REVENUE RECOGNITION: INSTALLMENT CONTRACT

REVENUE
The gross inflow of economic benefits during the period arising in the course of the ordinary activities of an
entity when those inflows result in increases in equity, other than increases relating to contributions from equity
participants.

Recognition Criteria:
a. A probable inflow of economic benefits will flow to the entity
b. The inflow of benefits can be measured reliably (with sufficient degree of certainty)

Identification of transactions:
The criteria are normally applied on a per transaction basis except when two or more transactions are linked in
such a way that the commercial effect cannot be understood without reference to the series of transactions as a
whole.

Measurement: Revenue shall be measured at the fair value of the consideration received or receivable.

Revenue recognition criteria for sales of goods:

1. the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
2. the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold;
3. the amount of revenue can be measured reliably;
4. it is probable that the economic benefits associated with the transaction will flow to the entity; and
5. the costs incurred or to be incurred in respect of the transaction can be measured reliably

Examples of retention of risk and rewards of ownership:

1. when the entity retains an obligation for unsatisfactory performance not covered by normal warranty
provisions;
2. when the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the
buyer from its sale of the goods;
3. when the goods are shipped subject to installation and the installation is a significant part of the contract
which has not yet been completed by the entity; an
4. when the buyer has the right to rescind the purchase for a reason specified in the sales contract and the entity
is uncertain about the probability of return

Subsequent uncertainty about collectivity

When an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible
amount or the amount in respect of which recovery has ceased to be probable is recognized as an expense, rather
than as an adjustment of the amount of revenue originally recognized.

Alternative Accounting Methods to Installment Sales

1. Installment Method– employed when

a. the outflow of economic benefits arising from the transaction is NOT reasonably assured
b. there is no means available to ascertain the degree of collectivity
- Under installment method, collections are regarded as both recovery of profits and costs.

2. Cost recovery method – employed when

a. Collectability of proceeds is very uncertain.
 b. The transaction is very speculative
c. The final sales price is contingent on future events
- No gross profit is recognized until all cash collections equals the cost of the goods sold.

3. Deposit method
- Employed when expenses connected to the sale cannot be measured reliably or when transaction is
subject to conditions which would negate revenue recognition such as the existence of:
a. Buy-back agreement c. Guarantee
b. Refund period
- All considerations received is credited to a liability account, the liability account is closed to income
upon closure of all activities connected to the transaction or when the condition lapsed.

4. Gross profit realization method

- First collections are regarded as recoveries of profits. Subsequent collections are deemed recoveries of
cost.
- Grossly violates GAAP due to total lack of conservatism. Not used in practice.

ACCOUNT RELATIONSHIP

I. Gross profit rates (GPR) IV. Collections

- Current year = (IS-COIS)/IS or GP/IS - IAR, beg - IAR, end - Repo or written off IAR
- Prior year = DGP, beg/IAR, beg - Cash collection + FV of trade-in
- Any year = DGP, end/IAR, end
V. Realized Gross Profit (RGP)
II. Deferred Gross Profit (DGP) - Collection x GPR
- DGP, beg = IAR, beg x GPR - DGP, beg - DGP, end
- DGP, end = IAR, end x GPR
- DGP, end = DGP, beg - DGP, end - DGP on Repo IAR

III. Installment Accounts Receivables (IAR)

- Current year = IS - Collection
- Prior year = DGP, beg/GPR
- IAR, = DGP, end/GPR

Illustrative Problems:
1. Fast, Inc. appropriately uses the installment-sales method of accounting to recognize income in its financial
statements. Some pertinent data relating to this method of accounting include:

2009 2010
Installment sales P 500,000 P480,000
Cost of installment sales 380,000 336,000
Gross profit P 120,000 P144,000

Rate of gross profit 24% 30%

Balance of deferred gross profit at year end:

2009 P 72,000 P 24,000
2010 132,000
Total P 72,000 P156,000
 What amount of installment accounts receivable should be presented in Fast December 31, 2010 balance
sheet?
a. P480,000. b. P540,000 c. P520,000. d. P577,777.

2. Grant Co. began operations on January 1, 2010 and appropriately uses the installment method of accounting.
The following information pertains to Grant's operations for 2010:

Installment sales P 1,200,000

Cost of installment sales 720,000
General and administrative expenses 120,000
Collections on installment sales 550,000

The balance in the deferred gross profit account at December 31, 2010 should be
a. P220,000. b. P330,000. c. P260,000. d. P480,000.

