Chapter 6 - Installment Sales PDF

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Chapter 6INSTALLMENT SALESIntroduction Generally, the point of sale is the point of revenue recognition. And among the exceptions to the point of sale realization concept is the installment method. Under this method, income is recognized when collections are made, because the uncertainty of collecti...

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Chapter 6 INSTALLMENT SALES Introduction Generally, the point of sale is the point of revenue recognition. And among the exceptions to the point of sale realization concept is the installment method. Under this method, income is recognized when collections are made, because the uncertainty of collecting accounts to be receive over an extended period of time may suggest the postponement of revenue recognition until the probability of collection can be reasonably estimated. GROSS PROFIT RECOGNITION ON INSTALLMENT SALES Installment sales may be regarded as calling for special treatment whereby gross profit is related to the periods in which the installment receivables are collected rather than to the periods in which the receivable are created. The inflow of cash (collections) rather than the time of sale become the criterion for revenue recognition. Accounting for installment method or installment basis could be test illustrated by providing for the recognition of gross profit in proportion to collections. Under this method, collections are regarded as both return of cost and realization of profit in the ratio in which these two factors are found in the original sales price. In applying the installment method in the accounts, the difference between the contract sales price and the cost of goods sold is recorded as deferred gross profit. This balance is recognized as revenue periodically in the proportion that the cash collections of the period bear to sales price. Stated differently, the original gross profit percentage on the sales is applied to periodic collections in arriving at the amounts to be recognized as revenue. At the end of each period a deferred gross profit balance remains on the books and is equal to the gross profit percentage applied to the balance of installment receivables as of this date. Gross Profit Rate Since, collections become the criterion for revenue recognition in installment method of accounting; determination of gross profit rate is an important factor to compute the realized gross profit to be reported for a period. Gross profit rate may be computed based on the data provided. Normally, it may be computed by dividing the gross profit by the installment sales. However, if this formula is not applicable, gross profit rate may also be computed by dividing the deferred gross profit (beginning) by the installment accounts receivable (beginning); or by dividing the deferred gross profit (end) by the installment accounts receivable (end). Realized Gross Profit The installment method of accounting recognizes profits at the point of collections, thus realized profit is based on amount collected. Ordinarily, realized gross profit may be computed by multiplying the gross profit rate by the amount collected. It should be pointed out that in case of defaulted contract, collections should be net of any unpaid balance on defaulted contract. However, if this formula is not applicable, realized gross profit may be computed by determining the difference between the deferred gross profit (before adjustment) and deferred gross profit (after adjustment). Deferred Gross Profit

As stated earlier, the installment method of accounting recognizes profits at the point of collection. If realized profit is based on amount collected, the deferred gross profit is based on unpaid balance. The deferral of gross profit is, in effect, the deferral of sales revenue accompanied by the deferral of cost of goods sold related to such sales revenue. To compute the deferred gross profit at the beginning of a period (before adjustment), installment accounts receivable at the beginning of the period should be multiplied by the related gross profit rate; and the deferred gross profit at the end of the period (after adjustment) is equal to installment accounts receivable multiplied by the related gross profit rate. Trade-Ins In certain sales on the installment plan, companies will accept a trade-in as part of payment on a new contract. The trade-in is recorded at the value allowed. Frequently, as a special sales inducement, an overallowance is given on the trade-in, which is, in effect, a reduction in the sales price. 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 reported either as charge to an overallowance account or as a reduction in installment sales. In either case, the gross profit on installment sales should be regarded as the difference between the cost of goods sold and net sales, the total installment sales less any trade-in overallowance. Defaults and Repossessions Default on an installment contract and subsequent repossession of the goods sold calls for an entry on the books of the seller that reports the merchandise reacquired, cancels the installment receivable together with the related deferred gross profit balance, and records the gain or loss on repossession. As in the case of goods acquired by trade-in, the repossessed article should be recorded at an amount that will permit a normal gross profit on its resale. Interest on Installment Contracts Installment contracts frequently provide for a charge for interest on the balance due. The interest charge is ordinarily payable with the installment payment that reduces the principal. Although interest is included in the payment, use of the installment method requires that only that portion of a payment which reduces the principal balance of the installment contract receivable should be considered in computing the realized gross profit. MULTIPLE CHOICE QUESTIONS PROB. 6 – 1 (AICPA) Cash collection is a critical event for income recognition in the Cost recovery Installment method method A. No No B. Yes Yes C. No Yes D. Yes No PROB. 6 – 2 (AICPA) The installment method of recognizing profit for accounting purposes is acceptable if A. Collections in the year of sale do not exceed 30% of the total sales price. B. An unrealized profit account is credited.

