 Hello and welcome to this session. This is Professor Farhad in which we will discuss the cost recovery method. The cost recovery method is the most conservative method in recognizing profit. Simply put, it waits until you recover your cost before you recognize any profit on any particular sale. The cost recovery method is used when you collect your cash over a period of time because you're waiting until you recover your cost and there is no basis of estimating in collectible. Simply put, there's a high degree of in collectibility. Simply put, you make a sale, you sell something and you ask the customer to make installment sales, to make payments. But you cannot recognize any profit until you recover your cost. Maybe you don't recover your cost until the third payment or the fifth payment or the sixth payment. Why? Because you don't know whether you're going to collect enough to recover your cost. Because if you don't recover your cost, you should not have any profit. Well, then guess what? Wait until you recover your cost. Now what type of companies uses this method in the real world? There's a company called Rent-A-Center. Maybe you heard of them. You will see their trucks maybe in your town or in your city because of the high degree of in collectibility. They are very generous in their credit policies. They basically allow anyone to rent from them. Guess what? Because you have that high generous credit policy. Some people may not pay because they were not supposed to rent them in the first place. Therefore, they would use this method. So no profit is booked till you recover your cost. It's even more conservative than the installment method that we work in another session. In the installment method, you recognize profit as you receive cash. The cost recovery method, you don't recognize any profit unless you have recovered your cost. The best way is to look at an example. Before we proceed any further, I have a public announcement about my company, foreheadlectures.com. Forehead accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. No obligation. No credit card required. Adam Company sold 51 acre lots for $20,000 each on installment for a total sales of a million in the state of Montana. So they sell 50 pieces of land. Each piece is an acre and each for $20,000. The cost for Adam to buy and develop the land was $400,000. So simply put, Adam is making $600,000 profit on this deal. The buyers were individuals who resides out of the state of Montana and there is a tend to be high degree of default on collection and it's difficult to estimate collection or in-collectable giving the current environment. So Adam sold those land on installment, but the problem is we don't know who's going to pay. We don't know who's not going to pay. There's a high degree of in-collectability. So what would Adam do under those circumstances? Well, Adam is being promised a million dollar and installment receivable or receivable is a million dollar. We debit this much. We credit land or land inventory for $400,000. Now the difference between those is $600,000 and that's basically the profit. What we're going to do for now, we're going to debit the third gross profit of $600,000. The third gross profit is a Contra AR, Contra receivable. Although we have a million dollar of receivable, we have a Contra profit, Contra receivable of $600,000 and this is basically the profit that we are going to recognize as we receive the cash. A year later, we received $250,000 in cash. We debit cash, credit installment receivable. This is year one. That's all. We cannot recognize any profit because the cash that we received have not recovered the cost of our delayed. In year two, we received cash of $450,000. Well, this is year two. We debit cash, credit installment receivable. Now in year one, we received $250,000. In year two, we received $450,000. So far we have received $700,000 in cash. What does that mean? It means we recovered our cost by year two and part of that $700,300 is now we can recognize as profit. What we do then in year two, we debit the third gross profit, we're starting to reduce the third gross profit by $300,000 and we credit realized profit for $300,000. So we did not book any profit until we got to year two because by year two, we recovered our cost. In year three, we received cash of $300,000 debit account receivable, credit installment receivable. Now going forward, any cash that we received, this is the remaining is profit. So this is year three. Therefore also in year three, we book another $300,000 in profit. Therefore $300,000, $300,000 in total, we booked $600,000 in profit on the income statement and the third gross profit is gone. And voila, we recognize he was lucky to collect all the money and recognize all the profit by year three. So this is how the cost method work, you wait until you recover your cost. What should you do now? Go to Farhat lectures and learn about the cost recovery, work, MCQs, true, false, that's going to help you understand revenue recognition better. Good luck, study hard and of course stay safe.