ADVANCED FINANCIAL ACCOUNTING AND REPORTING G.P.
COSTA
INSTALLMENT SALES
=================================================================================
REVENUE RECOGNITION - INSTALLMENT SALES
The earning of revenue by a business is recognized for accounting purposes when the transaction is
recorded. Revenue is often recognized at time of sale.
Revenue is also recognized (1) during production, (2) at completion, and (3) at time of collection.
(1) During production. The most common situation is the use of the percentage-of-completion method for
long-term construction contracts. The point of sale is much less significant than production activity. If
the contractor can expect to perform the contractual obligation, the revenue is assured by the contract.
To defer recognition until completion of the entire contract misrepresents the efforts (costs) and
accomplishments (revenues) of the interim periods. If progress toward completion can be estimated
with reasonable accuracy, the percentage-of-completion method should be used.
(2) At completion. Examples of revenue recognition at completion of production involve precious metals
and agricultural products with quoted prices. These sales prices are reasonably assured, there are low
additional costs of distribution, and unit costs cannot be determined because of joint costs.
(3) At collection. When collection is highly uncertain and there is no reasonably objective basis for
estimating the degree of collectability, revenue should not be recognized until cash is received. In
addition, if collection costs and bad debts are expected to be high and their amount cannot be
reasonably estimated, revenue recognition should be deferred. Examples are cost recovery method
and installment method.
Recognition of Gross Profit at the Time of Collection
a. Cost Recovery Method also known as “hybrid approach” or “zero profit approach”
b. Profit Realization Method - the first collection are regarded as realization of gross profit
c. Installment Method - a contract whereby the buyer, in exchange for the property acquired makes a
series of payments over extended period of time
Gross Profit Rate (GPR) = (Installment Sales – Cost of Installment Sales) / Installment Sales
Gross Profit Rate (GPR) = Deferred Gross Profit, end / Installment Receivable, end
Realized Gross Profit (RGP) = Collection X GPR
RGP = DGP beg – DGP written off – DGP end
Deferred Gross Profit, end = Installment Receivable, end x GPR
Problem 1
San Marcelino Corporation started operations on January 1, 2020 selling home appliances and furniture
sets both for cash and on installment basis. Data on the installment sales operations of the company
gathered for the years ending December 31, 2020 and 2021 were as follows:
2020 2021
Installment Sales 200,000
Cost of Installment Sales 120,000
Cash Collected on Installment Sales
2020 Installment Sales 105,000 75,000
Required: Compute the following:
Installment Cost Recovery Profit Realization Accrual Method
Method Method Method
RGP 12/31/20
RGP 12/31/21,
2020 Sales
DGP 2020
DGP 2021, 2020
Sales
Note: Use Installment Method if the problem is silent. Use accrual Method if the collectability is
reasonably assured.
AFAR-02
ACCOUNTING FOR REPOSSESSIONS
Repossessed merchandise is valued at its appraised or true worth at the time of repossession and a loss
is recognized representing the difference between the value assigned to the repossessed merchandise
plus the adjustment to the unrealized gross profit and the accounts receivable written off.
Journal Entry:
Repossessed Merchandise xxxx
Unrealized Gross Profit xxxx
(Installment A/R written off x GPR)
Installment Accounts Receivable xxxx
The difference between the total debits and the credit is recognized as loss on repossession (if debit)
and if credit, the amount must be deducted from the value of the repossessed merchandise. No gain is
reported at the time of repossession.
COMPUTATION OF TRUE WORTH OF REPOSSESSED MERCHANDISE
Estimated Selling Price after reconditioning xxxx
Less: Reconditioning costs xxxx
Selling expenses xxxx
Margin of profit xxxx xxxx
True worth of merchandise xxxx
DISPOSITION OF LOSS ON REPOSSESSION
The loss on repossession is shown as deduction from the realized gross profit on installment sales in the
income statement.
Problem 2
The Cavite Furniture Company appropriately used the installment sales method in accounting for the
following installment sale. During 2020, Cavite sold furniture to Bulacan Co. for P3,000 at a gross profit
of P1,200. On June 1, 2020, this installment account receivable had a balance of 2,200 and it was
determined that no other collections would be made. Cavite, therefore, repossessed the merchandise.
When reacquired, the merchandise was appraised as being worth only for P1,000. In order to improve its
salability, Cavite incurred costs of P100 for reconditioning. Normal profit on resale is P200. What should
be the loss on repossession attributable to this merchandise?
OVER-ALLOWANCE ON TRADE-IN
Represents the difference between the actual trade-in allowance granted on the merchandise traded-in
and the true worth of such merchandise.
