Under this method, Revenue is recognized only after all the costs of delivering a product or service have been recovered. It is based on the conservatism concept.
Key elements of this method:
No Revenue Recognition Initially: No revenue is recognized until the cost of goods sold is fully recovered.
Focus on cash collection: Cash collections are recorded first to offset costs.
Example: A construction company has a project to construct a township with a total amount paid by the customer of ₹120 crore and a total estimated cost of ₹100 crore. The customer will pay the amount in 5 installments for 5 years in the following way:
Here are the few steps and points to be kept in mind:-
* 1. As we see in the question that after the 4th instalment is received we will recover our complete cost i.e. 10+20+30+40=100 and hence we will first record the advance received for the first four years.
* 2. Next we will Transfer all the cost incurred in work in progress account until its cost is recovered; that will be at the end of 4th year.
* 3. At the end of 4th year when the cost is recovered we will then transfer the work in progress to cost of sales and total revenue will be recognized which will give the profit of 20 and receivables balance as 120
* 4. The advance received will now be adjusted against the Receivables and finally the 5th year entry for receivables will be made making the balance of receivables 0.
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