INTRODUCTION

Installment Sales contract is a credit arrangement that provides a series of

payments for months or years. This special type of credit arrangement is widely used

in the fields of real estate, home appliances and cars (Guerrero et al. 2017). It also

emphasizes collection rather than sale. Furthermore, it is not only used in retailing

where all types of farm, home equipment as well as furnishing are sold on an

installment bases but also in heavy equipment industry where installations are paid for

over a long period (Dayag 2017).

According to Kruger (2013), Installment Sales has a unique structuring of

financial responsibilities which allows many prospective buyers to purchase property.

Moreover, he also said that this agreement culminate more financially attainable

development which in turn imply better income and profit margins for the developers.

Although installment sales provide a wide scope for potential clients, this type

of agreement still face market challenges on the part of the seller due to the greater

risk of non-collection. According to Neil Harl (2015), he mentioned that in order to

attain a modicum of protection against possible defaults, sellers under installment

contracts retain the title until a substantial portion of the principal payments is

collected before giving up the title of the property to the purchaser. Among the chief

remedies for default is forfeiture which allows the seller to cancel the contract and

repossess the property while retaining payments and improvements already made

(Isham, 1981).
 2

RATIONALE

Inasmuch as installment accounting is justified when there is no reasonable

basis for estimating the degree of collectability, revenue should be recognized until

there is cash collection.

One major decision in structuring a transaction is whether or not to set the

transaction as a straight cash sale or in installment basis. A major reason why many

sellers prefer installment basis is the deferral of tax liability associated with the

installment method. This method is tax advantageous to the seller inasmuch as the

taxable gain from the sale of the asset will be spread over the term of the financing

(M. Health, 2010).

Moreover, any gain realized by the seller is deferred and recognized for tax

purposes when there is collection of payments which can produce estate and gift tax

savings if property sold produces an annual return in excess of the interest rate over

the term of repayment (M. Stanley, 2017).

According to Stern (2012), one way to purchase or sell commercial real estate

is through an installment approach. Installment Sales can be attractive to both buyers

and sellers. Buyers can defer their payments and benefit from leverage. Sellers can

increase their cash flow. Furthermore, if there is an impasse in negotiating the deal, an

installment sale could produce a favorable outcome. Characteristics of the transaction

such as the interest rate and purchase price can be manipulated to the benefit of both

the buyer and the seller.

Most business and private citizens must secure financing from a banking

institution in order to purchase real estate. It is relatively easy to obtain such financing

with solid or even average credit when the economy is growing at solid pace.
 3

However, when economic conditions worsen and it becomes more difficult to secure

bank financing, sellers have another option for selling a piece of real estate through

installment sale (InvestorGuide.com).

 4

METHODOLOGY

Installment sale contracts are popular method to transfer real estate,

particularly when attaining traditional financing from a bank is simply not possible for

the buyer. This type of contract is sometimes called a contract for deed─ generally the

owner agrees to sell the real estate to the buyer for periodic payments to be applied to

the purchase price. This contract gives the buyer and seller great flexibility to

negotiate terms such as the interest rate and the length of the contract. The buyer

usually receives possession of the real estate during the term of the contract (Bailey

2015).

According to Mancini et al (2017), while land contracts are marketed as an

alternative path to home-ownership, contract buyers almost never end up achieving

ownership for the reason that the contracts are designed to fail. Further, successive

cancellations allow the sellers to churn more would-be homeowners through the same

property, creating more profit each new contract.

While hopeful owners may opt to buy their dream home on an installment

plan, some default in paying one or more installments. Former Sen. Ernesto Maceda

introduced what was subsequently enacted as Maceda law (Mawis 2017). To protect

buyers in installment against oppressive conditions, “It is embodied in Republic Act

6552 commonly known as “Maceda Law” which provides for certain protection to

particular buyers of real estate on installment payments against onerous and

oppressive conditions” (Philippine Laws Library).

A seller of real estate will often choose the real estate installment sale contract

to measure and define the contract obligation to the vendee and his rights and

remedies if the vendee does not meet his end of the bargain. Such a contract is
 5

normally used when the purchaser can make only a small down payment and there is

substantial risk of nonperformance. The vendor uses the contract and retains title until

a substantial part or the entire purchase price has been paid (Cathey 1982).

Since land installment contracts are historically predatory which exploits low-

income would-be homeowners, this drove the researchers to come up with creating

synthesis about Installment Sales.

