ACCOUNTING FOR SPECIAL TRANSACTIONS - REVIEWER

INSTALLMENT SALES (CHAPTER 8)

Installment sales contract is a special type of credit arrangement which provides for a series of
payments over a period of months of years.

ACCOUNTING PROCEDURES UNDER INSTALLMENT METHOD

1. Installment sales of conventional merchandise
2. Installment sales of real estate
a. By a non-dealer (Casual sales)
b. By a dealer

Takeaway notes:
- Installment plans exposes the seller to a greater risk of non-collection
- In view of the greater risk of non-collection, the seller can repossess the property/merchandise
- The installment period should also be made as short as possible

Gross Profit Recognition under Installment Sales Method

When there is uncertainty as to the collectability of the sales price, generally accepted
accounting principle requires that revenue recognition should await the actual receipt of cash. The
most commonly applied method of dealing with the uncertainty of cash collections is the installment
sales method. Under this method of accounting, the recognition of gross profit is deferred until cash is
collected. Each cash collection on a contract is regarded as including both a return of cost and a
realization of gross profit in their ratio to the selling price.

Note: Revenue recognition

Regular Sale ----------- Upon delivery
Installment Sales ------------ Upon collection
Long-term construction contract -------------- Upon production

COST RECOVERY METHOD – Gross Profit is not recognized until collections are equal to the
amount of cost of goods sold. In other words, after collecting the interest and principal portions,
all collection in excess of it are regarded as realization of gross profit.

GROSS PROFIT REALIZATION METHOD – Gross profit is being recognized first before the cost of
goods sold.

INSTALLMENT METHOD – In every cash collection, both cost and gross profit is realized in
proportion to their ratio.

UNPAID BALANCE OF THE RECEIVABLE REPRESENTS TO A REPOSSESSED MERCHANDISE – aside

from deducting the ending balance of ICR to the Beginning balance of ICR, unpaid balance of the
receivable is deducted from the total credit of the year in which the repossessed merchandise
was sold.
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Installment Sales of Merchandise – Pro-Forma Entries

1. Upon Sale
Installment contracts receivable xx
Installment sales xx

2. Year-end adjusting/closing entries

Installment sales xx
Cost of installment sales xx
Deferred gross profit xx

Recognition of gross profit

Deferred gross profit xx
Realized gross profit (collection x GPR) xx

To close the balance of Realized Gross Profit

Realized gross profit xx
Income summary xx

CALCULATIONS
Deferred Gross Profit or Unrealized Gross Profit
DGP = Selling Price – Cost of Sale

Cash collection
CC = Beginning balance ICR – Ending balance ICR
CC = Beginning Balance ICR xx
Less: Ending balance ICR (xx)
Any unpaid balance at the time of repossession (xx)

Gross Profit Rate (GPR)

GPR = (Gross profit/ Installment sales)
GPR = (Deferred gross profit, beginning/ Installment contract receivable, beginning)
GPR = (Deferred gross profit, ending/ Installment contract receivable, ending)

Realized Gross Profit (RGP)

RGP = (GPR x Collection)
RGP = (DGP, beginning – DGP, ending)

Net Income (Regular and Installment Sales

Sales xx
Cost of goods sold (xx)
Gross Profit – regular sale xx
Realized GP – Installment sales xx
Total Gross Profit xx
Operating Expense (xx)
Operating Income xx
Interest Income xx
Net Income xx
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ILLUSTRATIVE PROBLEM (DGP, GPR, RGP)

PROBLEM #1
Regular account 207,500
2023 installment accounts 16,250
2024 installment accounts 90,000
Deferred Gross Profit (before adj.) 38,000

Sales on an installment basis in 2023 were made at 30% above cost, in 2024, at 33 1/3 above cost.
Expenses paid was 1,500 relating to installment sales. How much is the net income on installment sales?

SOLUTION:
Deferred Gross Profit 38,000
Less: Uncollected profit
2023: 16,250 x (30%/ 130%) 3,750
2024: 90,000 x (33.33%/133.33%) or 25% 22,500 26,250
11,750
Less: expense related to installment sales (1,500)
Net income on installment sales 10,250

PROBLEM #2
London Company, which began business on January 1, 2024, approximately uses the installment sales
method of accounting. The following data are available for 2024:

Installment accounts receivable, 12/31/24 200,000

Deferred gross profit, 12/31/24
(Before recognition of realized GP) 140,000
Gross profit on sales 40%

The cash collections and the realized gross profit on installment sales for the year ended December 31,
2024 should be:

SOLUTION:
Deferred gross profit 140,000
Divided by: Gross Profit rate on sales 40%
Installment accounts receivable beg 350,000 - ICR Beginning

