Cost recovery is a term used by accountants to describe the process of gaining back the value of an expense. This can be anything from a physical asset, such as an office or piece of equipment, to the initial investment that goes into starting up a company. Cost recovery accounting is an important concept to understand because it plays a role in determining how tax-efficient your business can be.
If you are a freelancer, for example, and you work on projects that may be paid in installments over a long period of time, using the cost recovery method of accounting means you don’t record any revenue until the payments from your client have exceeded the amount you spent hiring your copywriter, or whatever else went into producing your services. This method also applies to projects that are paid in cash, but where repayment is less certain.
As an accounting method, it’s important to remember that cost recovery isn’t a strategy for avoiding taxes. Deferring the recognition of revenue is against the principle of the Realization of Revenue, which states that you should recognize and record income only when you can reasonably expect to be paid for the goods or services that you have delivered. It’s fine to use the cost recovery method in unusual circumstances, but it should not be relied on as a way to avoid paying income tax.
Another key reason to consider using the cost recovery method of accounting is that it allows you to accurately assess your profit potential for a particular project before you actually begin work on it. It’s easy to underestimate the profitability of a new product or service, and you can end up spending more than you earn if you don’t carefully estimate your costs. This can be a significant problem if you’re working on a tight budget, or if you’re trying to convince a bank to lend you money.
Choosing the right accounting method isn’t always easy, and there are many factors that need to be taken into consideration. The best way to determine which method is best for your business is to consult an accountant. They’ll be able to provide advice about how best to track your expenses and earnings, as well as how to make the most of your tax deductions.
Please note that the FreshBooks Support team does not offer certified income tax or accounting advice, outside of helping you set up and manage your account. We recommend contacting a local accountant if you have specific questions about your finances or bookkeeping. For more general help with using FreshBooks, check out our Knowledge Base articles and videos. If you have an issue that needs to be resolved, submit a ticket here. The sooner we receive your request, the faster we can help you get back on track. You can even connect with a Certified Pro Advisor for one-on-one guidance. All of our experts are dedicated to your success.