Cost recovery is a method of accounting where you only record income from a sale once all the costs associated with the transaction have been recovered. It’s useful in situations where you don’t know if you’ll receive payment on time, or if you’re unsure how much a project will eventually produce. This method of accounting also allows you to delay paying taxes until the full cost of any goods or services is recouped, saving you money in the long run.
The first step in setting up your cost recovery system is to determine how you will calculate rate-recovery charges. You can choose to use a single rate to cover both owning and operating costs, or you can select two separate rates: one designed to recover owning costs and another to recover operating costs. You may also decide to require sites to record and pay for only actual hours or days of usage, or you can choose to charge a fixed number of hours or days per month regardless of utilization (column B).
In determining your rate-recovery rates, it’s important to remember that these are meant to reflect the true cost of the activity. You must consider your direct costs as well as indirect or shared costs such as overhead, utilities and human resources. The more you can identify the true cost of an activity, the better you’ll be able to estimate your profit margin.
It’s important to note that while a cost-recovery method of revenue recognition is convenient, it’s not in compliance with generally accepted accounting principles. The reason is that you’re not recognizing profit until the cost of goods sold has been fully recovered, which is in violation of the concept of realizing revenue, which states that income should only be recognized when you’re sure that you’ll be paid in full for any sales you make.
As such, you should only use the cost recovery method in cases where it makes sense. It’s not the right choice for run-of-the-mill installment sales, where you can be fairly certain that you’ll receive all payments on time and in full. This method should be used sparingly, and only for activities that are unique to your business, such as events or recurring subscriptions. Otherwise, you should stick to a traditional cash basis of accounting.