Cost Recovery Method

Definition

The cost recovery method is basically a method for recognizing revenue as per which the gross profit is not recognized till the time the entire merchandise cost has been successfully recovered. Thus, initially the payments that the customers make are treated in the form of cost recovery of the goods that are sold. Thereafter, the remaining amount collected is considered to be gross profit.

Overview

Under the cost recovery method no income is recognized on any sale till the time the cost of the product that has been sold is completely recovered in the form cash. This particular method is utilized at a time when collection of the selling price is highly uncertain and reaches an extent where it becomes difficult to justify the installment related method. This method is considered to be the very conservative when compared to other methods of recognizing revenue. As per the cost recovery method, both cost and revenue from selling an item is recognized at the selling point itself. However, the gross profit that comes with it is deferred till the time the entire sales cost has been fully recovered. Each of the installments should also be segregated between interest and principal. While under the installment related method a part of principal is used for recovering the sales cost and the remaining is recognized in the form of gross profit, under the cost recovery method the entire principal is utilized to recover the cost of the item sold. Once the entire costs of sales are recovered, any remaining cash receipt is recognized as gross profit.

This method does help the owner of business in making some savings as far as paying of certain taxes is concerned but the method simply defers the tax amount that is due till the sales costs are fully received. Even though the cost and sales get recognized, if a particular sales account is essentially a receivable, the gross profit from that particular sales is not taken into consideration till the entire receipts have been received. Thus, the cost of the item sold should be recouped ahead of recording of transaction as gross profit eventually on the income related statement.