1BDC CPA REVIEW INSTITUTE

O SQUARE ACCOUNTING SERVICES

3/F Fuentes Bldg., Marasbaras, Tacloban City

Mobile No.: 0927-981-6331; 0919-340-7505
E-mail: dargelaluser@gmail.com

Installment Sales Accounting

I. INTRODUCTION

Traditionally, under the Revenue Recognition Principle, revenue should be recognized when two conditions
exist:

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

2. An exchange has taken place.

These conditions was similarly indicated under PAS NO. 18, 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, Construction Accounting and Franchise Accounting.

II. INSTALLMENT SALES

Generally Accepted Accounting Principles states that the instalment method of accounting for sales is not
acceptable unless circumstances exist such that collection of sales price is “not reasonably assured”. GAAP
also permits use of the instalment sales method when receivables are collected over an extended period of
time, and when there is no reasonable basis for estimating the degree of collectibility. It requires that
revenue be recognized at the time of collection. The instalment sales method allows revenue to be deferred
and recognized each year in proportion to the receivables collected during that year. Receivable accounts
and deferred profit accounts must be kept separately for each year because the profit rate will often vary
from year to year.

A. Determining Gross Profit Rates:

For Prior Year(s) Sales:

Deferred Gross Profit, beginning of current year

Installment Accounts Receivable, beginning of current year

For Current Year:

Gross Profit
Installment Sales

B. Recognition of Gross Profit Under Instalment Sales Method

Prior Year(s) Current Year

Instalment A/R, beginning of the
current year (Instalment Sales –
current year) P xxx P xxx
Less: Instalment A/R, end of the
current year xxx xxx
Decrease in Instalment A/R P xxx P xxx
Less: Defaults, unpaid balance (if any) xxx xxx
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 Collections in current year P xxx P xxx
Multiply by: GP rate (based on sales) xx% xx%
RGP on Instalment Sales for the
current year P xxx P xxx

C. Determining Deferred Gross Profit, End of the Year:

Instalment A/R, end of the current year P xxx

Multiply by: GP rate (based on sales) xx%
Deferred GP, end of the current year P xxx

Or, alternatively:

Deferred GP before adjustment for RGP P xxx

Less: Realized Gross Profit on instalment sales xxx
Deferred Gross Profit, end of the current year P xxx

D. Determining gain or loss on repossession:

Estimated Resale Price after Reconditioning cost P xxx

Less: Reconditioning Costs P xxx
Normal Profit xxx
Cost to sell xxx xxx
Fair Market Value/True worth of Repossessed
Merchandise P xxx
Less: Unrecovered Cost:
Instalment Accounts Receivable, unpaid balance P xxx
Less: Deferred Gross Profit xxx xxx
Gain or (loss) on repossession P xxx

E. Determining Over or Underallowance of Trade-in Merchandise:

Trade-in allowance P xxx

Less: FMV/ True worth of Trade – in Merchandise:
Estimated resale price after
reconditioning cost P xxx
Less: Reconditioning costs xxx
Normal Profit xxx
Cost to sell xxx xxx
Over or (under) allowance P xxx

(For items 1 to 5)
The Karol Company accounts for its sales on the instalment sales basis. At the beginning of 2008, ledger accounts include
the following account balances:
Installment Accounts Receivable, 2006................................................. P 90,000
Installment Accounts Receivable, 2007................................................. 288,000
Deferred Gross Profit, 2006................................................................... 37,800
Deferred Gross Profit, 2007................................................................... 108,000

At the end of 2008 account balances before adjustment for realized gross profit on instalment sales are:
Installment Accounts Receivable, 2006................................................. P -0-
Installment Accounts Receivable, 2007................................................. 72,000
Installment Accounts Receivable, 2008................................................. 390,000
Deferred Gross Profit, 2006................................................................... 37,800
Deferred Gross Profit, 2007................................................................... 103,050
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 markup of 30% of sales and credit sales of P200,000 at a markup of 32%. During 2008 upon default in
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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 repossession.

Determine the:
1. 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.

