MODULE 3: Installment Sales

ACCOUNTING FOR INSTALLMENT SALES

 Introduction

Traditionally, under the Revenue Recognition Principle, revenue should be

recognized when two conditions exists.

1. The earning process is complete or virtually complete, and

2. An exchange has takes place.

These conditions were similarly indicated under PAS No. 1, wherein Revenue
is recognized when:

1. It is probable that future economic benefits will flow to the enterprise,

and
2. These benefits can be measured reliably.

Therefore, generally, the realization is deemed to occur on the date of sale.

Thus, the date of the sale transaction is the moment that the revenue is
recognized in the financial statement. However, the exceptions to this are
Installment Sales, Franchise Accounting and Construction Accounting.

 Learning Objectives

 Understand and explain major concepts of installment sales.

 Understand and explain the installment sale method of revenue
recognition.

 Revenue Recognition

Accrual method Collection reasonably assured

Degree of uncollectibility estimable
Installment sale Collection not reasonably assured
Cost recovery Collection not reasonably assured No
basis for determining whether or not
collectible

 Installment Sales

Installment sales: recognize revenue when cash is collected - not sale

 No accrual: gross profit deferred until collection
 Sales less cost of goods sold = gross profit
 Find rate of gross profit and apply to cash collections
 Rate = Gross profit / Total sale
 Rate x Gross profit = amount of profit to recognize on the
income statement and defer to future years gross profit not
realized (in a deferred gross profit account)
 Keep installment sales separate from other sales
 Seller is protected: title does not pass until all payments are made
 Justification for an installment sale: risk of not collecting accounts
receivable is great enough that sale of the good or service is not

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 evidence that revenue should be recognized now –only when cash is
collected
 Front end loading is the opposite: this is to recognize revenue
prematurely
 FASB prescribes installment sale method for real estate – the title
passes when the “mortgage is burned” (i.e.- no more payments)
 Repossession may occur if installment sale is deemed uncollectible
 Write off receivable with the attached deferred gross profit

 Journal Entry

Repossessed Merchandise………………………….xxx
Deferred gross profit……………………………...….xxx
Installment A/R……………………………………..….xxx

 Asset should be acquired at fair value

 Deferred gross profit on installment sales is an unearned revenue

 Unearned revenue is a quasi-liability
 Three elements that compose deferred gross profit:
 Income tax liability
 Collection expense
 Net income

 Cost-recovery method of revenue recognition

 No profit recognized until the cash payments by buyer exceed the sellers
Cost of Goods Sold

 Deposit method

 Postpone recognizing sale until the sale and asset transfer occurs
 Seller treats the cash received from buyer is a deposit on a contract , and
this is a liability that he owes to the buyer until the actual sale occurs)
 Since the seller has not performed, there is no claim on the deposit

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 ILLUSTRATIVE PROBLEMS

Multiple Choice Questions

1. MM Company began operation on January 1, 2019 and appropriately uses

the installment method of accounting. The following data are available for
2019 and 2020

2019 2020
Installment sales ₱1,200,000 ₱1,500,000
Cash collections from:
2019 sales 400,000 500,000
2020 sales 600,000
Gross profit on sales 30%

The realized gross profit for 2020 is

a. 240,000
b. 390,000
c. 440,000
d. 600,000

2. TT Company, which began business on January 1, 2019, appropriately

uses the installment sales method of accounting. The following data are
available for 2011:

Installment account receivable, 12/31/2019 ₱200,000

Deferred gross profit, 12/31/2019 (before recognition 140,000
of realized gross profit)
Gross profit on sales 40%

The cash collections and the realized gross profit on installment sales for
the year ended December 31, 2019 should be

Cash collections Realized gross profit

a. 100,000 80,000
b. 100,000 60,000
c. 150,000 80,000
d. 150,000 60,000

3. Dudong Electronics makes all of it sales on credit and accounts for them
using the installment sales method. For simplicity, assume that all sales
occur on the first day of the year and that all cash collections are made on
the last day of the year and that allcash collections are made on the last
day of the year. Dudong Electronics charges 18% interest on the unpaid
installment balance Data for 2019 and 2020 are as follows:

2019 2020
Sales ₱100,000 ₱120,000
Cost of goods sold 60,000 80,000
Cash collections (principal and interest)
2017 sales 40,000 50,000
2018 sales 90,000

The interest income recognized in 2020 amounted to:

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 a. 14,000
b. 21,600
c. 35,640
d. 49,700

4. Using the same information in No. 3 compute the realized gross profit in
2020:
a. 14,384
b. 22,800
c. 37,184
d. 39,600

5. The books of Harry Co. shows the following balances on December 31,
2020

Accounts Receivable ₱313,750

Deferred gross profit (before adjustment) 38,000

Analysis of the accounts receivable reveal the following:

Regular accounts ₱207,500

2019 installment accounts 16,250
2020 installment accounts 90,000

Sales on an installment basis in 2019 were made at 30% above cost; in

2020, at 33 1/3 above cost. Expenses paid was ₱1,500 relating to
installment sales. How much is the net income on installment sales?

