Cost Recovery Method

The business environment is getting more and more challenging these days with many sellers in the market. The expectations of the buyers too have grown over the years and this has forced many companies whether big or small change their approach and introduce new accounting measures. The cost recovery method of accounting follows the conservatism convention.

Cost Recovery Convention of Accounting

The concept states that the business enterprise should not consider any income until it has fully recovered the cost on selling any product to its customers. This means that the gross profit of the firm would be more if it has managed to recover all its pending dues from the customers or clients. This method in accounting helps the firms to play safe and not make any illogical and too high judgments about their profitability and total sales. The companies following this technique of accounting are aware of the ground reality and hence they are bound to do well in the future. This method helps in discounting all those factors which are negative for any business.

This method is used considering the changing financial position of the customers and their ability to pay. Revenue may be quickly realized in the case of some cash rich or high budget clients. However, some clients may take more time for complete payments and unless all the money is recovered, it cannot be included in the profits made during a period. The example given in the next section will help to understand things clearly.

Example

These examples are quite easy to understand. What you require is just the knowledge of basic accounting concepts and a calculator to do the math yourself. Let us assume that you are running a furniture supplying company named A. You have many customers who are giving you orders for furniture items for many years. However, how are you going to recognize the receipt of revenue? Consider the information given below to know this.

Your sales revenue for furniture items: $16,000.
Total cost of sales: $8,000.
Gross profit: $8,000.
Initial amount received from the client: $2,000.

From the above case, it is clear that you have been paid $2,000 as the down payment for the supply of the furniture item by the client. However, the gross profit shown above is not recognized or considered unless you are able to recover the remaining $6,000 and thus the entire cost of sales.

This method is more related to the facts and present situation of the business and gives more importance to received cash or money than the amount which we will be getting eventually. Any business person would be able to know the exact valuation of his firm or the extent, profits and sales volumes of his business with the help of this method. Apart from this, the firm needs to implement the well-known strategies to reduce the expenses and increase profit margins. Fast and successful expansion policies can make sure consistent growth in sales. With this optimistic approach, business firms would be able to achieve their set targets and give better guidance and returns to their investors in the days to come.

With a hope that you will implement this method properly, I would like to sign off here. Good luck!