In business, sometimes you have to make tough decisions. One of those could be selling a product or service even though you’re not certain that you will get paid for it. The cost recovery method is an accounting practice that helps companies better recognize profit and defer taxes in these uncertain situations.

Unlike other methods of recognizing revenue, the cost recovery method defers recognition of gross profit until all costs related to the sale are recovered. This method also defers the payment of sales tax until the total cost of goods sold has been paid, which can help businesses lower their taxes.

To use the cost recovery method, first enumerate all of the expenses you incurred to complete your project. These can include things like purchase orders, supplies, labor, materials, and transportation costs. Then add up the total amount of money you have collected from clients to determine your income. You can then subtract your actual costs from this number to find the total profit. This calculation can be done either in a lump sum or over a period of time, depending on the terms of your contract with the client.

The benefits of the cost recovery method include a delay in recording earnings, a reduction in the risk of collecting debts and taxes, and an ability to evaluate potential projects. It also makes comparing the viability of a project against other opportunities easier. This method is not without its drawbacks, however. For example, using a percentage as a measurement can lead to misguided assumptions about how profitable a project will be and may cause you to underestimate your profits.

As a result, it’s important to take a thorough look at the risks and benefits of the cost recovery method before adopting it for your business. You should also consult your accountant for specifics on how the method works within your particular tax jurisdiction.

For example, the EPA has set up a complex methodology for allocating its indirect cleanup costs to specific projects. These indirect costs are those not directly associated with a cleanup activity and include things like administrative matters, personnel issues, guidance development, office, utility, and supply costs, etc. Indirect costs are a significant component of EPA cleanup activities, often representing up to 50 percent of total cleanup costs.

The cost recovery method is an alternative to the standard-cost approach for estimating and reporting on environmental expenditures. The standard-cost approach requires that a company record and report both its owning and operating costs. The company recognizes the revenues and cost of goods sold, but defers the recognition of the gross profit until all owning costs and operating expenses have been recovered. This is a more conservative way of bookkeeping for a project because it can take several years to recover all of the initial investment. In addition, the resulting deferred tax expense can be a considerable burden on the financial statements of the company that uses this method.