ICR beginning 350,000

Less: ICR ending 200,000
Cash collection for 2024 150,000

Cash collection for 2024 150,000

Multiply: GPR 40%
Realized Gross Profit 2024 60,000

Defaults and Repossessions

1. When a buyer fails to make any further installment payments, the seller may:
a. Repossess the merchandise or property sold
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b. Recondition the merchandise, and

c. Resell the merchandise to recover the loss on the original sale

2. Repossessed merchandise is recorded at market value or net realizable value

Estimated resale price xx

Less: reconditioning cost and normal profit margin (xx)
Net realizable value xx

3. The uncollected installment receivable balance pf the defaulted contract is cancelled.

4. The balance of the deferred gross profit pertaining to the uncollected receivable is written off.
5. The resulting gain or loss on repossession is determined:

Fair Market Value or Net Realizable Value xx

Less Unrecovered cost: Installment contract receivable xx
Less Deferred gross profit (xx) (xx)
Gain (Loss) on repossession xx

ILLUSTRATIVE PROBLEM (REPOSSESSED MERCHANDISE)

Gross Profit Rate = 5,600/16,000

= 0.35 or 35%

Installment Contract Receivable 7,000

Deferred Gross Profit 2,450 (7,000 x .35)
Unrecovered Cost 4,550

Estimated Retail Price 6,000

Reconditioning Cost (1,500)
Commission (10% x 6,000) (600)
Net Realizable Value 3,900

NRV 3,900
Unrecovered Cost (4,550)
Loss on Repossession 650

Trade-Ins

1. Part of down payment

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2. Recorded at the actual value (same as FMV of repossessed merchandise)

Estimated resale price xx

Less: Expected reconditioning cost and normal profit margin (xx)
Actual value xx

3. Trade-in value allowed to customer is compared with actual value.

The excess of trade-in value over the actual value is an overallowance which must be
from selling price of new merchandise

4. Pro-forma entry:
Cash xx
Merchandise inventory – trade in xx
Installment contract receivable xx
Installment sales xx

ILLUSTRATIVE PROBLEM (TRADE-INS)

PROBLEM #1

M co. employs the perpetual inventory basis in its accounting for new cars. On August 15, 2021, a new
car was sold to Rex Conde with a list price of 220,000 costing 165,000. It granted Mr. Conde an
allowance of 85,000 for his old car as trade-in, the current value of which was estimated to be 81,700.
The balance of 135,000 was payable as follows:
Cash at time of purchase 35,000
Balance in 20 monthly payments of 5,000

First payment being made on September 1, 2021. On April 1, 2022, Mr. Conde defaulted in the payment
of March 1, 2022 installment. The new car sold was repossessed; its value to the seller is 40,000. (Use
two decimal places for gross profit percentage)

Compute for the total realized gross profit on installment sales in 2021 and gain (loss) on repossession in
2022.

SOLUTION:
Trade-In allowance 85,000
Current value of old-car or NRV 81,700
Over allowance 3,300

List price 220,000

Over allowance (3,300)
List price without allowance 216,700 100%
Cost of new car (165,000) 76.14%
Deferred Gross Profit 51,700 23.86%

Gross Profit Rate

(Gross Profit/LP without allowance) (51,700/ 216,700) = 23.86%
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COMPUTATION FOR REALIZED GROSS PROFIT (2021)

Current Value of old car 81,700

Cash payment 35,000
Installment (Sep. – Dec 31,2021) 20,000
Total collection 136,700

Realized gross profit 2021 = 136,700 x 23.86%

Realized gross profit 2021 = 32,617

COMPUTATION FOR GAIN (LOSS) ON REPOSSESSION

List Price without allowance 216,700

Less: Total cash collection 2021 136,700
Less: Collection 2022 (Jan. – Feb.) 10,000
Uncollected 70,000

Uncollected 70,000
Less: Uncollected Gross Profit
(70,000 x 23.86%) (16,702)
Uncollected cost 53,298

Net Realizable Value 40,000

Less: Uncollected cost (53,298)
Loss on repossession (13,298)

NOTE: Always remember that in installment sales interest income is different form the deferred gross
profit recognition. Good luck on your studies!! PADAYON FUTURE CPA-LAWYER <3
 ACCOUNTING FOR SPECIAL TRANSACTIONS - REVIEWER

LONG TERM CONSTRUCTION CONTRACTS (CHAPTER 9)

LONG TERM CONSTRUCTION CONTRACTS

The Revenue Recognition Principle

The revenue recognition principle dictates that revenue be recognized when the earning process
is complete or virtually complete and an exchanged transaction has taken place. Revenue is therefore
typically recognized when the firm delivers goods, performs services, or as time passes (as in the case of
interest revenue or rent revenue). There are other points in the operating cycle where revenue could be
recognized. Revenue could be recognized as production takes place, when production is completed, or
as cash is collected from the customer. Although the revenue recognition principle sets the general rule,
there are circumstances where revenue is recognized prior to delivery.

Revenue Recognition Prior to Delivery

Firms may justify recognizing revenue prior to delivery when the selling price of the product has
been reasonably assured, the firm has a reasonable basis for knowing or estimating the cost of the
product, and there is a good reason to expect that the price will be collected. Revenue from long-term
construction products may be recognized as production takes place (percentage of completion).

