Chapter 9: INSTALLMENT SALES

By: danicka acedera Bsa-4b

METHOD OF GROSS PROFIT RECOGNITION

GROSS PROFIT IS RECOGNIZED AT THE TIME OF

SALE

Account Receivable Sales

(full price) (full price)

The point at which good have customer have been

delivered to the customers and a definite amount of receivable has been acquired. Most of the expenses in selling goods are incurred and recorded in the year of sale (also the REVENUEto math cost and revenue). Require recognition of all expenses relating to the sales of the same period so that the determination of income will be a reasonable process. Expenses Liability (post sale collection and repossession

Bad Debts Allowance for Uncollectible Installment Contract Receivable

for recording estimated uncollectible accounts

GROSS PROFIT IS RECOGNIZED IN THE

PERIOD IN WHICH CASH IS COLLECTED - Recognized in the period in which the installment
receivables are collected instead of in the periods in which receivables are created.
COST RECOVERY METHOD gross profit is not

recognized until collections are equal to the amount of cost of good sold. Most applicable on the sale of services or products of a nature not permitting repossession and when the customer notes have no Fair market value. GROSS PROFIT REALIZATION METHOD the first collection are regarded as realization of gross profit INSTALLMENT METHOD cash collection is regarded as

THE INSTALLMENT METHOD OF ACCOUNTING

The difference between the selling price and the

cost of sale is recorded as deferred gross profit or unrealized gross profit ILLUSTRATION: assume that on March 31, 2008 an installment sale of property costing 60,000 was made. The selling price was 100,000. a down payment of 20,000 was required, the balance payable in forty manthly payments of 2,000 at the end of each month. GROSS PROFIT = (100,000 60,000) = 40,000 GROSS PROFIT RATE = gross profit selling price (40,000 100,000) = 40%

REALIZED GROSS PROFIT

Gross profit receivable
Year
2008 2009

DEFERRED GROSS PROFIT

Gross profit
Balance s, End
62,000 38,000

Collection X s Rate
*38,000 24,000 40 % 40

= RGP
15,200 9,600

X Rate
40% 40

= DGP
24,800 15,200

2010
2011

24,000
14,000 100,000

40
40

9,600
5,600 40,000

14,000
144,000

40
40

5,600
45,600

*P20,000 down payment plus 18,000(2k*9mos)installment collections

EXPENSES ON INSTALLMENT SALES

requires the examination of the consistency in

the treatment of the related expenses. Operating expenses incurred in making the sale are to be deferred. The matching of revenues and expenses on installment sales applies only to those cost and expenses necessary to and directly related with the acquisition or manufacture of the merchandise.

INTEREST ON INSTALLMENT CONTRACT RECEIVABLE

Interest charged to customers may be computed using one of the following plans: Equal periodic payments from customer, with a portion of each payment representing interest on the outstanding balance of the principal and the remainder representing a reduction from the aforementioned balance. Interest computed each month or the outstanding principal balance during the month. Interest computed on the installment due, from the date of the sales contract to the date of the installment payment.

Illustration: Equal periodic payments

Installment sale, June 30,2011 (cost,P42,000) P60,000 Cash down payment 20,000 Balance payable in 6monthly installment Plus 36% interest 40,000 Monthly installment P7,383.90 Periodic payment = original balance of installment contracts receivable/ present values of annuity of 1 for 6 periods at 3% = 40,000 / 5.417191

DATE

(1) CASH COLLECTION (DEBIT)

(2) INTEREST INCOME (CREDIT)

(3) INSTALLMENT CONTRACTS RECEIVABLE (CREDIT 1-2)

(4) OUTSTANDIN G PRINCIPAL (4-3)

Jun 30
30 P 20,000 Jul 31 7,383.90 Aug 7,383.90 31 Sept 7,383.90 30 Oct 7,383.90 31 P 1,200 P 20,000 6,183.90