C. Collection of the sales price is not reasonably assured. D. The method is consistently used for all sales of similar merchandise. PROB. 6 – 3 (AICPA) Under the installment sales method, A. Revenue, costs, and gross profit are recognized proportionately to the cash that is received from the sale of the product. B. Gross profit is deferred proportionately to cash uncollected from sale of the product, but total revenue and costs are recognized at the point of sale. C. Gross profit is not recognized until the amount of cash received exceeds the cost of the item sold. D. Revenues and costs are recognized proportionately to the cash received from the sale of the product, but gross profit is deferred until all cash is received. PROB. 6 – 4 (AICPA) Under the cost recovery method of revenue recognition. A. Income is recognized on a proportionate basis as cash is received on the sale of the product. B. Income is recognized when the cash received from the sale of the product is greater than the cost of the product. C. Income is recognized immediately. D. None of these. PROB. 6 – 5 (AICPA) Chris Co. sells equipment on installment contracts. Which of the following statements best justifies Chris’ use of the cost recovery method of revenue recognition to account for these installment sales? A. The sales contract provides that title to the equipment passes to the buyer only when all payments have been made. B. No cash payments are due until one year from the date of sale. C. Sales are subject to a high rate of return. D. There is no reasonable basis for estimating collectibility. PROB. 6 – 6 (AICPA) Winner Co. is engaged in extensive exploration for water in Utah. If, upon discovery of water, Winner does not recognize any revenue from water sales until the sales exceed the costs of exploration, the basis of revenue recognition being employed is the A. Production basis B. Cash (or collection) basis C. Sales (or accrual) basis D. Cost recovery basis PROB. 6 – 7 (AICPA) Leopard Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest. What is the balance of an installment note receivable 6months after the sale? A. 75% of the original sales price. B. Less than 75% of the original sales price. C. The present value of the remaining monthly payments discounted at 12%.

D. Less than the present value of the remaining monthly payments discounted at 12%. PROB. 6 – 8 (AICPA) On January 2, 2009, Colt Co. sold land that cost P600,000 for P800,000, receiving a note bearing interest at 10%. The note will be paid in three annual instalments of P321,700 starting on December 31, 2009. Because collection of the note is very uncertain, Colt will use the cost recovery method. How much revenue from this sale should Colt recognize in 2009? A. 0 B. 6,000 C. 8,000 D. 20,000 PROB. 6 – 9 (AICPA) Several of Pitt, Inc.’s customers are having cash flows problems. Information pertaining to these customers for the years ended March 31, 2009 and 2010 follows: 2,009 2,010 Sales 10,000 15,000 Cost of sales 8,000 9,000 Cash collections: On 2009 sales 7,000 3,000 On 2010 sales 12,000 If the cost recovery method is used, what amount would Pitt report as gross profit from sales to these customers for the year ended March 31, 2010? A. 2,000 B. 3,000 C. 5,000 D. 15,000 PROB. 6 – 10 (AICPA) The following information pertains to a sale of real estate by South Co. to Nord. Co. on December 31, 2009: Carrying amount 4,000,000 Sales price: Cash 600,000 Purchase money mortgage 5,400,000 6,000,000 The mortgage is payable in nine annual installments of P600,000 beginning December 31, 2010, plus interest of 10%. The December 31, 2010 installment was paid as scheduled, together with interest of P540,000. South uses the cost recovery method to account for the sale. What amount of income should South recognize in 2010 from the real estate sale and its financing? A. 1,140,000 B. 740,000 C. 540,000 D. 0

PROB. 6 – 11 (AICPA) Hill Company began operations on January 1, 2009, and appropriately uses the installment method of accounting. Data available for 2009 are as follows: Installment accounts receivable, 12/31/09 500,000 Installment sales 900,000 Cost of goods sold, as percentage of sales 60% Using the installment method, Hill’s realized gross profit for 2009 would be A. 360,000 B. 240,000 C. 200,000 D. 160,000 PROB. 6 – 12 (AICPA) Luge Co., which began operations on January 2, 2009, appropriately uses the installment method of accounting. The following information is available for 2009: Installment accounts receivable December 31, 2009 800,000 Deferred gross profit, Dec. 31 (before recognition of realized gross profit for 2009) 560,000 Gross profit on sales 40% For the year ended December 31, 2009, cash collections and realized gross profit on sales should be Cash Realized Collections Gross Profit A. 400,000 320,000 B. 400,000 240,000 C. 600,000 320,000 D. 600,000 240,000 PROB. 6 – 13 (RPCPA) The books of Paiyakan Company show the following balances on December 31, 2009: Accounts receivable 313,750 Deferred gross profit (before adjustment) 38,000 Analysis of the accounts receivable reveal the following: Regular accounts 2008 installment accounts 2009 installment accounts

