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Cost Recovery Method
Overview of the Cost Recovery Method
The cost recovery method does not recognize any income on a sale until the cost of the item sold has been fully recovered through cash receipts. Once the seller has recovered all costs, any subsequent cash receipts are included in income. The cost recovery method is used when the uncertainty of collection of the sales price is so great that even use of the installment method cannot be justified. The cost recovery method is the most conservative of all revenue recognition methods.
Under the cost recovery method, both revenues and cost of sales are recognized at the point of sale, but the related gross profit is deferred until all costs of sales have been recovered. Each installment must also be divided between principal and interest, but unlike the installment method where a portion of the principal recovers the cost of sales and the remainder is recognized as gross profit, all of the principal is first applied to recover the cost of the asset sold. After all costs of sales have been recovered, any subsequent cash receipts are realized as gross profit.
Example of the Cost Recovery Method
Henderson Equipment Company sells a machine for $5,000 to a customer with a dubious credit history on 12/31/X1. The machine cost Henderson $3,750. The terms of the agreement require a $1,000 down payment on the date of the sale. The remaining $4,000 is payable in equal annual installments of $1,401.06, including 15% annual interest, at the end of each of the next four years. Henderson can then recognize gross profit on the sale in accordance with the following schedule:
| Date |
Cash (debit) |
Deferred interest income (credit) |
Installment accounts receivable (credit) |
Installment accounts receivable balance |
Unrecovered cost |
Realized gross profit |
Realized interest revenue |
| 12/31/X1 | $5,000.00 | $3,750.00 | |||||
| 12/31/X1 | $1,000.00 | $ -- | $1,000.00 | 4,000.00 | 2,750.00 | $ -- | $ -- |
| 12/31/X2 | 1,401.06 | 600.00 | 801.06 | 3,198.94 | 1,948.94 | -- | -- |
| 12/31/X3 | 1,401.06 | 479.84 | 921.22 | 2,277.72 | 1,027.72 | -- | -- |
| 12/31/X4 | 1,401.06 | (31.68) | 1,059.40 | 1,218.32 | -- | -- | 373.34 |
| 12/31/X5 | 1,401.06 | (1,048.16) | 1,218.32 | -- | -- | 1,250.00 | 1,230.90 |
| $6,604.24 | $5,000.00 | $1,250.00 | $1,604.24 |
Related Topics
Completed contract method
Cost to cost method
Installment method
Percentage of completion method
Revenue recognition criteria