P 60,000
40,000 33,816.10 27,446.68 20,886.18

1,014.48 6,369.42 823.40 6,560.50

626.59

6,757.31

14,128.87

Total collections, june 30 dec 31 (1) P64,303.40 Less total interest income (2) 4,303.40 Collections applying to principal (3) 60,000 Multiply by gross profit rate:

Gross profit = 60,000-42,000 Imstallment sales P60,000 Realized gross profit on the contract

30%

P18,000

ACCOUNTING PROCEDURES UNDER INSTALLMENT METHOD

Installment sales of conventional merchandise

Installment sales of real estate

By non dealer (casual sales) By a dealer

Installment sales of conventional merchandise 2010 2011

Sales Regular (on account) Installment- down payment balance (payable w/in 3yrs at the start of each month, apply 36 % interest for 3yrs)
Cost of sales regular Installment Collections Accounts Receivable Installment contract receivable 2010 Sales Applying to interest Applying to principal 2011 Sales Applying to interest Applying to principal P250,000 20,000 80,000 P230,000 24,000 96,000

120,000 60,000 120,000

130,500 69,600 130,500

26,000 19,000
-

18,000 26,000 31,000 22,000 65,000

1,020

Operating expenses paid

Accrued interest receivable 2007 sales

50,000
1,800

Journal entries January december 2010 perpetual inventory system

To record regular sales

Accounts receivable 250,000 Sales 250,000 To record installment sales Cash 20,000 Installment Contracts receivable 2010 80,000 installment sales 100,000 To record cost of sales cost of sales 120,000 Cost of Installment sales 60,000 Merchandise Inventory 180,000 if the periodic inv sys is used Cost of installment sales 60,000 Shipment of Installment Sales 60,00

 To record collection of accounts receivable

120,000 Accounts Receivable 120,000 To record collection of installment contracts receivable Cash 45,000 Installment Contracts Receivable, 2010 19,000 Interest Income 26,000 To record payment of operating expenses Operating Expenses 50,000 Cash 50,000

Cash

adjusting & closing entries, december 31, 2010

To recognized accrued interest receivable for

Dec.31,2010
Accrued Interest Receivable

1,800
1,800

Interest Income
To set up deferred gross profit on 2010
Installment Sales

100,000 Cost of Installment Sales 60,000 Deferred Gross Profit,2010 40,000 Gross profit rate = P40,000100,000=40% 15,600 15,600 P39,000 40 %

To record realized gross profit on installment sales

deferred Gross Profit,2010

Realized Gross Profit Collections applying t principal Multiply by gross profit rate

 To close realized gross profit account

Realized Gross Profit 15,600

Income Summary
Sales

15,600

To close other nominal accounts

250,000 Interest Income 27,800 Cost of Sales 120,000 Operating Expenses 50,000 Income Summary 107,800
123,400 Retained Earnings 123,400

To close result operations for 2010

Income Summary

January December 2011

To reverse accrued interest receivable
Interest Income

1,800 Accrued Interest Receivable

1,800

To record regular sales

Accounts Receivable 230,000

Sales
To record installment sales
cash

230,000

24,000 Installment Contracts receivable2011 96,000 Installment sales 120,000

 To record cost of sales

Cost of sales

130,400 Cost of Installment Sales 69,600 Merchandise Inventory 200,000 130,500 Accounts Receivable

To record collection of accounts receivable

Cash

130,500

To record collection of installment contracts receivable

Cash

97,000 Installment Contracts Receivable,2010 Installment Contracts Receivable,2011 Interest Income

26,000 22,000 49,000

To record payment of operating expenses

operating Expenses

Cash

65,000 65,000

 To recognized accrued interest receivable for Dec.31,2011

Accrued Interest Receivable

adjusting & closing entries, december 31, 2011

Interest Income

3,270

3,270

To set up deferred gross profit on 2011

Installment Sales

120,000 Cost of Installment Sales 69,600 Deferred Gross Profit,2010 50,400 Gross profit rate = P50,000120,000=42% 10,400 19,320 29,720