Construction Contract
PAS No. 11 defines construction contract as a contract specifically negotiated for the
construction of an asset or a combination of assets that are closely interrelated or 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.

Types of Contract Costs

1. COST INCURRED TO DATE
- These include precontract costs and costs incurred after contract acceptance

Precontract costs – are costs incurred before a contract has been entered into, with expectation that
the contract will be accepted and these costs are recoverable through billings.

The criteria for such costs are:

a. Capable of being identified
b. Can be measured reliably
c. Probable that the contract will be obtained

Cost incurred after contract acceptance – are costs incurred toward the completion of the project and
are also capitalized in the Construction in Progress (CIP) account.
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Note: Precontract costs become contract costs incurred to date when the has been accepted.
However, if the precontract costs are already recognized as expense in the period in which they are
incurred, they are not included in the contract costs once the contract is obtained and accepted.

2. ESTIMATED COSTS TO COMPLETE

- Anticipated cost of materials, labor, subcontracting costs, and indirect costs (overhead)
required to complete a project at a scheduled time.

Note: Construction in Progress normally include both direct and indirect costs but usually not
include general and administrative expenses or selling expenses since they are not normally
identifiable with a particular contract and should therefore be expensed.

SUBCONTRACTOR COSTS
- Principal contractor will hire other contractors to perform part of the construction project.
- The amount billed to the principal contractor for work done by the subcontractor should be
included in contract costs.
- The amount billed is directly traceable, therefore included in the CIP amount.

COMBINING AND SEGMENTING CONTRACTS

Combining Contracts
- A group of contracts may be combined if:
o Are negotiated as a single package
o Closely interrelated construction activities, in effect, part of a single project with an
overall profit margin
o Are performed concurrently or in a continuous sequence

Segmenting a contract
- Breaking up a larger unit into smaller units for accounting purposes
o The contractor has submitted separate proposals on the separate component of the
project
o Each asset has been subject to separate negotiation and the contractor and customer
had the right to accept or reject part of the proposal relating to single asset
o The cost and revenues of each asset can be separately identified

Method of Recognizing Revenue in Construction Accounting

1. 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 using any of the following methods:

a. Input Measures (Cost-to-cost method). The proportion that contract costs incurred for
work performed to date bear to the estimated total contract costs. This is the most
popular method whereby the basis of measurement is the ratio of cost incurred to date to
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the total estimated cost.

b. Output Measures (Unit of delivery). The progress is based on the results.
i. Surveys of work performed (architect’s or engineer’s estimates).
ii. Completion of a physical proportion of the contract work (architect’s or engineer’s estimates).

Steps in Using Percentage of Completion Method

Under the percentage of completion method, revenue is recognized as production takes place.
At the end of each accounting period, the construction company will determine the percentage of
completion of the product. An estimate of final gross profit (contract price minus estimated total
construction costs) is made. Gross profit recognized for the period is the difference between total gross
profit earned to date and gross profit already recognized in previous periods. Construction costs to date
plus the part of the total gross profit earned to date are accumulated in the inventory account called
Construction in Progress. The steps in using the percentage of completion method are described below.

Step 1. Actual construction costs are accumulated in the inventory account, Construction in Progress.

Step 2. Accounts Receivable is debited, and Contract Billings is credited when the firm bills the customer
for progress payments. The billing account is a contra construction in progress account. The excess of
Construction in Progress account over Contract Billings account is treated as a current asset (due from
customer). If Contract Billings account is more than Construction in Progress account, the excess is
reported as a current liability (due to customer).

Step 3. Cash collected is credited to Accounts Receivable and debited to Cash.

Step 4. At the end of each period the cumulative amount of gross profit earned to date on the contract
is estimated.

Gross Profit Earned to Date = Percentage of Completion x (Contract Price – Estimated Total Costs)

Step 5. Gross Profit to be recognized for the accounting period equals to gross profit earned to date
minus gross profit recognized in previous periods. The gross profit for the period is debited to
Construction in Progress and credited to Contract Revenue. The balance in Construction in Progress is
equal to total construction costs to date plus recognized profit earned to date. Construction revenue
equals current period construction costs plus gross profit recognized for the period.

The entry to recognize revenue

Cost of Construction XX
Construction in Progress XX
Construction Revenue. XX

(Amount debited to Construction in Progress is the current period gross profit computed applying
percentage of completion)

Step 6. When the contract is completed and fully billed, the debit balance in Construction in Progress
will be identical to the credit balance in Contract Billings. The entry to close out the project debits the
Contract Billings account and credit the Construction in Progress account.
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2. Zero Profit Method/Cost Recovery Method of Construction Accounting. This method is used when
the outcome of the construction contract cannot be reliably estimated. It is recommended for cost-plus
contracts.
a. Revenue should be recognized only to the extent of the contract costs incurred
that 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 the total contract costs will exceed total contract revenue, the
expected (anticipated) loss 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 number of profits expected to arise on other contracts which are not treated as a single
construction contract.