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

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

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

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

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

5. Realized gross profit in instalment sales in 2008 for 2008 sales.

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

6. Assuming that Karol Company wants 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 payment of 40%. Compute the realized gross profit on the subsequent instalment sale:
a. P850 b. P812 c. P650 d. P520

7. Since there is no reasonable basis for estimating the collectibility, the Gwapito Appliance Company uses
the instalment method of recognizing revenue for the following sales:
2007 2008
Sales P225,000 P337,500
Collections from:
2007 sales 75,000 37,500
2008 sales -0- 112,500
Defaults:
2007 sales 7,500 15,000
2008 sales -0- 30,000
Accounts written-off:
2007 sales 18,750 56,250
2008 sales -0- 18,750
Gross profit percentage 30% 40%

What amount should Gwapito Appliance Co. report as deferred gross profit, ending balance in its
December 31, 2008 balance sheet?
a. P123,750 b. P93,750 c. P75,000 d. P70,500

Franchise Accounting
Franchise
A franchise agreement involves the granting of business rights by the franchisor to the franchisee who will
operate the franchise outlet in a certain geographical area or location.

Types of Franchise Fee:

1. Initial franchise fee. The initial franchise fee is a consideration for the establishment of franchise
relationship providing some initial services. These services are as follows:
a. Assistance in site selection (analyzing location and negotiating lease)
b. Evaluation of potential income.

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 c. Supervision of construction activity (obtaining financing, designing building, and supervising contractor
on the on-going construction)
d. Assistance in the acquisition of signs, fixtures, and equipment.
e. Provision of bookkeeping and advisory services (setting up franchisee’s records, advising on income, real
estate, other taxes local regulations, etc.)
f. Provision of employee and management training.
g. Provision of quality control
h. Provision of advertising and promotion

When is Initial Franchise Fee Recognized as Revenue?

Initial franchise fee is recognized as revenue only when the franchisor makes substantial performance of the services it
is obligated to perform and collection of the fee is reasonably assured.

Substantial performance occurs only when the franchisor has no remaining obligation to refund any cash received or
excuse any non-payment of a note and has performed all the initial services required under the contract. The
commencement of operations by the franchisee shall be presumed the earliest point at which substantial performance
has occurred, unless it can be demonstrated that substantial performance of all obligations, including services
voluntarily, has occurred before that time.

2. Continuing Franchise fee. Continuing franchise fee is a fee received in return for the continuing rights
granted by the franchise agreement and providing such services such as management training, advertising,
and promotion.

When is Continuing Franchise Fee recognized as Revenue?

Continuing franchise fee should be recognized as revenue when they are earned, unless a portion of them has been
designated for a particular purpose such as providing a specified amount for advertising, building maintenance. In that
case, the portion deferred shall be an amount sufficient to cover the estimated costs in excess of continuing franchise
fees and provide a reasonable profit from continuing services.

3. Bargain Purchases. In addition to paying continuing franchise fees, franchisees frequently purchase or all of
their equipment and supplies from the franchisor at an amount normally lower than the prevailing market
price. The franchisor would account for these sales as a regular product sales.

4. Commingled Revenue. It refers to a single initial franchise fee for franchise rights, initial services, tangible
property such as supplies and equipment.

5. Option to Purchase the Franchise Outlet. A franchise agreement may give the franchisor an Option to
Purchase the franchisee’ business. If it is probable at the time the option is given that the franchisor will
ultimately (or certain to) purchase the outlet, then the Initial Franchise Fee should not be recognized as
revenue, but should be recognized as liability. When the option is exercised, and the franchisor acquires the
franchisee, the liability would reduce the franchisor’s investment in the outlet.

