Thanks to visit codestin.com
Credit goes to www.scribd.com

Scribd
Upload
263 views3 pages

Cost Recovery Method Explained

The cost recovery accounting method reports revenue and cost of goods sold at the time of sale but delays recognizing profit until cash received from customers exceeds the cost of goods sold. It can be used when revenue is recognized after delivery due to uncertainty in payment. The method recognizes total revenue and cost of goods sold in the period of sale, but defers profit until cash exceeds costs. An example company records $7.5M in sales but only collects $3M in cash, so it defers $1.5M in gross profit since cash did not exceed the $6M cost of goods sold.

Uploaded by

Obe Absin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
263 views3 pages

Cost Recovery Method Explained

The cost recovery accounting method reports revenue and cost of goods sold at the time of sale but delays recognizing profit until cash received from customers exceeds the cost of goods sold. It can be used when revenue is recognized after delivery due to uncertainty in payment. The method recognizes total revenue and cost of goods sold in the period of sale, but defers profit until cash exceeds costs. An example company records $7.5M in sales but only collects $3M in cash, so it defers $1.5M in gross profit since cash did not exceed the $6M cost of goods sold.

Uploaded by

Obe Absin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

Cost Recovery Accounting Method

Definition
The term cost recovery refers to an accounting method that reports revenue and the cost of goods sold
in the period of sale, but delays recognizing profit until the cash received from customers is in excess of
the cost of goods sold. Along with the installment sales method, this approach can be used when
companies recognize revenue after delivery.

Explanation

The FASB Concept Statement No. 5 states that companies cannot recognize revenues as being earned
until they are realized or realizable, and the company has substantially completed what it needs to do in
order to be entitled to payment. Revenue can be recognized at the point of sale, before, and after
delivery, or as part of a special sales transaction.

If the sales price is not reasonably assured after delivery of the product or service to a customer, the
company may choose to defer recognizing revenue until cash is received. Generally, there are two
accepted ways to account for these transactions: the installment method and the cost recovery method.

The cost recovery method is similar to the installment method, since both approaches recognize total
revenue and the cost of goods sold in the period of the sale. However, while the installment method
recognizes income as cash is collected from customers, the cost recovery method delays recognizing
profit until the cash received is in excess of the cost of goods sold.

APB Opinion No. 10 allows sellers to use the cost-recovery method when there is no reasonable basis for
estimating collectability. FASB Statements No. 45 (Franchises) and No. 66 (Real Estate) require use of
this approach when there is a high degree of uncertainty related to the collection of receivables.

Example

Company A recorded $7,500,000 in installment sales in the current fiscal year. The cost of goods sold
associated with these sales was $6,000,000. Company A was also able to collect $3,000,000 from
customers through their scheduled installment payments. The determination of gross profit to record in
the current fiscal period would be as follows:

Installment Sales $7,500,000
Cost of Goods Sold $6,000,000
Gross Profit $1,500,000

Cash Receipts $3,000,000
Realized Gross Profit $0
Deferred Gross Profit $1,500,000
Since the cash receipts of $3,000,000 in the current accounting period is less than the cost of goods sold,
Company A would defer all gross profit. The journal entries associated with these transactions would be
as follows.

To record the sales for the current fiscal year:

Debit Credit
Installment Accounts Receivable $7,500,000
Installment Sales $7,500,000
The journal entry to record the collection of cash from customers:

Debit Credit
Cash $3,000,000
Installment Accounts Receivable $3,000,000
The journal entry to record the cost of goods sold:

Debit Credit
Cost of Installment Sales $6,000,000
Inventory (Goods Sold on Installment) $6,000,000
The journal entry to record the installment sales:

Debit Credit
Installment Sales $7,500,000
Cost of Installment Sales $6,000,000
Deferred Gross Profit (Installment Sales) $1,500,000
Since the cash collected from customers ($3,000,000) is less than the cost of goods sold ($6,000,000) in
the current accounting period, all gross profit is deferred.

You might also like