recovery method is a revenue recognition method under which no gross profit is recognized until all the cost of the merchandise has been recovered. Under this method the first payments received from customers are treated as a recovery of the cost of goods sold. Once the cost is recovered then the remaining collections are recognized as gross profit. This method is used because of the uncertainty of collections, and also is not generally accepted.

The cost recovery method of accounting is a method that does save the business owner on paying some tax, but just defers the tax due until cost of sales are actually received. The cost recovery method is a method which does not recognize any income on a sale until the cost of the item sold has been fully recovered through tax receipts. Although the sales and cost of sales are recognized, if a sales account is a receivable, the gross profit of that sale is not counted until all the receipts are received. Therefore the cost of the product sold must be recouped before the transaction is recorded as a gross profit on the income statement.

Let us consider that a company sells a machine worth $10,000 for $15,000, it can start recording profit only when the buyer pays more than $10,000. This means that for each dollar collected greater than $10,000 goes towards your anticipated gross profit of $5,000. The cost recovery method directly affects the income statement that is an essential tool when preparing a business tax return. Under this method of cost recover the profits are not placed on the income statement until the entire cost of the item sold is recovered.

Questions

• What is a cost recovery method?
• How is the cost recovery method applicable in a company? Explain with an example.