a. 11,000
b. 11,500
c. 16,000
d. 10,250

6. On January 1, 2019, Art Company sold its idle plant facility to Tony, Inc.
for ₱1,050,000. On this date, the plant had a depreciated cost of
₱735,000. Tony paid ₱150,000 cash on January 1, 2019 and signed a
₱900,000 note bearing interest at 10%. The note was payable in three
annual installments of ₱300,000 beginning January 1, 2020. Art
appropriately accounted for the sale under the installment method. Tony
made a timely payment of the first installment on January 1, 2020 of
₱390,000 which included interest of ₱90,000 to date of payment. At
December 31, 2020, Art has a deferred gross profit of

a. 153,000
b. 180,000
c. 225,000
d. 270,000

7. On October 1, 2019, Rienna Company, a real estate developer, sold land

to Wook Company for ₱5,000,000. Wook paid cash of ₱600,000 and
signed a ten-year ₱4,400,000 note bearing interest at 12%. The carrying
amount of the land was ₱4,000,000 on the date of sale. The note was
payable in forty quarterly principal installment of ₱110,000 beginning
January 2, 2020. Rienna appropriately accounts for the sale under the
cost recovery method. On January 2, 2020, Wook paid the first principal
installment of ₱110,000 and interest of ₱132,000. For the year ended

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 December 2020, what total amount of income should Rienna recognize
from the land sale and the financing?

a. 0
b. 208,000
c. 508,200
d. 309,640

8. Asser Computer Co. began operation at the beginning of 2020, During the
year, it had cash sales of ₱6,875,000 and sales on installment basis of
₱16,500,000. Asser adds a markup on cost of 25% on cash sales and
50% on installment sales. Installments receivable at the end of 2020 is
₱6,600,000.

Total realized gross profit for 2020 is:

a. 1,375,000
b. 3,300,000
c. 4,675,000
d. 3,575,000

Use the following information to answer questions 9,10,11,12,13, and 14.

Johnson Enterprises uses the cost recovery method for all installment sales.
Complete the following table:

2018 2019 2020

Installment Sales ₱80,000 ₱95,000 ₱?
Cost of Installment Sales ? 56,050 68,250
Gross profit percentage 38% ? 35%
Cash collections:
2018 sales 25,600 46,400 5,600
2019 sales 22,800 ?
2020 sales 32,550
Realized Gross Profit on ? ? 16,050
Installment Sales

9. The installment sales in 2020:

a. 92,137.50
b. 105,000
c. 112,612.50
d. 195,000

10. Using the same information in the cost of installment sales in 2018:

a. 0
b. 30,400
c. 47,619
d. 49,600

11. Using the same information the cost of installment sales in 2019:

a. 29%
b. 41%
c. 59%
d. Cannot be determined

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 12. Using the same information the collection in 2020 and 2019 sales:

a. 10,450
b. 33,250
c. 43,700
d. 48,600

13. Using the same information, the realized gross profit on installment sales
in 2018:

a. 9,728
b. 7,049
c. 4,800
d. Zero

14. Using the same information, the realized gross profit on installment sales
in 2019:

a. 8,664
b. 9,348
c. 18,012
d. 22,400

Use the following information to answer questions 15, 16, 17, 18, 19, and 20.

Pampanga industrial sells machinery on the installment plan. On September 1,

2011, Pampanga entered into an installment sale contract with GMA Productions
for a six-year period. Equal annual payments under the installment sale are
₱187,500 and are due on August 31 each year beginning in 2012.

Additional information:

a. The cost of the machinery sold to GMA was ₱637,500

b. The implicit interest rate on the installment sale is 10%

Pampanga industrial uses calendar year as a result of the above transaction and
use effective-interest rate method of amortizing any discount.

The present value factors at 10% for six periods are as follows:

Year PV of P1 PV of an annuity of P1
1 .9091 .9091
2 .8264 1.7355
3 .7513 2.4869
4 .6830 3.1699
5 .6209 3.7908
6 .5645 4.3553

15. Assuming that circumstances are such that the collection of the
installments due under the contract is reasonably assured, compute the
realized gross profit on installment sales for 2019 (rounded)

a. Zero
b. 81,250
c. 179,119
d. 487,500

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16. Using the same information compute the total income for 2019 (rounded)

a. 27,221
b. 108,471
c. 206,340
d. 541,721

17. Using the same information compute the total income for 2020 (rounded)

a. 71,221
b. 108,471
c. 206,340
d. 541,721

18. Assuming that circumstances are such that the collection of the
installments due under the contract cannot be reasonably assured.
Compute the realized gross profit on installment sales for 2019 (rounded)

a. Zero
b. 81,250
c. 179,119
d. 487,500

19. Using the same information in No. 18, compute the total income for 2019
(rounded)

a. 27,221
b. 108,471
c. 206,340
d. 541,721

20. Using the same information in No. 18, compute the total income for 2020
(rounded)

a. 78,134
b. 101,418
c. 102,194
d. 119,384

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 ILLUSTRATIVE PROBLEM ANSWER KEY

Multiple Choice Questions

1. B

2. D

3. C

4. C

5. D

6 B

7. A

8. C

9. B

10. D

11. B

12. C

13. D

14. D

15. C

16. C

17. B

18. A

19. A

20. D

-END OF DISCUSSIONS-
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