Installment Sales

An installment sales contract is a special type of credit arrangement which provides for a series of payments over a period
of months or years. Installment sales are widely used by dealers in real estate, home appliances and cars. Since the seller
must wait for a considerable period of time to collect the full amount, it is customary to provide for interest on the unpaid
balance.

Methods of Gross Profit Recognition on Installment Sales

1. The gross profit is recognized at the time of sale
- Sale on installment is treated exactly the same way as they treat any other sale on account.
- The Account Receivable account is debited and the Sales account is credited for the full price when the sale is made.
- This treatment is not different from that employed for regular sales on credit.
- Gross profit is recognized at the period of sale – the point at which goods have been delivered to the customers and a
definite amount of receivables has been acquired.

2. The gross profit is recognized in installments over the period of the contract on the basis of cash collections
- Gross profit is recognized in the periods in which the installment receivables are collected instead of in the periods in
which receivables are created. The amount of cash collections then becomes the basis for gross profit recognition

a. Cost Recovery Method

- Gross profit is not recognized until collections are equal to the amount of cost of goods sold.
- All collections both interest and principal portions are treated first as recovery of the property costs. After the recovery
of the full cost, all collections are regarded as realization of gross profit.
- This deferral of gross profit until cost is fully recovered is too conservative.
- This method is probably most applicable in the sale of services or products of a nature not permitting repossession and
when the customer notes have no fair market value.

b. Gross Profit Realization Method

- The first collections are regarded as realization of gross profit. After the recognition of the full profit, all subsequent
collections are treated as recovery of cost.
- This method is seldom used since it lacks conservatism.
- It fails to take into consideration the probability that repossession during the life of the contract might impair the gross
profit margin.

c. Installment Method
- Cash collection is regarded as a partial recovery of cost and a partial realization of profit in the same proportion that
these two elements are present in the original selling price.
- This method aims to spread the gross profit in the installment sale over the life of the contract, and to anticipate possible
failure to realize the full amount of gross profit in the event of defaults and repossessions.
- Revenue matches with expenses incurred after the sale.
- This method is frequently used in practice and is acceptable for income tax purposes.

Journal Entries

Installment Receivable xx
Installment Sales xx

Cost of Installment Sales xx

Inventory xx

Cash xx
Installment Receivable xx

Adjusting Entry at Dec. 31

Installment Sales xx
Cost of Installment Sales xx
Deferred Gross Profit xx

Deferred Gross Profit xx

Realized Gross Profit xx
Installment Sales
- Use mark-up based on sales as opposed to mark-up based on cost for computations

GP % Formulas
1. Gross profit / Sales
2. Deferred GP / Installment A/R Balance
a. Deferred GP Beginning of Year / Installment A/R Balance Beginning of Year
b. Deferred GP End of Year / Installment A/R Balance End of Year
c. Deferred GP End of Year (unadjusted) / Installment A/R Balance Beginning of Year
3. Realized GP / Cash Collections

Realized GP from installment sales

1. Cash Collections x GP %
2. Deferred GP end of year – unadjusted xx
Less: Deferred GP end of year – adjusted
(Installment A/R end x GP %) (xx)
Realized GP from installment sales xx

*Total realized GP = GP from regular sales + GP from installment sales

Defaults and Repossession

- When installment sales are not paid in due time (default), repossession must be done to satisfy the remaining debt.

Fair value of the repossessed merchandise xx

Less: unrecovered cost (Installment A/R – Deferred GP) (xx)
Loss on repossession xx

*Note that only loss is recognized and not a gain on repossession.

*Reconditioning cost on repossessed merchandise is capitalized inventory.

Trade-Ins
- Companies may accept payment in the form of merchandise as part of down payment for installment sales
- Trade-in value = Actual value or fair value of asset received

Trade-in value allowed to customer xx if higher is over allowance

Less: NRV of merchandise
Selling price xx
Reconditioning cost (xx)
Normal profit margin (xx) (xx) if higher is under allowance
Over / Under Allowance xx

Presented below are the information taken from the books of A Company:
2020 2021
Sales:
Regular 125,000 187,500
Installment 62,500 100,000
Cost of goods sold:
Regular 75,000 112,500
Installment 31,250 45,000
Operating expenses 25,000 31,250
Collections on accounts from:
Regular sales 100,000 137,500
Installment sales – 2020 37,500 25,000
Installment sales – 2021 62,500

Requirement:
I. What is the net income for the year ended December 31, 2020?
II. What is the net income for the year ended December 31, 2021?
2020
Regular Sales 125,000
Regular COS (75,000)
Regular GP 50,000