COMPUTATION OF TRUE WORTH OF MERCHANDISE TRADED-IN
Estimated Selling Price after reconditioning xxxx
Less: Reconditioning costs xxxx
Selling expenses xxxx
Margin of profit xxxx xxxx
True worth of merchandise traded-in xxxx
COMPUTATION OF OVER-ALLOWANCE ON TRADE-IN
Trade-in allowance granted xxxx
Less: True worth of merchandise traded-in
Selling price after reconditioning xxxx
Less: Reconditioning costs xxxx
Selling & admin. expenses xxxx
Normal profit margin xxxx xxxx xxxx
Over-allowance on trade-in xxxx
DISPOSITION OF OVER-ALLOWANCE ON TRADE-IN
The over-allowance on trade-in is carried as a separate account in the books because the trade-in
should be recorded at no more than the company would pay on its purchase.
Journal Entry:
Trade-in merchandise (at true worth) xxxx
Over-allowance on merchandise traded-in xxxx
Accounts Receivable xxxx
Installment Sales xxxx
In computing the gross profit rate on installment sales, the over-allowance on merchandise traded-in is
deducted from the installment sales.
When closing the books, the balance of the over-allowance on merchandise traded-in is closed against
installment sales.
Adjusted Installment Sales = Installment Sales – over-allowance on trade-in
Adjusted GPR = (Adjusted Installment Sales – Cost of Installment Sales) / Adjusted Installment Sales
RGP = (Cash Collections + True worth of merchandise traded-in) x Adjusted GPR
Problem 3
Aman Group, Inc. sold a fitness equipment on installment basis on October 1, 2020. The unit cost to the
company was 60,000 but the installment selling price was set to P85,000. Terms of payment included the
acceptance of a used equipment given a trade-in value of P30,000. Cash of P5,000 was paid in addition
to the added trade-in equipment with the balance to be pain in ten (10) monthly installments due at the
end of each month after the month of sale. It would require P1,250 to recondition the used equipment so
that it would be resold for P25,000. A 15% gross profit rate was usual from the sale of used equipment.
What amount of realized gross profit should Aman report during 2020?
INTEREST ON INSTALLMENT CONTRACTS
Installment contracts frequently provide for a charge for interest on the balance due. The interest charge
is originally payable with the installment payment that reduces the principal.
The arrangement for the periodic payment of interest generally takes one of the following forms:
a) Interest is computed on the balance of the principal owed between installment periods. This is
sometimes referred to as long-end interest.
b) Interest is computed on the amount of the individual installment due, from the date of the contract
until the date of installment payment. This is sometimes referred to as short-end interest.
c) Periodic payments are equal in amount and represent interest on the balance of the principal
owed between installment periods, the remainder a reduction in the principal balance.
d) Interest throughout the payment period is computed on the original principal.
When interest is involved in installment sales, it should be separately accounted for as interest revenue
distinct from the gross profit recognized on the installment sales collections during the period.
Problem 4
Lucena Industrial sells machinery on the installment plan. On September 1, 2020, Lucena entered into
an installment sale contract with Western Productions for a six-year period. Equal annual payments
under the installment sale are P187,500 and are due on August 31 of each year beginning in 2021.
Additional information:
(a) The cost of the machinery sold to Western was P637,500.
(b) The implicit interest rate on the installment sale is 10%.
Compute the income or loss before taxes that Lucena should record for the year ended December 31,
2020, as a result of the above transaction, assuming that circumstances are such that the collection of
the installments due under the contract
(1) is reasonably assured.
(2) is not assured.
AFAR-02
Multiple Choice:
1. Manahan Co., which began operations on January 1, 2020, appropriately uses the installment
method of accounting to record revenues. The following information is available for the years ended
December 31, 2020 and 2021:
2020 2021
Sales P 1,000,000 P 2,000,000
Gross profit realized on
Sales made in:
2020 150,000 90,000
2021 - 200,000
Gross profit percentages 30% 40%
What amount of installment accounts receivable should Manahan report in its December 31, 2021,
balance sheet?
a. P1,100,000 c. P1,700,000
b. P1,300,000 d. P1,900,000
2. On January 1, 2020, Enteng Co. sold a used machine to Cooper, Inc. for P525,000. On this date,
the machine had a depreciated cost of P367,500. Cooper paid P75,000 cash on January 1, 2020
and signed a P450,000 note bearing interest at 10%. The note was payable in three annual
installments of P150,000 beginning January 1, 2021. Enteng appropriately accounted for the sale
under the installment method. Cooper made a timely payment of the first installment on January 1,
2021 of P195,000, which included interest of P45,000 to date of payment. At December 31, 2021,
Enteng has deferred gross profit of
a. P105,000 c. P 90,000
b. P 99,000 d. P 76,500
3. Sendong Co., which began operations on January 1, 2021, appropriately uses the installment method
of accounting. The following information pertains to Sendong's operations for the year 2021:
Installment sales P 1,000,000
Regular sales 600,000
Cost of installment sales 500,000
Cost of regular sales 300,000
General and administrative expenses 100,000
Collections on installment sales 200,000
The realized gross profit for the year 2021 should be
a. P 200,000 c. P 400,000
b. P 320,000 d. P500,000
4. Refer to Sendong, The balance in the deferred gross profit account in Sendong's December 31, 2021
balance sheet should be
a. P 200,000 c. P 400,000
b. P 320,000 d. P500,000
5. Several of Fox, Inc.'s customers are having cash flow problems. Information pertaining to these
customers for the years ended December 31, 2020 and 2021 follows:
12/31/20 12/31/21
Sales P 10,000 P 15,000
Cost of sales 8,000 9,000
Cash collections
On 2020 sales 7,000 3,000
On 2021 sales - 12,000
If the cost-recovery method is used, what amount would Fox report as gross profit from sales to these
customers for the year ended December 31, 2021?
