Accounting Recovery: Definition & Cost Recovery Methods

Accounting Recovery: Definition & Cost Recovery Methods
Accounting Recovery: Definition & Cost Recovery Methods

Accounting recovery method is a way of recognizing and classifying income in accounting. 

When using the accounting recovery method, the company does not record revenue related to the sale of its services until the money received from the customer exceeds the cost of the services provided.  You may also hear a cost recovery method called the collection method.

What Is Accounting Recovery?

Accounting recovery is a general accounting term used to describe different types of accounting.  When an accountant needs to adjust an account because a bad debt has been discharged, that debt is considered collected and requires a new entry. 

Similarly, companies often make new entries for various expense reimbursements to show how expenses have changed over time.  Reimbursement may also refer to a broader type of practice involving cost-to-cost comparisons for accurate record-keeping.

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How Does It Work?

For entrepreneurs, cost recovery methods are an important concept.  Company founders are interested in evaluating and optimizing the return on their efforts, especially their capital. 

Without getting too deep into the subject, start by evaluating the return on investment of anything: the business as a whole, the equipment, even the hired employee. 

Even more, the entrepreneur is really interested in the return on capital; explained simply by the return of their investment percentage.  This is different from ROI, which measures the return on all investments.

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What Does Accounting Recovery Mean?

For accountants, cost recovery accounting means recovering the cost of costs.  Accountants do this mainly through depreciation; using the depreciation tax law to minimize taxes paid, thus increasing the firm’s bottom line. 

These accountants study the tax laws to find the rules that will most benefit their employers.  Ultimately, a tax law professional is best placed to accomplish this goal.

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Why Is Accounting Recovery Important?

The cost recovery method can provide an accurate picture of the financial health of your business at any point in time because it does not involve forecasting future revenues.  Because of this, the cost recovery method is considered the most conservative form of revenue recognition in accounting.

If you’re not sure you’ll ever receive the full revenue you’ve billed a client for, or if you don’t know you’ll receive all payments within a calendar year, it’s a good idea to use the accounting recovery method so you don’t overestimate the revenue you. 

You will probably get a any case of income uncertainty, the cost recovery method is recommended.

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Accounting Recovery Example

Mazalin Designs Ltd, a retail store that recently purchased $100,000 worth of inventory.  A retail store sells its product to several customers for a total sales price of $130,000, for a profit of $30,000. 

Sales were made on credit, and Mazalin Designs Ltd does not know the percentage of reimbursement of its sales to customers.  The company decides to use the cost recovery method to recognize revenue.

A retail store had sales of $100,000 in period 0 and received sales cash flows of $50,000, $60,000, and $20,000 in the next three periods, respectively.

Remember that expenses must be covered before any profit is recognized.  In the above scenario, Mazalin Designs Ltd will begin to recognize income in period 2 when the cash inflows exceed the cost of sales. 

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Benefits Of Accounting Recovery

  • The Company uses the cost recovery approach to recognize revenue when there is a reasonable uncertainty as to whether money will be collected from customers for sales made on credit because this method is by far the most conservative of all the revenue recognition methods available.
  • If the cost recovery method is used, there is a delay in the payment of the tax, as the tax is payable only after the company recovers the full cost of the product.  So, with this method, the business owner can save quite a bit.

Disadvantages

  • Using the cost recovery method, even though the company recognizes cost and sales, gross profit will not be recognized in relation to them, even if some sale is essentially a receivable of the company, and gross profit will be recognized only if all receipts are received.
  • In this method, the profit of the company is called the period when the payment for that profit is received.  So, even if the sale relates to one period, the company will not be able to show it as revenue for that period.

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What Is Bad Debt Recovery Accounting?

Bad debt collection or bad debt recovery is the money your business receives after being written off as bad.  In a bad debt collection process, you can collect some or all of what you owe. 

After collecting a bad debt, record the income, update your books, and report the collection to the IRS (if applicable).

Many bad debts are difficult to collect and are often written off.  In most cases, a company has taken many steps before being declared bad debt, including in-house and third-party debt collection or even a lawsuit.  Debt collection efforts can still be pursued after the debt is discharged.

Payment can still be made after the debt is discharged, making it a bad debt collection.  The payment may come as a partial payment from the receiver or because the debtor has decided to pay off the debt for a lower amount.

Bad debt can also be recovered by selling a portion of the collateral.  For example, the lender may repossess the car and sell it to pay off the outstanding loan. 

The bank can also receive equity in exchange for writing off the loan, which can later lead to repayment of the loan and possibly additional profits.

Conclusion

Accounting recovery is a way of recognizing revenue.  It is used in cases where the return is not guaranteed.  Generally, when a company receives payment in instalments, it uses the instalment method to recognize revenue.  Revenue and cost of goods sold are recognized at the time of sale, but gross profit is deferred to be recognized when cash is received.

Upon receipt of each instalment of any percentage of total sales, that percentage of deferred gross profit is recognized.  This ensures that net income remains close to operating cash flow.

If repayment of each instalment is less certain, the cost recovery method defers recognition of gross profit until the company recovers the cost of goods sold.  Therefore, gross profit will not affect net income (or before taxes owed). This will be until the company recovers the cash it spent on its expenses.

Accounting Recovery FAQs

Is Accounting Recovery The Same As Depreciation?

Depreciation and its cousins, depletion and amortization, are different forms of accounting recovery deductions from the income statement. When a business buys an asset above a certain price (determined by the business), generally accepted accounting principles state that the full amount of the purchase cannot be deducted from the income statement in the first year.

How Does Bad Debt Recovery Work?

Sometimes bad debts that the accountant did not expect to be paid are actually paid at the last minute before the debts are permanently written off as losses.  In this case, bad debt collection is necessary.  The accountant deducts the amount from the bad debt allowance account and returns it to accounts receivable, then credits accounts receivable and debits cash because the money is finally received.

How Does Expense Recovery Work?

In other cases, expenses may be reimbursed.  A good example of this is a discount.  A company pays for a specific asset, such as a computer program, and records the full cost on its books.  However, if the cost of the computer program exceeds a certain amount, the supplier may allow a 10 percent discount. 

The company fills out the documentation and receives reimbursement.  The accountant will then make a refund entry in the expense account to show that some of the money has been refunded and actual expenses have been reduced.

References

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