To record realized gross profit on installment sales

deferred Gross Profit,2010

deferred Gross Profit,2011 Realized Gross Profit Collections applying t principal 2010 sales 26,000 x 40% = 10,400 2011 sales 46,000 x 42% = 19,320 Realized Gross Profit 29,720

 To close realized gross profit account

Realized Gross Profit 29,720

Income Summary
Sales

29,720

To close other nominal accounts

230,000 Interest Income 50,4700 Cost of Sales 130,400 Operating Expenses 65,000 Income Summary 85,070
114, 790 Retained Earnings 114,790

To close result operations for 2011

Income Summary

Allocation of Cost of Good Sold

Procedure will depend upon the circumstances and info

available. ILLUSTRATION: Cash sales Charge Sales Installment Sales Mer Inv, jan1 Purchases Freight In Repossessed Merch Mer Inv, Dec 31

P150,000 300,000 750,000 120,000 725,000 30,000 35,000 130,000

Defaults and repossessions

repossessed merch subsequently sold after

incurring reconditioning costs and at a normal profit margin. PROCEDURES:

Record the repossessed merchandise in an appropriate

inventory account at its fair value Cancel uncollected installment receivable balance of the defaulted contract. Write-off the balance of the deferred gross profit relating to the above receivable. recognize the resulting gain or loss on repossession.

 Installment Contract Recceivable, 2011

P2,000 Gross Profit Rate,2011 Sales 30% Estimated market value of reposses merchandise P1,200
Loss on Repossession

FMV of repossessed merchandise 1,200 Less unrecovered cost Installment contract Receivable 2,000 Less deferred Gross profit(30%x2,000) 1,400

600

2011 Apr 30 Repossessed Merchandise 1,200 Deferred Gross Profit,2011 600 Loss on Repossession 200 Installment Contract Receivable,2011 2,000 To record repossession assuming periodic inventory is made
Reconditioning cost which relate to repossessed

merchandise should be charged to Repossessed Merchandise Account. Perpetual repossessed property is debited to Merchandise Inventory repossessed Account

Steps used in recording repossession

On the date of repossession, record the

repossessed merchandise in an appropriate account with a corresponding credit to loss on repossession. after the gross profit rat is established at the end of the period, the installment contract receivable balance of the defaulted contract and the related deferred gross profit are close to Loss on Repossession. The realized Gross profit is determined based on collection received prior to the defaults.

TRADE-INS
TRADE IN VALUE IS EQUAL TO ACTUAL

VALUE Assume that on april 1, 2011, the Motor sales Company sells a car for an installment price of P145,000. the car costs 100,000. the customer is allowed a trade-in value of 45,000 for his old car. He makes a downpayment of 40,000 and a balance to be paid in 12 equal installments is 5,000 each. It is estimated that the old car can be sold for 70,000 after incurring

Trade-in value allowed to customer P45,000 Less Net Realizable Value of merchandise trade-in: estimated resale value 70,000 Less Reconditioning cost 11,000 normal profit margin(20%x70,000) 14,000 45,000 Difference entry to record the sale Merchandise Inventory Traded-in 45,000 Cash 40,000 installment Contract Receivable 60,000 Installment Sales 145,000 perpetual

 TRADE-IN VALUE IS GREATER THAN NET

REALIZABLE
Assume that a stereo component with a cost of 12,000 is

sold for 17,000. a used stereo is accepted as a trade-in at a valuation of 6,000. the seller expects to spend 250 to recondition the used merchandise before reselling it for 5,000. the seller expects a 15% profit from sale of the used merchandise. _______________________________________________ _____ Trade-in value allowed to customer P6,000 less NRV of the merchandise traded in; estimated resale value 5,000 less reconditioning cost 250 normal profit margin(15%x5,000) 750 4,000

