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Cost Recovery Method

See Also:
Accounting Principles
Point of Sale Method (POS)
Installment Method
Percentage of Completion Method
Completed Contract Method

Cost Recovery Method Definition

Also known as the collection method, cost recovery method accounting is a way of recognizing revenue under the revenue principle. The method is commonly used in conjunction with companies who do not believe that they will receive a future payment of cash or it is highly unlikely that they will.

Cost Recovery Method Explanation

When using collection method accounting a company will commonly reduce the accounts receivable account through the allowance for doubtful accounts. It will then only recognize the revenue upon the receipt of cash up to the inventory or service amount. In other words, if a company only receives cash of $20,000 for an inventory item costing $50,000, then the company will defer this recognition of revenue until the other $30,000 has been received in cash. Because the company has reduced the amount of revenue that it would normally recognize under the accounts receivable account, cost recovery accounting is the most conservative form of revenue recognition.

Cost Recovery Method Example

The following is a cost recovery method example. It shows when a company should adopt recovery cost to paint a better picture of what sort of condition the company is in:

For example, Steel Company is a company that supplies steel to customers who use that steel to make all sorts of items. These items range from beams to construct buildings to ship building companies. One of Steel’s long time customers Ship Builders R’ Us has recently been going through some trouble. It is becoming more and more likely that the company will need to file for bankruptcy. Because of this Steel Company has decided to use the cost recovery method of revenue recognition. The inventory that has been sold to Ship Builders is in total around $500,000 with a cost to Steel Company of $400,000.

The company is expected to pay Steel in installments of $100,000 in the next three years (2008, 2009 and 2010). They have already paid Steel $200,000 upon the sale in 2007. Thus the company needs to take the installments out of accounts receivable to reduce the amount of revenue. Then the company will not recognize revenue until the end of 2009 when the total cash paid is $400,000 or the cost to Steel Co. The last payment in 2010 is like any normal sale assuming that it occurs because the full cost was recovered in 2009.

Note: The above example does not account for interest.

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Cost Recovery

See Also:
Disaster Planning for IT
Modified Accelerated Cost Recovery System (MACRS)
Cost Recovery Method
Payment Terms
Business Drivers

Cost Recovery Definition

Cost recovery, defined as the method to recovering an expenditure which a business takes on, is both a specific and general term. Generally, cost recovery is simply recovering the costs of any given expense. This can be the initial startup costs of the business by meeting and exceeding the break even point, the cost of an investment through evaluating the return on investment, or even the cost of capital taken to finance the firm. Specifically, the cost recovery method of accounting gains back the cost of an investment by relying on the certified depreciation schedule of the item.

Cost Recovery Explanation

Cost recovery, explained simply as regaining the value of an expense, is an important concept for accountants and company founders alike. Each of these parties are interested in cost recovery solutions.

Cost Recovery Methods

For entrepreneurs, cost recovery methods are an important concept. Founders of a company are interested in evaluating and optimizing the benefit of their effort, especially their capital. Without moving too extensively into the subject, start by evaluating the return on investment of anything: the business as a whole, a piece of equipment, even a hired employee. Even more, an entrepreneur is truly interested in return on equity; explained simply as the return on their investment interest. This differs from return on investment which measures the return on the entire investment.

Cost Recovery Accounting

For accountants, cost recovery accounting means gaining back the value of an expense. Accountants do this mainly through depreciation; using depreciation tax law to minimize the taxes paid, thus increasing final profit for the firm. These accountants study tax law to find the rules which result in the greatest benefit for their employer. Ultimately, a tax law expert will be the best at achieving this goal.

Cost Recovery Example

Dee is a tax accountant for a fortune 500 company. Unlike where many accountants deal with the everyday expenses, projects, and various operations of of the business, she does not. Dee has one focus: optimizing cost recovery deductions by minimizing the tax expense of her company. She is a tax accountant and loves to save her firm money.

Now, Dee is working on the cost recovery model of depreciation. She understands the laws well and follows a strict system to assure that she is processing company records properly. Dee is a creature of habit.

At a networking event, Dee heard about a tax law change that just happened this month. Even though she has done a great job so far, she wants to use this to make even more profit for her employer. After the event, she rushes back to work to see what value she can create.

Example Conclusion

Dee finds that she can save the company $1,000,000. If she had not heard of the recent change, this large sum of money would have been lost. These kind of thing happens all the time. Tax law generally stays the same but often a small change occurs to the statute. In this case, the small change caused big results for Dee and the business she works at.

After saving the company, Dee receives a big promotion and raise. In her field, she is an expert. Though a creature of habit, Dee can change when she needs to. She has shown it through this achievement. As she moves forward, Dee will continue to keep track of tax law to make sure she can do the best job possible.

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cost recovery

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Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

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