Cost recovery is one of the ways that business expenses are made back through income. It’s one of the most conservative forms of revenue recognition in accounting, and it’s used when it’s improbable that a company will receive payment for a product right away. In these cases, it’s important to keep track of all the costs associated with a project, so that they can be recouped over time.
There are several different types of cost recovery, but the most common is a fee charged by a company to recover all costs associated with a specific project. It can be a flat fee, or it can be based on the number of hours or days that an asset is deployed on site. Some companies choose to use a single rate to cover both owning and operating costs, while others opt for a separate rate designed to recover only owning expenses (columns B and C).
Another type of cost recovery is an internal charge imposed by a company on departments or other units within the same organization to recover a portion of their expenses. The amount charged is usually equal to the amount that the department pays, plus any additional fees. Often, this method is used to ensure that departments are not overpaying for goods or services.
In some cases, a company will not be able to recover the full amount of its expenses, which may require it to file for bankruptcy. However, if a company can demonstrate that it has been successful in recovering its expenses, it may be able to avoid filing for bankruptcy.
A company that uses a cost recovery method to recognize its income must make sure that it has covered all of its expenses before it can declare any profit on a sale. This is a very prudent approach to revenue recognition, and it makes it difficult for business owners to overestimate their potential profits.
For example, if Shiny Clothes Ltd. sells $100,000 worth of clothing on credit to customers, the company must first ensure that all payments received for the purchase have covered its cost of goods sold. This means that any excess payments will not be considered profit until the company has recovered all of its costs through the installment sales. This can take years.
In addition to using a cost recovery system, EPA also tracks the amount of money that it is owed by PRPs in its accounting systems. If a PRP does not pay the money it owes to EPA, the agency will send them a demand letter requesting that they do so. Failure to comply with the demand letter will result in a lawsuit filed by EPA, which will trigger prejudgement interest on the outstanding debt.