 Over allowance on Trade-in account, Perpetual

Merchandise inventory

4,000 over allowance on Trade-In 2,000 Installment Contract Receivable 11,000 Installment Sales 17,000 _______________________________________________ _____ Installment sales P17,000 Less over allowance 2,000 Net installment sales 15,000 Less Cost of Ins sales 12,000 Gross profit 3,000 GP rate (3,00015,000) *%computing realized GP

 over allowance is treated as reduction

from installment sales account, perpetual Merchandise Inventory Traded-in 4,000 Installment Contract Receivable 11,000 Installment sales 15,000

*under allowance= addition to the SP of the new merc

ALTERNATIVE PROCEDURES for computing Realized gross Profit for a Series of Years
APPROACH 1 COLLECTION & GP RATE determine the collections during the year ( beg end balance of installment contracts receivable) total credit of the year. gross profit rate = gross profit installment sales Realized GP for each installment period = total collections X GP rate APPRAOCH 2 DEFERRED GP BEFORE & AFTER ADJUSTMENT GP recognition adjustment, any decreased in the bal of the Deferred GP = realized GP balance of adj deferred GP = product of GP rate & ending

ILLUSTRATION
2011 January December
__________________________________________________ _____ Installment Accounts Receivable,2010 P60,000 P30,000 Installment Accounts Receivable,2011 70,000 Deferred Gross Profit, 2010 18,000 17,400 Deferred Gross Profit, 2011 35,000 Installment sales 2011

Approach 1
Installment contracts receivable, Jan1 Less Installment contracts Receivable Total credit for representing the period Less credit representing repossession Credit representing collections

2010 SALES 60,000 30,000

2011 SALES 100,000 70,000

30,000
2,000 28,000

30,000

30,000

Multiply by gross profit rate

30%

35%

2010: Deferred gross profit, jan 1 18,000 = 30% installment contract receivable,jan1 60,000 2011: Deferred gross profit,b4 adj,Dec31 35,000 = 35% installment sales 100,000 *repossession in 2011 of CGS, the deferred GP relating to the unpaid balance of the repossessed merchandise should be added back to the deferred GP bal before adj at the end of the period.

Approach 2
Deferred GP before adjstment,Dec31 Less Deferred GP, Dec31
(installment Contract receivable X GP rate)

2010 SALES 17,400

2011 SALES 35,000

9,000 24,500

2010: P30,000 X 30% 2011: P70,000 X 35% Realized Gross Profit 8,400

10,500

Fely Sales Corporation statement of Comprehensive income Year Ended December 31,2011 (Installment Sales not shown)

sales
Cost of Good sold GP on reg sales add realized GP on installment sales total GP Operating Expenses Operating Income Add interest Income Net Income

230,000 130,400 99,600 29720 129,320 65,000 64,320 50,470 114,790

Computation of Realized GP on Installment Sales Installment Sales Cost of Installment Sales GP on installment sales GP rate Collections in 2011 applying to principal Realized GP 2011 2010 installment sales 40%X26,000 2011 installment sales 42%X46,000 Total 2,010.00 2,011.00 100,000.00 120,000.00 60,000.00 69,600.00 40,000.00 50,400.00 40% 42% 26,000.00 46,000.00 10,400.00 19,320.00 29,720.00

ASSETS Current Assets Installment Contract Receivable: 2010 Sales 2011 Sales LIABILITIES Noncurrent Liability Deferred gross profit, 2010 Deferred gross profit, 2011

35,000.00 74,000.00 109,000.00

14,000.00 31,080.00

45,080.00

INSTALLMENT SALES ON REAL ESTATE

CASUAL SALES ILLUSTRATION

Assume that on October 1, 2011 Mr.