Installment Sales 62,500

Installment COS (31,250)
Installment GP 31,250 50% GP

37,500 x 50% = 18,750 Realized GP

NI for 2020 = 50,000 + 18,750 – 25,000 = 43,750

2021
Regular Sales 187,500
Regular COS (112,500)
Regular GP 75,000

Installment Sales 100,000

Installment COS (45,000)
Installment GP 55,000 55% GP

Collections from 2020 50% x 25,000 = 12,500

Collections from 2021 55% x 62,500 = 34,375
46,875

NI for 2021 = 75,000 + 46,875 - 31,250 = 90,625

SM Appliance Company uses the installment method of accounting. Pertinent data from the company’s records show the
following:
2019 2020 2021
Installment sales 750,000 937,500 900,000
Cost of installment sales 562,500 712,500 630,000
Deferred gross profit, December 31:
2019 141,250 45,000
2020 150,000 30,000
2021 195,000

I. Total cash collections for 2019, 2020 and 2021

II. Total realized gross profit for the years 2019, 2020 and 2021
III. Balance of Installment Accounts Receivable on 2019, 2020 and 2021

Cash Collections
2019 2020 2021
2019 Sales 185,000 385,000 180,000
2020 Sales 312,500 500,000
2021 Sales 250,000
Total 185,000 697,500 930,000

2019 (187,500 - 141,250 = 46,250 RGP / 25% = 185,000 Cash collections)

2019 sales (141,250 - 45,000 = 96,250 RGP on 2020 from 2019 sales / 25% = 385,000 Cash collections)
2019 sales (45,000 / 25% = 180,000 Cash collections)

Realized Gross Profit

2019 2020 2021 Total
2019 Sales 46,250 96,250 45,000 187,500
2020 Sales 75,000 120,000
2021 Sales 75,000
Total 46,250 171,250 240,000
2020 (225,000 – 150,000 = 75,000 RGP from 2020 sales / 24% = 312,500 Cash collections
2020 (150,000 – 30,000 = 120,000 RGP from 2020 sales / 24% = 500,000 Cash collections
2021 (270,000 – 195,000 = 75,000 RGP / 30% = 250,000 Cash collections

Installment Accounts Receivable at Dec. 31

2019 2020 2021
2019 Sales 565,000 180,000 P0
2020 Sales 625,000 125,000
2021 Sales 650,000
Total 565,000 805,000 775,000

2019 750,000 - 185,000 = 565,000

2020 937,500 - 312,500 = 625,000
2020 625,000 - 500,000 = 125,000
2021 900,000 - 250,000 = 650,000

2019 2020 2021

Installment sales 750,000 937,500 900,000
Cost of installment sales (562,500) (712,500) (630,000)
Gross Profit 187,500 225,000 270,000
% of Gross Profit 25% 24% 30%

JJ Company sold goods on installment. For the year just ended, the following were reported:
Installment sales 3,000,000
Cost of installment sales 2,025,000
Collections on installment sales 1,800,000
Repossessed accounts 200,000
Fair value of repossessed merchandise 120,000

The repossession resulted to: gain or (loss)

a. Gain of 5,000 c. No gain, no loss
b. Loss of 80,000 d. Loss of 15,000

Solution
Fair value of repossessed merchandise xx
Unrecovered cost:
Installment contracts receivable xx
Deferred gross profit xx xx
Loss on repossession xx

Fair value of repossessed merchandise 120,000

Unrecovered cost:
Installment contracts receivable 200,000
Deferred gross profit (200,000 x 32.5%) (65,000) 135,000
Loss on repossession (15,000)

GP% = 3M – 2,025,000 = 975,000 / 3M = 32.5%

TMT Company which began operations on January 2, 2021 appropriately uses the installment method of accounting. The
following data pertain to 2021 operations:
Installment sales 900,000
Cost of installment sales 630,000
Regular sales 375,000
Cost of regular sales 215,000
Operating expenses 72,000
Collections (including interest of 24,000) 312,000
Installment accounts written off due to defaults 44,000
Repossessed accounts 100,000
Reconditioning cost 4,000
Fair value of repossessed merchandise 54,000
What is the net income for the year ended December 31, 2021?
a. 151,600 c. 158,400
b. 127,600 d. 165,600

Solution
Installment GP% = 900,000 – 630,000 = 270,000 / 900,000 = 30%
Regular sales 375,000
Cost of regular sales (215,000)
Regular Sales GP 160,000
Earned GP from Installment Sales Collection
(312,000 – 24,000) x 30% 86,400
Interest Income 24,000
Operating expenses (72,000)
Loss on write off due to defaults (44,000 x 70%) (30,800)
Loss on repossession
100,000 x 70% = 70,000 – 54,000 (16,000)
Net Income 151,600