Cost recovery is a type of accounting that allows you to recognize income while factoring in the full cost of your transactions. It defers profit recognition until your total revenues exceed your total costs, and it is often used in situations where you are unsure whether or not your revenue streams will be realized as expected. Depending on the industry in which you operate, cost recovery may be a necessary part of your bookkeeping.
There are several ways to calculate and use cost recovery. You can use a percentage to measure the profitability of projects, or you can simply subtract your project costs from your total revenue to determine how much profit you’ve made. A percentage is an easy-to-read method, and it can help you compare the profitability of different projects.
One example of direct cost recovery occurs when a city or county sponsors a large event, such as an annual festival, sporting event, or concert. The city or county may require the event organizers to pay for all or a portion of the associated traffic management and other costs. This is an effective way to recover the costs of these events without passing them on to federal, state or local taxpayers. The benefits of utilizing this strategy include the ability to directly identify traffic impacts, promote event awareness, and pass some incentive along to organizers to minimize their traffic impact costs.
Another common method of indirect cost recovery involves charging a fee for a product or service to cover costs. This method is a popular choice for businesses that want to offer their products and services to the public. A variety of fee strategies can be employed, and each has its own advantages and disadvantages. For instance, a fee can be a useful tool for recovering the costs of a new service or product that is expected to be profitable, but it’s important to collect data on demand and customer satisfaction before implementing a fee-based system.
Indirect cost recovery can also be used for a range of public service events. For example, a jurisdiction can recover traffic costs by collecting fees from event attendees or by charging a permit fee for a special event. In addition to providing an outlet for community expression, such events can stimulate economic activity and provide publicity for the local economy. However, the costs associated with these events can also be high, and a jurisdiction should engage in data collection and resource utilization before proceeding to direct cost recovery.
A final example of indirect cost recovery is a fee charged by an organization to recover the costs of its research activities. This includes facilities and administrative rates built into grants or contracts, as well as fees set up by self-sustaining units to recover their costs for program delivery. Each proposal budget that UC submits to a funder should seek full-cost recovery.
Using the cost recovery method of accounting is often necessary in situations when you cannot be sure that your projected profit will materialize. This is often the case with payments that are made through credit cards or checks, which can take some time to clear. It is also a good idea to use the method when you are working with clients who have a history of non-payment.