Marco Ruiz for sold for 100,000 a parcel of land acquired for 60,000. the contract of sale called for a down payment of 20,000 and the issuance of a note for the balance. Payment of the balance entails 24 monthly installment of 4,723.79 each starting on Nov. 1, 2011. the interest is the annual rate of 36% and is applied to

TABLE OF PAYMENTS FOR 2011 Date 1-Oct 1-Oct 1-Nov 2-Nov Appying to Appying to Unpaid Collections Interest Principal Principal 100,000 20,000.00 20,000.00 80,000.00 4,723.79 2,400.00 2323.79 77,676.21 4,723.79 2,330.29 2393.5 75,282.71

1-Oct Cash Notes Receivable Land Deferred Gain on Sale of land To record sale of Land 1-Nov Cash

20,000.00 80,000.00 60,000.00 40,000.00

4,723.79 Notes Receivable Interest income (3%X80,000) To record monthly collection and the recognition of interest income earned in October 2,323.79 2,400.00

1-Dec Cash

4,723.79 Notes Receivable Interest Income(3%X77676.21) To record monthly collection and the recognition of interest income 2,393.50 2,330.29

ADJUSTING ENTRIES Accrued Interest Receivable Interest Income(3%X75,282,71) To recognized accrued interest for December

2,258.48 2,258.48

Deferred Gain on Sale of Land 9,886.92 Realized gain in sale of land To record the realized gain in 2011 Collections Applying to principal X GP rate(40,000/100,00) Reallized Gain

9,886.92

24,717.29 40% 9,886.92

INSTALLMENT SALE OF REAL ESTATE BY A DEALER

The entire contract price applicable to the installment

sale is reported as revenue on the year the sale is recorded. cost of sales including future improvement costs are charged to income of the current accounting period. gross profit is deferred and recognized as income if payments of principal are received on the installment contract receivable. interest at the estate contract rate is recorded as income when received, and the balance of the deferred gross profit is deducted from related installment contracts receivable in the balance sheet.

ILLUSTRATION - FilEstate Realty, Inc in 2011 Total Selling price of lots Total cost of lots: Acquisition cost Improvement cost Gross Profit 1,000,000.00 150,000.00 450,000.00

600,000.00 400,000.00 35,000.00 12,000.00

Sales made during the year(lot no.1) collections during the year including int of 5,000

a ) To record the a cquis ition cos t a nd the improvement cos t of the lots

Land Improvement Cost Cash

150,000.00 450,000.00 600,000.00

b) To record ins tallment s a les for the period

Installment Contract Receivable2011 35,000.00 Installment Sales

35,000.00

c) To record the rela ted cos t of ins tallment s a les (60%X35,000)

Cost of installment sales Land Improvement Cost

21,000.00 5,250.00 15,750.00

total
Acquisition cost Improvement cost Total

Percantage Allocated to total Cost 150,000.00 25% 5,250.00 450,000.00 75% 15,750.00 600,000.00 100% 21,000.00

d) to record collection Cash Installment Contracts Receivable2011 Interest Income YEAR END ADJUSTING ENTRIES e) To set up deferred GP Installment sales Cost of Installment sales Deferred Gross profit GP rate = 14,000/35,000 = 40% f) to recognized GP Deferred Gross Profit Realized gross Profit collection applying to principal GP rate

12,000.00 7,000.00 5,000.00

35,000.00 21,000.00 14,000.00

2,800.00 2,800.00 7,000.00 40% 2,800.00

FINANCIAL STATEMENT PRESENTATION Assets Merchandise Inventory Land Improvement Cost

144,750.00 434,250.00

579,000.00

StrawHat Comp sells appliances on the installment basis. Below are the info. 2012 750,000.00 450,000.00 275,000.00 180,000.00 2011 600,000.00 375,000.00

Installment sales Cost of sales Collectiions on: 2012 installment sales 2011 installment sales

240,000.00

the realized gross profit in 2012 collections of 2012 installment sales was

 realized GP in 2012 P275,000 X 40% 110,000

(750,000-450,000)/750,000 = 40%