If you’re in business, you know that there are times when it isn’t possible to be confident that you will receive all of the payments that you invoice. For example, you may purchase equipment on credit from a supplier and not expect to receive full payment until after it has been paid off, or you might rent office space that isn’t fully used for an entire year. If you use the cost recovery method of accounting, you will recognize income for these types of transactions even though you don’t know when you will recover your investment.
Cost Recovery is an accounting method that defers recognizing profit until you have recovered the full amount of the cash that you invested in the project. This differs from the installment method of revenue recognition, which recognizes each payment as a sale transaction, but only recognizes gross profit when the total amount has been received. This allows your accounting to be more accurate in situations where there is a greater likelihood that you will not be paid the entire amount of the cash for which you invoiced.
You can apply a cost recovery model in many ways in your business, including by insisting that certain jobs pay for a minimum number of days or hours per month – whether or not they use the equipment. This helps reduce your risk by passing ownership to the site managers, who are more likely to make day-to-day operating decisions about the use of equipment, and it also gives you a good basis for negotiating with vendors for better pricing on the equipment.
Another way to use a cost recovery model is by seeking out ways to eliminate expenses completely. This could mean shopping for discounts on supplies, asking for donations of equipment or meeting space, or by using the money that you would spend on a program to fund other initiatives instead. While this approach won’t reduce your overall costs as much as finding lower-cost options, it will help you to avoid certain expenditures altogether and free up resources to pursue cost reduction elsewhere.
A common practice in cost recovery is to track the ratio of total project costs to earned revenues. This metric allows you to determine how many projects are profitable or not and can be a very useful tool for evaluating the effectiveness of your programs. If the number is greater than 100 percent, it means that all expenses were covered and that the investments you made have paid off.
If you are planning to use a cost recovery method in your department, be sure that all transactions are processed in the correct fund. For external cost recovery activities, your department should invoice the auxiliary organization that funded the activity, and all expense transactions should be coded to an auxiliary project code. The auxiliary project codes will trigger invoicing by the end of the fiscal period. If you are unsure of how to process these transactions, please contact the Accounts Receivable & Billing group.