3. On November 1, 2013, Sleeping Beauty sold its equipment costing P800,000 on an installment basis for
P1,000,000. 20% downpayment is required and the balance is due in 5 monthly installments starting
December 1, 2013. Compute the deferred gross profit as of December 31, 2013.
a. P0 b. P96,000 c. P128,000 d. P160,000

4. Dolce Co., which began operations on January 1, 2012, appropriately uses the installment method of
accounting to record revenues. The following information is available for the years ended December 31,
2012 and 2013:

2012 2013
Sales P1,000,000 P2,000,000
Gross profit realized on sales made in:
2012 150,000 90,000
2013 - 200,000
Gross profit percentages 30% 40%

What amount of installment accounts receivable should Dolce report in its December 31, 2013 balance
sheet?
a. P1,225,000 b. P1,300,000 c. P 1,700,000 d. P1,775,000

5. Luge Co., which began operations on January 2, 2013, appropriately uses the installment sales method of
accounting. The following information is available for 2013:

Installment accounts receivable, 12/31/2013, P800,000

Deferred gross profit, 12/31/2013 (before recognition of realized gross profit for 2013), P560,000
Gross profit on sales, 40%

For the year ended December 31, 2013, cash collections and realized gross profit on sales should be
Cash collections Realized gross profit Cash collections Realized gross profit
a. P400,000 P320,000 c. P600,000 P320,000
b. P400,000 P240,000 d. P600,000 P240,000

6. Betty Corporation uses the installment method of accounting and it has the following data at the year-end:
 Gross margin on cost 66 2/3%
Unrealized gross profit P 192,000
Cash collections including P 360,000
downpayments

What was the amount of sales on installment basis?

a. P480,000 b. P552,000 c. P648,000 d. P840,000

7. Helen sells subdivision lots on installment basis. The following information were taken from the company’s
records at December 31, 2010:

Installment receivables:
January 1, 2010 P
755,000
December 31, 2010 840,000
Unrealized gross profit, January 1, 339,750
2010
Installment sales 950,000

How much is the unrealized gross profit as at December 31, 2010?

a. P378,000 b. P399,750 c. P427,500 d. P389,250

8. These data pertain to installment sales of Hester Store:

- Down payment of 20%
- Installment sales: P545,000 in 2010; P785,000 in 2011; P968,000 in 2012
- Mark-up on cost: 35%
- Collection after down payment: 40% in the year of sale, 35% in the year after, and 25% in the third year.

Compute the installment accounts receivable at the end of 2012 and the total unrealized gross profit at the
end of 2012, respectively.
a. P621,640; P217,547 c. P464,640; P161,166
b. b. P464,640; P217,574 d. P621,640; P161,166

Illustrative: Regular sales

ABC, Inc. made P8,250,000 cash sales and P16,500,000 installment sales. ABC marks regular sales and
installment sales 20% and 50% on cost, respectively. ABC appropriately uses the installment method on
installment sales. Installment receivable at the end of the year were P6,600,000. Compute the realized gross
profit.
a. P1,375,000 c. P4,675,000
b. P3,300,000 d. P3,575,000

COST RECOVERY METHOD

CPA Exam Questions:

1. The following information pertains to a sale of real estate by Ryan Co. to Sudan Co. on 12/31/2008:

Carrying amount P 2,000,000

Sales price:
Cash P 300,000
Purchase money mortgage 2,700,000 3,000,000
 The mortgage is payable in nine annual installments of P300,000 beginning December 31, 2009, plus
interest of 10%. The December 31, 2009, installment was paid as scheduled, together with interest of
P270,000. Ryan uses the cost recovery method to account for the sale. What amount of income should Ryan
recognize in 2009 from the real estate sale and its financing?
a. P570,000 b. P370,000 c. P 270,000 d. P 0

What is the unrecovered cost of the property in the above problem?

a. P1,130,000 b. P1,400,000 c. P1,700,000 d. P2,000,000

2. On January 1, 2009, Carr Co. sold land that cost P150,000 for P200,000, receiving a note bearing interest at
10%. The note will be paid in three annual installments of P80,425 starting on December 31, 2009. Because
collection of the note is very uncertain, Carr will use the cost recovery method. How much revenue from
this sale should Carr recognize in 2009?
a. P0. b. P15,000 c. P20,000. d. P50,000