 6

REFERENCE

Bailey, A. (2015, June 9). Sloan, Eisenbarth, Glassman, McEntire & Jarboe, LLC.
Retrieved October 10, 2018, from Installment Sales Contracts for the Purchase
of Real Estate and Equitable Foreclosure: Buyer and Owner Beware:
https://www.sloanlawfirm.com/articles/2015/06/09/installment-sales-
contracts-for-the-purchase-of-real-estate-and-equitable-foreclosure-buyer-and-
owner-beware/

Cathey, M. (1982). University of Arkansas at Little Rock Law Review. Retrieved

October 16, 2018, from The Real Estate Installment Sale Contract: Its
Drafting, Use, Enforcement, and Consequences:
https://www.google.com/url?sa=t&source=web&rct=j&url=https://lawreposito
ry.ualr.edu/cgi/viewcontent.cgi%3Farticle%3D1484%26context%3Dlawrevie
w&ved=2ahUKEwi17TR74feAhXYMN4KHT2sAVcQFjAKegQICBAB&usg
=AOvVaw07d0Nw- n9oqm2vfSSRurrL

Dayag, A. (2017). Advanced Financial Accounting. Manila: Lajara Publishing House.

Guerrero, P., & Peralta, J. (2017). Advanced Accounting. Manila: GIC Enterprises &
Co.,INC.

Harl, N. (2015). “Structured Sales” – A Different Twist from. Retrieved September

29,2018,fromhttps://lib.dr.iastate.edu/cgi/viewcontent.cgi?article=2299&conte
xt=aglawdige st

Health, M. (2010). Real Estate Report. Retrieved September 2, 2018, from Cash vs.
InstallmentSale:http://www.billgladstone.com/resources/newsletters/2010/oct2
010.pdf

Isham, R. (1981). Montana Law Review. Retrieved October 13, 2018, from The
Default Clause in the Installment Land Contract:
http://scholarship.law.unt.edu/mlr/vol42/issl/5

Krüger, E. E. (2013). Retrieved September 2, 2018, from Instalment Sales

Agreement: an alternative home financing option in the property market.:
https://repository.up.ac.za/bitstream/handle/2263/41067/Kr%C3%BCger_Insta
lment%20Sales%20Afreement%282013%29.pdf?sequence=1

Mancini, S., & Saunders, M. (2017). Retrieved October 10, 2018, from Communities
&Banking:https://scholar.google.com.ph/scholar?start=20&q=installment+sale
s+contract&hl=en&as_sdt=0,5&as_ylo=2014#d=gs_qabs&p=&u=%23p%3D
xMGOl74-qq4J
 7

Mawis, S. (2017). Inquirer.net. Retrieved October 2018, 2018, from Buying on

Installment:
https://www.google.com/amp/s/business.inquirer.net/235800/buying-on-
installment/amp

Philippine Laws Library. (2018). Retrieved October 10, 2018, from

https://batasnatin.com/law-library/civil-law/sales/2358-realty-installment-
buyer-act-maceda-law.html

Stanley, M. (2017). Installment Sales. Retrieved September 29, 2018, from

https://www.irs.gov/pub/irs-pdf/p537.pdf

Stern, J. (2012). Buying on Time. Retrieved October 16, 2018, from Commercial
Installment Sales:
https://www.google.com.ph/url?sa=t&source=web&rct=j&url=https://assets.re
center.tamu.edu/documents/articles/2003.pdf&ved=2ahUKEwiBw_fJ9_vdAh
WRIIgKHZGOAp4QFjAaegQIABAB&usg=AOvVaw2N8nCUjw1zrwDH-
0Up7vrD

WebFinance, Inc. (2018). Retrieved October 13, 2018, from InvestorGuide.com:

http://www.investorguide.com/article/11832/what-is-an-installment-sale-and-
when-is-it-good-option-igu
 8

THE BODY

Revenue Recognition

The area of revenue recognition does not include specific guidance for

applying broad accounting principles. In relation to the conceptual framework in the

recognition of income, two conditions must be present:

a) It is probable that economic benefits will flow to the entity as a result of an

increase in asset or a decrease in a liability.

b) The economic benefits can be measured reliably.

In comparison to the US Standard, the revenue recognition principle provides

that revenue is recognized when:

a) It is realized or realizable and;

b) It is earned.