a. P 2,000 c. P 5,000
b. P 3,000 d. P15,000
6. Wood Corporation has a normal gross profit on installment sales of 30%. A 2019 sale resulted in a
default in 2021. At the date of default, the balance of installment receivable was P8,000, and the
repossessed merchandise had a fair value of P4,500. Assuming the repossessed merchandise is to
be recorded at fair value, the gain or loss on repossession should be
a. P0 c. a P1,100 gain.
b. a P1,100 loss. d. a P2,500 loss.
7. Cagayan Furniture uses the installment sales method. No further collections could be made on an
account with a balance of P10,000. It was estimated that the repossessed furniture could be sold for
P5,500 if P900 were spent reconditioning it. The gross profit rate on the original sale was 40% and
gross profit on the sale of repossessed furniture was 20%. The loss on repossession was
a. P2,700 c. P4,500
b. P2,500 d. P7,000
8. Matson Company sold some machinery to the Finney Company on January 1, 2020. The cash selling
price would have been P473,850. Finney entered into an installment sales contract which required
annual payments of P125,000, including interest at 10%, over five years. The first payment was due
on December 31, 2020. What amount of interest income should be included in Matson’s 2021 income
statement (the second year of the contract)?
a. P12,500. c. P39,670
b. P39,624. d. P34,885.
9. On January 1, 2020, Colt Co. sold land that cost P60,000 for P80,000, receiving a note bearing
interest at 10%. The note will be paid in three annual installments of P32,170 starting on December
31, 2020. 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 2020?
a. P0 c. P 8,000
b. P 6,000 d. P20,000
10. The Brownout, Inc. began operating at the beginning of the calendar year 2021 and, using the
installment method of accounting, presented the following data for the first year:
Installment sales P400,000
Gross margin 40%
Inventory, Dec. 31, 2021 P 60,000
General and administrative expenses 30,000
Accounts receivable, Dec. 31, 2021 100,000
The balance of the deferred gross profit account should be:
a. P192,000 b. P160,000 c. P 96,000 d. P 40,000
11. Refer to Brownout, Inc., the net income for the year 2021 amounted to
a. P40,000 c. P90,000
b. P10,000 d. P130,000
12. Quincy Enterprises uses the installment method of accounting, and it has the following data at year-
end:
Gross margin on cost 66-2/3%
Unrealized gross profit P192,000
Cash collections including down payments 360,000
What was the total amount of sales on installment basis?
a. P480,000 b. P552,000 c. P648,000 d. P840,000
13. A refrigerator was sold to Alyanna Castro for P16,000, which included a 40% mark-up based on
selling price. She made a down payment of 20%, paid four of the remaining sixteen equal payments,
and then defaulted on further payments. The refrigerator was repossessed, at which time the fair
value was determined to be P6,800. The repossession resulted in the following loss/gain:
a. P 56.80 c. P2,960.00
b. P1,040.00 d. P4,056.80
AFAR-02
14. Home Appliances, Inc. began operation in May, 2020 by selling exclusively on the installment basis.
Using the installment method of income recognition, the company summarized the following data at
the end of the first eight-month period: installment sales, P450,000; various expenses, P23,000;
accounts receivable, P330,000; and, inventory, P80,000. If the gross margin based on cost is 66-
2/3%, the net income was:
a. P25,000 c. P57,000
b. P48,000 d. P80,000
15. On January 2, 2020, Yardley Co. sold a plant to Ivory, Inc. for P1.5 million. On that date, the plant's
carrying cost was P1 million. Ivory gave Yardley P300,000 cash and a P1.2 million note, payable in
four annual installments of P300,000 plus 12% interest. Ivory made the first principal and interest
payment of P444,000 on December 31, 2020. Yardley uses the installment method of revenue
recognition. In its 2020 income statement, what amount of realized gross profit should Yardley
report?
a. P344,000 b. P200,000 c. P148,000 d. P100,000
-ooo0ooo-