TRADE-IN
Illustrative
An item of merchandise costing P436,510 was sold by A, Inc. The agreed selling price was P1,000,000 payable
as follows: 20% upon the signing of the contract on January 1, 2008. As part of the downpayment, A, Inc. is to
accept a certain equipment with a fair value of P100,000 and an trade-in allowance of P120,000. The balance is
payable in 4 semi-annual installments every June 30 and December 31. Assume that the relevant discount rate is
12%. Present value factors are as follows:

Present value of annuity of 6% over 4 3.4651

periods
Present value of annuity of 12% over 4 3.0373
periods

Required: Compute the following

1. Cash downpayment
a. P 80,000 b. P 100,000 c. P 180,000 d. P 200,000

REPOSSESSION AND WRITE-OFF

Illustrative: Repossession - all methods

HHH Company sold an item of equipment costing P3,800,000 to VVV for P5,000,000. 20% downpayment was
required upon signing of the agreement and the balance was payable in four equal annual installment. VVV
defaulted on the second installment prompting HHH to repossess the sale. The repossessed equipment was
appraised at P2,250,000 after P100,000 reconditioning cost.

Compute the repossession gain or (loss) assuming the installment sale was recorded was initially recorded
under:
1. accrual method.
a. (P850,000) b. (P750,000) c. P350,000 d. (P130,000)

2. installment method.
a. (P850,000) b. (P750,000) c. P350,000 d. (P130,000)
3. cost recovery method.
a. (P850,000) b. (P750,000) c. P350,000 d. (P130,000)

Illustrative 2:
Aberdeen marks its merchandise 25% above cost for installment sales and appropriately uses the installment
method. The following relates to its installment accounts in 2013:

Fair value of repossessed merchandise P 10,000

Repossession loss 2,000
Deferred gross profit account, before adjustment 80,000
Installment receivable account, end 100,000

Required: Compute the cash collection during the year. ___________

Illustrative 3: Write-off
Since there is no reasonable basis for estimating the degree of collectibility, Astor Co. uses the installment
method of revenue recognition for the following sales:

2009 2008
Sales P900,000 P600,000
Collections from:
2008 sales 100,000 200,000
2009 sales 300,000 -
Accounts written off:
2008 sales 150,000 50,000
2009 sales 50,000 -
Gross profit percentage 40% 30%

What amount should Astor report as deferred gross profit in its December 31, 2009 balance sheet for the
2008 and 2009 sales?
a. P150,000 b. P160,000 c. P 225,000 d. P250,000

CPA Exam Questions (CONCEPT RECALL QUESTIONS):

1. Harber Co. uses the installment sales method. When an account had a balance of P5,600, no further
collections could be made and the dining room set was repossessed. At that time, it was estimated that the
dining room set could be sold for P1,600 as repossessed, or for P2,000 if the company spent P200
reconditioning it. The gross profit rate on this sale was 70%. The gain or loss on repossession was a
a. P3,920 loss. b. P4,000 loss c. P400 gain. d. P120 gain.

2. Yarbow Corporation has a normal gross profit on installment sales of 30%. A 2008 sale resulted in a default
early in 2009. At the date of default, the balance of the installment receivable was P40,000, and the
repossessed merchandise had a fair value of P22,500. Assuming the repossessed merchandise is to be
recorded at fair value, the gain or loss on repossession should be
a. P0. b. a P5,500 loss. c. a P5,500 gain. d. a P17,500 loss.

3. Seeman Furniture uses the installment sales method. No further collections could be made on an account
with a balance of P12,000. It was estimated that the repossessed furniture could be sold as is for P3,600, or
for P4,200 if P200 were spent reconditioning it. The gross profit rate on the original sale was 40%. The loss
on repossession was
a. P3,200. b. P3,000 c. P8,000. d. P8,400.

4. Confidence Corporation sells goods on the installment basis. For the year just ended, the following were
reported: Cost of installment sales, P8,400,000; Loss on repossession, P202,500; Wholesale value of
repossessed merchandise, P1,687,500; Repossessed account, P2,700,000; Deferred gross profit after
adjustment, P1,620,000.
 How much was the collections for the year?
a. P5,850,000 c. P3,900,000
b. P6,600,000 d. P3,150,000

5. Restwoods Corp. accounts or sales on the installment basis. The balances of the control accounts for
Installment Contracts Receivable at the beginning and end of 2012 were:

1/1/2012 12/31/2012
Installment contract receivable – 2010 P 24,020 -
Installment contract receivable – 2011 344,460 P 67,440
Installment contract receivable – 2012 - 410,090

During 2012, the company repossessed a refrigerator which had been sold in 2011 for P5,400 and P3,200
had been collected prior to default. The company sales and cost of sales figures are summarized below:
2010 2011 2012
Net sales P 380,000 P 432,000 P 602,000
Cost of sales 247,000 285,120 379,260

Restwoods Corp. values the repossessed goods at market value. The resale price of the repossessed
merchandise amounted to P1,700.