The general rule on revenue and gain recognition is the time (point) of sale.

The receiving flow of economic benefits realized or realizable and ownership transfer

and measurability must be met. This method is known as full accrual method. (Dayag,

2017)
 9

Methods of Gross Profit Recognition

1. Time of Sale (sales basis or Accrual Basis)

Profit is recognized in the period in which sale is made. Outright recognition

of revenue, costs and gross profit should be made at point of sale (Dayag, 2017). The

Account Receivable is debited and sales account is credited for the full price when the

sale is made (Guerrero et.al, 2017). In addition, most of the expenses in selling goods

are incurred and recorded in the year of sale; therefore the revenue should also be

reported at that time to properly match cost and revenue.

2. Time of collection

Profit is recognized in the periods in which cash is collected. Initially the gross

profit is deferred then subsequently gross profit is realized when collections are made

(Dayag, 2017).

a) Cost Recovery Method

Gross profit is not recognized until collections are equal to the amount

of cost of goods sold. That is, all collections both interest and principal

portions are treated first as recovery of the property costs. After the recovery

of the full cost, all collections are regarded as realization of gross profit.

b) Gross Profit Realization Method

The first collections are regarded as realization of gross profit. After

the recognition of the full profit, all subsequent collections are treated as

recovery of cost.
 10

c) Installment Method

Cash collection is regarded as a partial recovery of cost and a partial

realization of profit in the same proportion that these two profit in the

installment sale over the life of the contract, and to anticipate possible failure

to realize the full amount of gross profit in the event of defaults and

repossessions (Guerrero et.al, 2017).

Procedures for Deferring Revenue

1. Sales in the current year

a) During the year, record both sales and cost of sales in the regular

way, and compute the rate of gross profit on installment sales

transactions.

b) At the end of the year, apply the rate of gross profit to the cash

collections of the current year’s installment sales to arrive at the

realized gross profit.

c) The gross profit not realized should be deferred to future years. To

compute deferred gross profit, apply the gross profit rate to the

ending balance of Installment Contracts Receivable.

2. Sales made in prior years

a) The gross profit rate of each year’s sales must be applied against

cash collections of accounts receivable resulting from that year’s

sales to arrive at the realized gross profit.

 11

Defaults and Repossession

If a customer defaults on an installment contract and no further collections can

be made, the seller may repossess the property sold to satisfy the remaining

indebtedness of the buyer. Usually, the repossessed merchandise is subsequently sold

after incurring reconditioning costs and at a normal profit margin (Guerrero et al

2017).

Repossessed merchandise may be reconditioned before being offered for sale.

As a general rule, assets should not be carried at amounts greater than those expected

from their sale or use. In the case of inventories, it should be recorded at its net

realizable value which is equal to estimated selling price less reconditioning and costs

to sell. However, this amount could fall below cost when the items are damaged or

become obsolete, or when the costs to completion have increased in order to make the

sale (Dayag 2017).

Computation of Gain or loss on repossession (Guerrero et al)

1. Record the repossessed merchandise at fair value (estimated selling price less

reconditioning cost and normal profit margin) at the date of repossession.

2. Compute for the deferred gross profit by multiplying deferred gross profit rate

to the uncollected Installment Contract Receivable of the defaulted contract.

3. Subtract the deferred gross profit from the relating Installment Contracts

Receivable which was defaulted to arrive at the unrecovered cost.

4. Subtract the unrecovered cost from the fair value of the repossessed

merchandise to compute the gain or loss on repossession.

 12

Ordinarily, conservatism would suggest that no more than the unrecovered

cost, the difference between receivable balance and the deferred gross profit balance,

be assigned to repossessed good. No gain then would be reported at the time of

repossession; recognition of any gain would await the sale of the repossessed goods

(Dayag 2017). Any gain or loss on defaults and repossessions is normally recognized

on the income statement as an addition to or subtraction from the realized gross profit

on installment sales and the resulting balance is labeled as “Total realized gross profit

after gain or loss on repossession.”

Trade-ins

Companies using installment sale plans sometimes accept merchandise traded-

in as part of the down payment. A typical example of the use of trade-ins is the

acceptance by a car dealer of used car as partial payment for a new car. The actual

value or the fair market value of the asset received as a trade-in should be used in

valuing the said item (Guerrero et al, 2017).

