Cost recovery is a method of revenue recognition in which a company recognizes income from a sale transaction only after the cost element of that sale has been collected from the customer in cash. It is one of the key processes involved in accrual accounting, which is the accounting method that identifies when a business has earned its profit.
In addition to avoiding over-estimations of profitability, the cost recovery method also helps to protect companies from the risk of uncollectible accounts receivable. This is because the amount of any outstanding costs will be subtracted from the total amount of the received payment, thereby leaving only the amount that represents actual profits for the company to collect.
For example, let’s say a web developer is working on a project for a client that is paying in installments over an extended period of time. The web developer may incur significant additional costs to complete the project, such as hiring a freelance copywriter and buying new software. In this case, the web developer would record all of these cost as a project expense, and then recognize and record the income earned from the project only when the income exceeds the project costs.
A more common instance of using the cost recovery method involves a regular installment sale to an existing customer. For example, a company could sell equipment on credit to the customer in exchange for a series of yearly payments over a period of five years. The company would recognize the entire sales price as revenue in the first year, but then only recognize the remaining amounts received as profit over the next four years.
Whether your department is providing services to outside customers or is in the process of charging back auxiliary expenses, it is important to understand how these transactions are recorded and reported. Departments should only charge back to the appropriate funds and reference the corresponding auxiliary project codes. All cost recovery revenue and expenses should be reflected in the Accounts Receivable and Billing module. Exceptions to this rule can be requested through Accounting Services, but they should not be approved for more than $100,000 per fiscal year.