207,500 16,250 90,000

Sales on an installment basis in 2008 were made at 30% above cost; in 2009, at 33 1/3% above cost. Expenses paid was P1,500 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 PROB. 6 – 14 (RPCPA) A company uses the installment method of accounting to recognize income, and pertinent data are as follows: 2007 2008 2009 Installment sales 300,000 375,000 360000 Cost of sales 225,000 285,000 252000 Balances of gross Profit at year-end: 2007 52,500 15,000 2008 54,000 9000 2009 72000 The balance of the receivable on December 31, 2009 is: A. 270,000 B. 277,500 C. 279,000 D. 300,000 PROB. 6 – 15 (AICPA) Taft Corp., which began business on January 1, 2008, appropriately uses the installment sales method of accounting. The following data are available for December 31, 2008 and 2009: 2008 2009 Balance of deferred gross profit on sales account: 2008 300,000 120,000 2009 440,000 Gross profit on sales 30% 40% The installment accounts receivable balance at December 31, 2009 is A. P1,000,000 B. 1,100,000 C. 1,400,000 D. 1,500,000 PROB. 6 – 16 (AICPA) Dolce Co., which began operations on January 1, 2008, appropriately uses the installment method of accounting record revenues. The following information is available for the years ended December 31, 2008 and 2009: 2008 2009 Sales 1,000,000 2,000,000 Gross profit realized on sales made in: 2008 150,000 90,000 200,0 2009 00

Gross profit percentage

30%

40%

What amount of installment accounts receivable should Dolce report in its December 31, 2009, balance sheet? A. 1,225,000 B. 1,300,000 C. 1,700,000 D. 1,775,000 PROB. 6 – 17 (AICPA) Pacific Corp. uses the installment method of reporting. The following data were gathered for its three years of operations: 2007 2008 2,009 Installment sales 300,000 405,000 495,000 Cost of installment sales 210,000 243,000 321,750 Gross profit rate 30% 40% 35% Balance of installment receivable, Dec. 31: 2007 installment sales 2008 installment sales 2009 installment sales

180,000

135,000 300,000

60,000 195,000 390,000

In 2009, a customer defaulted; accordingly, the merchandise with an estimated value of P15,000 was repossessed. The sale was made in 2007 and the unpaid balance on the date of repossession was P22,500. 1.) What is the total realized gross profit in 2009? A. 412,500 B. 183,750 C. 94,500 D. 36,750 2.) What is the amount of gain (loss) on repossession in 2009? A. (7,500) B. (750) C. 6,000 D. 3,000 PROB. 6 – 18 (RPCPA) The Central Plains Subdivision sells residential subdivision lots in installment. The following information was taken from the accounting records of Central Plains Subdivision as at December 31, 2009: Installment accounts receivable, 1/1/09 755,000 Installment accounts receivable, 12/31/09 840,000 Unrealized gross profit, 1/1/09 339,750 Installment sales 950,000

How much is the realized gross profit in 2009? A. 427,500 B. 339,750 C. 378,000 D. 389,250 PROB. 6 – 19 (AICPA) Rosson Corp., which began business on January 1, 2009, appropriately uses the installment sales method of accounting for income tax reporting purposes. The following data are available for 2009: Installment accounts receivable, 12/31/09 200,000 Installment sales for 2009 350,000 Gross profit on sales 40% Under the installment sales method, what would be Rosson’s deferred gross profit at December 31, 2009? A. 120,000 B. 90,000 C. 80,000 D. 60,000 PROB. 6 – 20 (AICPA) Karr Co. began operations on January 1, 2009 and appropriately uses the installment method of accounting. The following information pertains to Karr’s operations for 2009: Installment sales 800,000 Cost of installment sales 480,000 General and administrative expenses 80,000 Collections on installment sales 300,000 The balance in the deferred gross profit account at December 31, 2009 should be A. 120,000 B. 150,000 C. 200,000 D. 320,000 PROB. 6 – 21 (RPCPA) The Brownout, Inc., operating at the start of the calendar year 2009, uses the installment method of accounting: Installment sales 400,000 Gross margin on cost 66 2/3% Inventory, December 31, 2009 80,000 General & administrative expense 40,000 Accounts receivable, December 31, 2009 320,000 The balance of the deferred gross profit account at December 31, 2009 should be: A. 192,000 B. 128,000