Compute the gain or (loss) on repossession; and the total realized gross profit on installment sales,
respectively, for the year 2012:
a. (P381); P172,852.50 c. P248; P172,852.50
b. (P381); P71,006.70 d. P248; P71,006.70

CASE PROBLEMS
Case 1
The Mountain Breeze, Inc. accounts for its sale on the installment sales basis. At the beginning of 2008, the
ledger accounts include the following account balances:

Installment accounts receivable, P 90,000

2006
Installment accounts receivable, 288,000
2007
Deferred gross profit, 2006 37,800
Deferred gross profit, 2007 108,000

At the end of 2008, account balances before adjustments for realized gross profit on installment sales are:
Installment account receivables, P 0
2006
Installment account receivables, 72,000
2007
Installment account receivables, 390,000
2008
Deferred gross profit, 2006 37,800
Deferred gross profit, 2007 108,000
Deferred gross profit, 2008 180,000

Installment sales in 2008 are made at 25% above the cost of merchandise sold; cash sales amounting to
P700,000 were made at a mark-up of 30% of sales and credit sales of P200,000 at a mark-up of 32%. During
2008 upon default in payment by the customer, the company repossessed the merchandise with an estimated
market value of P6,000. The sales was made in 2007 for P32,400 and P19,200 had been collected prior to the
repossession.

Required: Compute the following:

1. The total realized gross profit before gain or loss on repossession in 2008:
a. P489,850 b. P215,850 c. P113,850 d. P102,000

2. Realized gross profit on installment sales in 2008 for 2008 sales

a. P489,850 b. P215,850 c. P113,850 d. P102,000

3. Realized gross profit on installment sales in 2008 for 2007 sales

a. P489,850 b. P102,000 c. P76,050 d. P37,800

4. Realized gross profit on installment sales in 2008 for 2006 sales

a. P489,850 b. P102,000 c. P76,050 d. P37,800

5. Realized gross profit on installment sales in 2008.

a. P489,850 b. P215,850 c. P113,850 d. P102,000

6. Assume that in order to improve the salability of the repossessed merchandise, the company incurred P500
for reconditioning. After which the company was able to sell the merchandise to another customer for
P8,125 at a down of 40%. How much is the realized gross profit on the re-sale?
a. P850 b. P812 c. P650 d. P520

Case 2
The December 31, 2009 trial balance of Foressoft Company which started operation last year follows:
Deb Credi
it t
Cash and cash equivalent P
100,000
Accounts receivables 350,000
Installment accounts 450,000
receivables
Inventories 300,000
PPE 800,000
Accounts payables P
300,000
Notes payables 400,000
Deferred gross profit 250,000
Ordinary share 500,000
Share premium 150,000
Retained earnings 200,000
Dividends 100,000
Home office
Sales 1,200,000
Installment sales 500,000
Purchases 1,000,000
Operating expenses 400,00
0 -
Total P P
3,500,000 3,500,000
Forressoft Company sells both on regular sale and on a 1-year installment basis. It bills regular sales at 50%
above cost on regular sales. There was no change in billing rates since last year. Ending inventory as counted
was P200,000.

Required: Prepare the balance sheet and determine the following for 2009:
1. Realized gross profit on regular sales
a. P800,000 b. P600,000 c. P400,000 d. P360,000

2. Realized gross profit on 2008 installment sales

a. P20,000 b. P30,000 c. P40,000 d. P50,000

3. Total collections on installment sales

a. P175,000 b. P350,000 c. P400,000 d. P450,000

4. 2009 profit
a. P170,000 b. P150,000 c. P100,000 d. P70,000

5. Retained earnings, end

a. P120,000 b. P150,000 c. P170,000 d. P200,000

Case 3
On installment sales, the contract price is 106% of the cash sale price. A standard installment contract is used
whereby a down payment of ¼ of the installment price is required, with the balance payable in 15 equal
monthly installments. The interest charged per month is 1% of the unpaid cash sales price equivalent. It is
recognized in the period earned. Installment receivable and installment sales are recorded at the contract price.
When the defaulted, the unpaid balances are charged to bad debt expense. Sales of defaulted merchandise are
credited to bad debt expense.