Problem 1

On December 31, 2010, Reyna authorized Naldo to operate as a franchisee for an initial franchise fee of P270,000. Of
this amount, P108,000 was received upon signing the agreement and the balance is represented by a note due in three
annual payments of P54,000 each beginning December 31, 2011. The present value on December 31, 2010, for the three
annual payments appropriately discounted is P129,600. According to the agreement, the non-refundable down payment
represents a fair measure of the services already performed by Reyna and future services are still to be rendered.
However, the collectibility of the note is reasonably certain. Reyna’s December 31, 2010, income statement, earned
franchise fee from Naldo’s franchise should report as:
a. P -0- c. P129,600
b. P108,000 d. P237,600

Problem 2

Flapper Jack’s Pancake Restaurants Inc. sells franchise for an initial fee of P36,000 plus operating fee of P500 per month.
The initial fee covers site selection, training, computer and accounting software, and on-site consulting and

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troubleshooting, as needed, over the first five years. On March 15, 2010, Tim Cruise signed a franchise contract, paying
the standard P6,000 down with the balance due over 5 years with interest.

1. Assuming that the initial services to be performed by Flapper Jack’s subsequent to the signing are substantial
and that collection of the receivable is reasonably assured, the journal entry required at signing would include a
credit to:
a. Unearned franchise fee revenue for P36,000.
b. Unearned franchise fee revenue for P30,000.
c. Franchise fee revenue for P36,000.
d. Franchise fee revenue for P6,000.

2. Assume that at the time of signing the contract, collection of the receivable was assured and that service
obligations were substantial. However, by October 20, 2010, substantially all continuing obligations had been
met. The journal entry required at October 20, 2010 would include a:
a. Credit to franchise fee receivable for 27,000
b. Debit to unearned franchise fee revenue for P36,000
c. Credit to franchise fee revenue for P9,000
d. Debit to unearned franchise fee revenue for P27,000

3. Assume at March 15, 2010, the time of signing the contract, collectibility of the receivable was reasonably
assured and there were no significant continuing obligations. The journal entry at signing would include a:
a. Credit to franchise fee revenue for P36,000.
b. Credit to franchise fee revenue for P9,000
c. Credit to unearned franchise fee revenue for P36,000
d. Credit to unearned franchise fee revenue for P27,000

Problem 3
Each of Goldylocks Inc., 21 new franchisees contracted to pay an initial franchise fee of P30,000. By December 31, 2009,
each franchisee had paid a non-refundable P10,000 fee and signed a note to pay P10,000 principal plus the market rate
of interest on December 31, 2010, and December 31, 2011. Experience indicates that one franchisee will default on the
additional payments. Services for the initial fee will be performed in 2010. What amount of net unearned franchise fees
would Silverlocks report at December 31, 2009?
a. P400,000 c. P610,000
b. P600,000 d. P630,000

Problem 4

Criselda Company sells a franchise that requires an initial franchise fee of P70,000. A down payment of P20,000 cash is
required with the balance covered by the issuance of P50,000, 10% note, payable by the franchisee in 5 equal annual
instalment. Criselda Company also charge the franchisee a continuing franchise fee of P9,000. Compute the franchise
revenue – continuing franchise at the time of receipt of P9,000: (1) if the fee is earned for providing continuing services;
(2) if P1,000 of the fee is for national advertising that is still to be rendered:
a. (1) P -0-; (2) P -0- c. (1) P9,000; (2) P8,000
b. (1) P9,000; (2) P9,000 d. (1) P -0- ; (2) P8,000

Problem 5

Sweet, Inc. charges P90,000 for a franchise, with P18,000 paid when the agreement is signed and the balance in four
annual payments. The present value of the annual payments, discounted at 9%, is P58,315. The franchisee has the right
to purchase P20,000 of equipment for P16,000. If the collectibility of the payments is reasonably assured, and
substantial performance by Sweet, Inc has occurred, the amount of revenue from franchise fees that should be
recognized is:
a. P72,000 c. P76,315
b. P72,315 d. P90,000

Problem 6

Pizza Hut, Inc. grants a franchisee to Ms. Conrad for an initial franchise fee of P2,000,000. The agreement provides that
Pizza Hut, Inc. has the option to purchase within one year to acquire franchisee’s business and it seems certain that Pizza
Hut, Inc. will exercise the option. On Pizza Hut, Inc.books, how should the initial franchise fee to be recognized?
a. Deferred revenue and to be amortized
b. Realized revenue
c. Extraordinary revenue
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 d. Deferred revenue and treated as reduction from Pizza’s investment when the option is exercised.