C. D.

96,000 80,000

PROB. 6 – 22 (RPCPA) Quincy Enterprises uses the installment method of accounting and has the following data at yearend: Gross margin on cost 66 2/3% Unrealized gross profit 192,000 Cash collections including down payments 360,000 What was the total amount of sale on installment basis? A. 480,000 B. 552,000 C. 648,000 D. 840,000 PROB. 6 – 23 (AICPA) Lane Co., which began operations on January 1, 2009, appropriately uses the installment method of accounting. The following information pertains to Lane’s operations for the year 2009: Installment sales 1,000,000 Regular sales 60,000 Cost of installment sales 50,000 Cost of regular sales 30,000 General and administrative expenses 100,000 Collections on installment sales 200,000 The deferred gross profit account in Lane’s December 31, 2009 balance sheet should be A. 150,000 B. 320,000 C. 400,000 D. 500,000 PROB. 6 – 24 (AICPA) Since there is no basis for estimating the degree of collectibility, Astor Co. uses the installment method of revenue recognition for the following sales: 2009 2008 Sales 900,000 600,000 Collections from: 2008 sales 100,000 200,000 2009 sales 300,000 Accounts written off: 2008 sales 150,000 500,000 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. 150,000 B. 160,000 C. 225,000 D. 250,000 PROB. 6 – 25 (RPCPA) These data pertain to installment sales of Mickey’s Store:    

Down payment, 20%. Installment sales: P545,000 in Year 1; P785,000 in Year 2; and P968,000 in Year 3. Mark-up on cost, 35%. Collections after down payment: 40% in the year of sale, 35% in the year after sale, and 25% in the third year.

1) The realized gross profit in year 1 is: A. 109,357 B. 73,474 C. 99,190 D. 114,825 2) The unrealized gross profit for installment sales made during Year 2, as of the end of Year 2 is: A. 97,689 B. 131,880 C. 141,112 D. 114,063 3) The installment accounts receivable at the end of Year 3 is: A. 652,722 B. 621,640 C. 602,991 D. 685,358 4) The unrealized gross profit at the end of Year 3 is: A. 211,047 B. 161,166 C. 198,574 D. 217,574 PROB. 6 – 26 (Adapted) When assets that have been sold and accounted for by the installment method are subsequently repossessed and returned to inventory, they should be recorded on the books at A. Selling price. B. The amount of the installment receivable less associated deferred gross profit. C. Net realizable value. D. Net realizable value minus normal profit

PROB. 6 – 27 (Adapted) The method most commonly used to report defaults and repossessions is A. Provide no basis for the repossessed asset thereby recognizing a loss. B. Record the repossessed merchandise at fair value, recording a gain or loss if appropriate. C. Record the repossessed merchandise at book value, recording no gain or loss D. None of these. PROB. 6 – 28 (RPCPA) The following selected accounts appeared in the trial balance of Union Sales as of December 31, 2009: Debit Credit Installment receivable, 2008 15,000 Installment receivable, 2009 200,000 Inventory, 12/31/08 70,000 Purchases 555,000 Repossession 3,000 Installment sales 425,000 Sales (regular) 385,000 Unrealized gross profit, 2008 54,000 Additional information: Installment receivable, 2008 sales as of December 31, 2008 Inventory of new and repossessed merchandise as of December 31, 2009 Gross profit percentage on regular sales during the year Repossession was made during the year. It was a 2008 sale and the corresponding uncollected account at the time of repossession

120,000 95,000 30% on sales

7,750 1) The gross profit realized on collection for installment sales in 2008 was: A. 47,250.00 B. 50,737.50 C. 43,762.50 D. Answer not given 2) The gross profit realized on collections for installment sales in 2009 was: A. 87,075.00 B. 88,672.50 C. 85,500.00 D. Answer not given 3) The loss on repossession made on a 2008 sale was: A. 1,262.50 B. 487.50 C. 1,805.00

D. Answer not given PROB. 6 – 29 (AICPA) On December 31, 2009, Mill Co. sold construction equipment to Drew, Inc. for P1,800,00. The equipment had a carrying amount of P1,200,000. Drew paid P300,000 cash on December 31, 2009 and signed a P1,500,000 note bearing interest at 10%, payable in five annual installments of P300,00. Mill appropriately accounts for the sale under the installment method. On December 31, 2010, Drew paid P300,000 princ...