The following data show the results of transactions in 2010:

Sales:
Cash sales P126,000
Installment sales 265,000
Repossessed sales 230
Merchandise inventory, January 1, 2010 58,060
Purchases 209,300
Merchandise inventory, December 31, 2010:
New merchandise 33,300
Repossessed inventory 180
Cash collections on installments contracts:
Down payment 66,250
Subsequent installments including interest of P9,252.84 (average of six
monthly installments on all contracts, except on defaulted contracts) 79,341

Five contracts totaling P1,060 defaulted after 3 monthly installment payments.

Required:
1. The gross profit percentage in 2010 based on cash sales price equivalent is:
a. 35% b. 45% c. 37.75% d. 37%

2. The total interest earned on a P1,060 installment sale contract for the first four month is:
a. P20.67 b. P37.16 c. P39.15 d. P159.00
3. Compute the net gain or (loss) on defaulted contracts during 2010, and the realized gross profit for 2010,
respectively.
a. P38.57; P99,084.86 c. P38.57; P99,024.86
b. (P38.57); P99,024.86 d. (P38.57); P99,084.86

Case 4
The following data were taken from the records of Samely Company, before the accounts are closed for the year
2012. The company sells exclusively on the installment basis and uses the installment method of recognizing
profit.
2010 2011 2012
Installment sales P400,000 P440,000 P420,000
Cost of installment sales 240,000 272,800 256,200
Operating expenses 100,000 94,000 104,000

Balances as of December 31:

Installment contract receivable 2010 220,000 110,000 28,000
Installment contract receivable 2011 250,000 92,000
Installment contract receivable 2012 238,000
Deferred gross profit – 2010 44,000 44,000
Deferred gross profit – 2011 95,000 95,000

During 2012, because the customer can no longer be located, the company wrote off P9,000 of the 2010
accounts and P2,800 of the 2011 accounts as uncollectible, and the entry made was:

Operating expenses 11,800

Installment contract receivable – 2010 9,000
Installment contract receivable – 2011 2,800

Also during 2012 a customer defaulted and the company repossessed the merchandise appraised at P4,000 after
costs of reconditioning estimated at P400. The merchandise had been purchased in 2010 by a customer who still
owed P5,000 at the date of repossession. The entry made was:

Inventory of repossessed merchandise 5,000

Installment contract receivable-2010 5,000

Required:
1. Compute the total realized gross profit on installment sales for the year 2012, and the gain (loss) on
repossession, respectively:
a. P157,156; (P960) c. P86,176; (P960)
b. P70,986; P600 d. P157,156; P600

2. What is the correcting entry for write-offs?

a. Deferred gross profit – 2010 3,600
Deferred gross profit – 2011 1,064
Operating expenses 4,664
b. Deferred gross profit 4,664
Operating expenses 4,664
c. Realized gross profit 4,664
Operating expenses 4,664
d. Operating expenses 4,664
Deferred gross profit – 2010 3,600
 Deferred gross profit – 2011 1,064

RECENT CPALE QUESTIONS

On January 1, 2018, an entity sold a car to a customer at a price of P400,000 with a production cost of P300,000. It is the
entity’s policy to employ installment method to recognize gross profit from installment sales.
At the time of sale, the entity received cash amounting to 25% of the selling price and old car with trade-in allowance
P50,000. The said old car has fair value of P150,000. The customer issued a 5-year note for the balance to be paid in equal
annual installments every December 31 starting 2018. The note payable is interest bearing with 10% rate due on the
remaining balance of the note.
The customer was able to pay the first annual installment and corresponding interesting due. However, after the payment
of the second interest due, the customer defaulted on the second annual installment which resulted to the repossession of
the car sold with appraised value of P110,000. On December 31, 2019, the repossessed car was resold for P140,000 after
reconditioning cost of P10,000.

1. What is the entity’s correct gross profit rate on installment sales based on sales? (May. 2019 CPALE)
a. 25%
b. 67%
c. 20%
d. 40%
2. What is the entity’s realized gross profit for the year ended December 31, 2018? (May. 2019 CPALE)
a. 50,000
b. 120,000
c. 108,000
d. 128,000
3. What is the loss on repossession for the year ended December 31, 2019? (May. 2019 CPALE)
a. 30,000
b. 20,000
c. 10,000
d. 40,000

 -- END OF HANDOUT -- 