Problem 7

On January 2, 2012, Nyalyn got the franchise of Rickey Inc. a known steak house of upscale patronage. The franchise
agreement required a P500,000 franchise fee payable P100,000 upon signing of the franchise and the balance in four
annual instalments starting December 31, 2012. At present value using 12% as discount rate, the four instalments would
approximate P199,650. The fees once paid are not refundable. The franchise may be cancelled subject to the provisions
of the agreement. Should there be unpaid franchise fees attributed to the balance of main fee (P500,000), same would
become due and demandable upon cancellation. Further, the franchisor is entitled to a 5% fee on gross sales payable
monthly within the first ten days of the following month.

The note receivable for the balance of the franchise fee was guaranteed by the Metro Bank.

The first year of operations yielded gross sales of P9 million. On December 31, 2012, Rickey Inc. earned franchise fee is:
a. P550,000 c. P749,650
b. P650,000 d. P950,000

Construction Contract

PAS No.11 defines construction contract as a contract specifically negotiated for the construction of an asset or
combination of assets that are closely interrelated of interdependent in terms of their design, technology or function or
their ultimate purpose or use.

Two types of Construction Contract or Contract Price:

1. Fixed Price Contract- is a construction contract in which the contractor agrees to a fixed contract price, or a
fixed rate per unit of output, which in some cases is subject to cost escalation clauses.
2. Cost-plus contract- is a construction contract in which the contractor is reimbursed for allowable or otherwise
defined costs, plus a percentage of these costs or a fixed fee.

Method of Recognizing Revenue in Construction Accounting:

A. Percentage-of-completion method- when the outcome of the construction contract can be estimated
reliably, contract revenue and costs associated with the contract should be recognized as revenue and
expenses, respectively, by reference to the stage of completion of the contract activity at the balance sheet
date.

Measuring Stage of Completion. The stage of completion of a contract may be determined in a variety of
ways. The enterprise uses the method that measures reliably the work performed. Depending on the nature
of the contract, the methods may include:
a. Input Measure. Input measures are made in relation to the costs of efforts devoted to a contract. They
are based on an established or assumed relationship between a unit of input and productivity.
b. Output Measures. Output measures are made in terms of results achieved. This is based on the
completion of a physical proportion of the contract work. Architects and engineers are sometimes asked
to evaluate jobs and estimate what percentage of a job or contract is complete.
B. Cost recovery method of Construction Accounting. This method is used when the outcome of the
construction contract cannot be reliably estimated, then:
a. Revenue should be recognized only to the extent of the contract costs incurred that it is probable will be
recoverable; and
b. Contract costs should be recognized as an expense (costs of construction) in the period in which they are
incurred.

Recognition of Expected or Anticipated Losses

When it is probable that total contract costs will exceed total contract revenue, the expected (anticipated) losses should
be recognized as an expense (or loss) immediately. The amount of such loss is determined irrespective of:
1. Whether or not the work has commenced on the contract;
2. The stage of completion of contract activity; or
3. The amount of profits expected to arise on other contracts which are not treated as a single construction
contract.

Problem 1
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On February 1, 2009, SHEKISS Construction Company obtained a contract to build an athletic stadium. The stadium was
to be built at a total cost of P10,800,000 and was scheduled for completion by September 1, 2011.One clause of the
contract stated that SHEKISS was to deduct P30,000 from the P13,200,000 billing price for each week that completion
was delayed. Completion was delayed six weeks, which resulted in a P180,000 penalty. Below are the data pertaining to
the construction period.
2009 2010 2011
Costs incurred each year P3,564,000 4,136,000 3,300,000
Estimated cost to complete 7,236,000 3,300,000 -0-
Progress billings each year 3,600,000 4,200,000 5,220,000
Cash collection to date 3,600,000 7,740,000 13,020,000
Operating expenses 200,000 180,000 140,000

For each year show how the details related to this contract would be disclosed on the balance sheet and on the income
statement:

Percentage-of-completion Method:
1. In its December 31 yearly income statement, the recognize revenue would be:
2009 2010 2011
a. 4,356,000 4,884,000 3,780,000
b. 2,400,000 2,200,000 2,020,000
c. 3,564,000 4,136,000 3,300,000
d. -0- -0- 13,020,000

2. In its December 31 yearly income statement, the Construction Cost (cost incurred):
2009 2010 2011
a. 10,800,000 11,000,000 11,000,000
b. 3,564,000 7,700,000 11,000,000
c. 3,564,000 4,136,000 3,300,000
d. -0- 7,700,000 11,000,000

3. In its December 31 yearly income statement, the gross profit would be:
2009 2010 2011
a. -0- -0- 2,020,000
b. 792,000 1,540,000 2,020,000
c. 2,400,000 2,200,000 2,020,000
d. 792,000 748,000 480,000

4. In its yearly income statement, the net income (loss) would be:
2009 2010 2011
a. 792,000 748,000 480,000
b. 592,000 568,000 340,000
c. 530,000 640,000 800,000
d. (200,000) (180,000) 1,880,000

5. In its December 31 balance sheet, the Construction-in-progress account would be:

2009 2010 2011
a. 10,800,000 11,000,000 11,000,000
b. 4,356,000 4,384,000 3,780,000
c. 4,356,000 9,240,000 13,020,000
d. -0- 7,700,000 11,000,000

Cost recovery Method of Construction Accounting (Zero-profit approach)

1. In its December 31 yearly income statement, the recognize revenue would be:
2009 2010 2011
a. 4,356,000 4,884,000 3,780,000
b. 2,400,000 2,200,000 2,020,000
c. 3,564,000 4,136,000 5,320,000
d. -0- -0- 13,020,000

2. In its December 31 yearly income statement, the Construction Costs (cost incurred):
2009 2010 2011
a. 10,800,000 11,000,000 11,000,000
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 b. 3,564,000 7,700,000 11,000,000
c. 3,564,000 4,136,000 3,300,000
d. -0- 7,700,000 11,000,000

3. In its December 31 yearly income statement, the gross profit would be:
2009 2010 2011
a. -0- -0- 2,020,000
b. 792,000 1,540,000 2,020,000
c. 2,400,000 2,200,000 2,020,000
d. 792,000 748,000 480,000

4. In its December 31 yearly income statement, the net income (loss) would be
2009 2010 2011
a. 792,000 748,000 480,000
b. 592,000 568,000 340,000
c. 530,000 640,000 800,000
d. (200,000) (180,000) 1,880,000

5. In its December 31 balance sheet, the Construction-in-progress account would be:

2009 2010 2011
a. 3,564,000 7,700,000 13,020,000
b. 4,356,000 4,384,000 3,780,000
c. 4,356,000 9,240,000 13,020,000
d. -0- 7,700,000 11,000,000

Problem 2
In 2009, PJD Construction Corporation began construction work under a 3-year contract. The contract price was
P4,000,000. PJD uses the percentage-of-completion method for financial accounting purposes. The income to be
recognized each year is based on the proportion of costs incurred to total estimated costs for completing the contract.
The financial statement presentation relating to this contract at December 31, 2009 was as follows:

Balance Sheet
Accounts Receivable- construction contract billings P86,000
Construction-in-progress P260,000
Less: Contract Billings 246,000
Cost of uncompleted contract in excess of billings 14,000

Income Statement
Gross profit (before tax) recognized in 2009 72,800

Required:
1. How much was collected in 2009 on this contract?
a. 14,000 c. 160,000
b. 86,000 d. 246,000
2. What was the initial estimated gross profit before tax on this contract?
a. 72,800 c. 260,000
b. 187,200 d. 1,120,000
3. What is the percentage of completion for the year ended?
a. 6.50% c. 28.00%
b. 13.00% d. 100.00%
4. What is the gross profit rate on the contract?
a. 6.50% c.28.00%
b. 13.00% d. 100.00%
5. What is the recognized revenue to date at the end of 2009?
a. 72,800 c. 260,000
b. 187,200 d. 1,120,000
6. What is the recognized revenue in 2009?
a. 72,800 c. 260,000
b. 187,200 d. 1,120,000

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