Frequently, as a special sale inducement, an over-allowance is given on the

trade-in. such over-allowance is in effect, a reduction in the sales price, and the

accounts should properly report this fact. Under such circumstances, the trade-in

should be recorded at no more than the company would pay on its purchase; the

difference between the amount allowed and the value of the article to the company

should be regarded as the difference between the costs of the goods sold and net

sales─ the installment sales less any trade-in over-allowance.

 13

a. Trade-in value is equal to actual value

Normally, trade-in value allowed to a customer is the amount charged

to the asset traded-in provided the amount is realistic and is indicative of the

fair market value or net realizable value of the item. Net realizable value is the

value of the old merchandise traded-in after the provisions of expected

reconditioning expenses cost of disposal and a normal profit upon its resale.

b. Trade-in value is greater than net realizable value

As a special inducement to the customer, the seller sometimes grants a

customer a trade in value greater than the fair market value or net realizable

value of the item received. An accounting problem arises if the seller grants an

over allowance on the used merchandise taken in. Over allowance is the

excess of the trade in value granted over the net realizable value of the used

merchandise. The amount of the over allowance may be recorded either as a

charge to Over Allowance on Trade In account as a reduction from installment

Sales account to arrive at a valid amount for the net sales price.

Computation of Over Allowance for Trade-ins

1. Record the Trade-in value allowed to customer.

2. Multiply the gross profit rate to the estimated resale value of the merchandise

trade-in, to arrive at the normal profit margin.

3. Subtract normal profit margin and reconditioning cost from the estimated

resale value to the merchandise trade-in to arrive at the net realizable value of

merchandise trade in.

4. To compute over allowance, subtract the net realizable value of the

merchandise trade-in from the Trade –in value allowed to customers.

 14

Computation of Realized Gross Profit for a series of years

Under the installment sales method, the realized gross profit on installment

sales varies in direct proportion to collections on installment accounts receivable

while the deferred gross profit varies in the same manner as the installment accounts

receivable.

Approach 1

1. Compute the collections for the current year and the gross profit rates.

2. To compute for the gross profit rate of the previous year, divide the beginning

gross profit by the beginning installment contracts receivable.

3. Compute the gross profit rate of the current year by dividing ending deferred

gross profit before adjustment by the installment sales.

4. To compute for the total credit for each period, find the difference between the

beginning and ending balances of installment contracts receivable.

5. Any unpaid balance of the receivable pertaining to repossessed merchandise is

deducted from the total credit of the year, to arrive at the credit representing

collections.

6. To arrive at the realized gross profit, multiply gross profit rate to the credit

representing collections.

Approach 2

1. To compute for the ending deferred gross profit, multiply deferred gross profit

rate to Installment Contracts Receivable.

2. Compute for the realized gross profit by subtracting ending deferred gross

profit from the beginning deferred gross profit. (Guerrero et.al, 2017)
 15

Installment Sale of Real Estate

The installment sales method of accounting is often used for sales of real

estate on a long-term contract basis. These sales are frequently characterized by a

small down payment s with long period of installment payments on the balance. If

circumstances reduce the probability of collection or if the market value of the

property is unstable, then the installment sale method may be applied.

a. Casual Sale of Real Estate

If the seller of a real property is not engaged in the real estate business but

sells property rarely, the sale is considered as a casual transaction. In this kind of

transaction, the cost and the corresponding valuation account is removed from the

books. The difference between the sales price and the book value of the real property

is credited to Deferred Gain on Sale of Real Property.

b. Real Estate by a Dealer

Real estate sold by a dealer either in the form of land or ready-made houses,

the real estate acquired shall be considered as the company’s inventory is recorded in

the same manner as a sale of merchandise.

The accounting procedures that may be followed under the installment method

of accounting for retail sale of land must conform to the following:

1. The entire contract price applicable to the installment sale is reported as

revenue on the year sale is recoded.

2. Cost of sales including future improvement costs are charged to income of the

current accounting period.

 16

3. Gross profit is deferred and recognized as income if payments of principal are

received on the installment contracts receivable.

4. Interest at the stated contract rate is recoded as income when received, and the

balance of the deferred gross profit is deducted from related installment

contracts receivable in the balance sheet.

5. Disclosure is made of the portion of sales and contracts receivable applicable

in the installment method of accounting.(Guerrero et al,2017)

 17

CONCLUSION