Cost recovery is a concept in accounting that relates to recouping costs related to goods or services sold. In essence, it means that a business will not record income until cash payments have recovered all the associated costs, or at least enough to cover those costs. It is one of the more conservative methods for recognizing revenue. This is also known as the cost-of-goods-sold method.
The Integrated CSU Administrative Manual on Cost Allocation/Reimbursement states that “the university must recover costs incurred by its programs, facilities, and services, whether provided to internal or external customers.” As such, any fees charged to outside organizations and to sororities/fraternities are considered part of the cost recovery process. Likewise, any other revenue collected from non-appropriated sources, such as donation and savings, is included in this category as well.
To illustrate the concept, we will look at an example. The fictional company Shiny Clothes Ltd, which sells high-end clothes to customers, recently purchased some inventory that cost $100,000. This inventory was then sold to several different buyers for a total sales price of $130,000 – implying a profit of $30,000. However, the business is not actually recording any profit until the cash received from the sale covers all the associated expenses and more.
This is because the business is using the cost-of-goods-sold accounting method, and this method requires that a profit be recorded only when cash payments have recovered all the associated costs of a good or service. The remaining amount is then considered the profit. This is the most cautious method for recognizing revenue and helps to avoid over-estimating profits.
In addition to implementing the cost-of-goods-sold approach, the business should use depreciation or amortization to recover the cost of large capital investments. The IRS provides various methods for calculating depreciation, including straight line and accelerated. Using either of these methodologies allows the business to recover its investment over time and reduces taxes in the long run.
As you can see, the cost-of-goods-sold and profit recognition processes are critical components of any business. Inaccurate or delayed recognition of revenue can lead to financial issues, so it is important that these accounting practices be followed.
Note: The FreshBooks support team is not certified income tax or accounting professionals, and cannot provide advice in these areas beyond supporting questions about our software. For more information about these topics, we recommend speaking with a local accountant in your area.
EPA uses the cost recovery method to offset costs related to cleanup activities, such as environmental monitoring and investigation, negotiating with PRPs, and providing technical assistance to communities involved in environmental contamination issues. EPA’s accounting system tracks the amount owed by PRPs and, when needed, if the amount is not received or the negotiated settlement is inadequate, a cost recovery action may be filed with the Department of Justice. During the course of a cost recovery action, EPA will adjust the amount owned to account for additional cleanup work conducted by EPA and legal costs incurred by EPA and the PRPs.