MODULE

7 INSTALLMENT SALES
Week 7

INTRODUCTION
This module demonstrates an understanding about the concept of
installment sales method” of recognizing revenues. At the end of this module, learners
are expected to learn and understand the accounting procedures for installments sales
method, cost recovery and accounting treatment for repossession, and trad-in. This
module also discusses the computation or allocation of cost of goods sold and the
computations of cash collections, gross profit rate and realized gross profit rate.

INTENDED LEARNING OUTCOMES

At the end of this module, student should be able to:

1. State the applicability of the “installment sales method” of recognizing revenues

2. Apply the installment sales method
3. Account for accounting for repossessions and trade-in
4. Compute the deferred gross profit and realized gross profit and rate

LEARNING CONTENT

Introduction

Installment Sales Method

The "installment sales method" is a special case of revenue recognition that deviates from the
revenue recognition principles of PFRS 15. This method may be used for taxation purposes (1) or
when the entity is a "micro entity" (2) and has opted to use the income tax basis " of accounting.
(1) National Internal Revenue Code 'NIRC Sec. 49)
(2) A “micro entity" is an entity that has total assets or total liabilities below (SEC
guideline on SMEs
Accounting procedures

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Under the "installment sales method," the gross profit from an installment sale is initially
deferred and subsequently realized on a piecemeal basis as the installment payments are
received using the formula below:

Realized gross profit = Collection on sale x Gross profit rate

▪ Gross profit based on sales = Gross profit ÷ Sales S=100% COS=80%=GP 20%

▪ Gross Profit based on cost= S=120%,COS 100%= GP=20%

Illustration 1: Journal entries

ABC Co. uses the "installment sales method." On Jan. 1, 20X1 ABC co. sold a bulldozer
costing P600,000 for P1,000,000 payable as follows: 20% down payment and balance
due in 4 equal annual installments every Dec. 31.
Journal entries
Jan. 1, Cash 200,000
20x1 Installment accounts receivable 800,000
Sales 1,000,000
Jan. 1, Cost of sales 600,000
20x1 Inventory 600,000
Dec. 31, Cash (800K/4) 200,000
20x1 Installment accounts receivable 200,000
The realized gross profit in 20x1 is computed as follows:

Down payment – Jan 1, 20x1 200,000

1st installment- Dec 31, 20x1 200,000
Total collections-20x1 400,000
Multiply by: GP rate based on sales (1M-600K)/1M) 40%
Realized gross profit- 20x1 160,000
=======
The adjusting entry to record the deferred gross profit is as follows:
Dec. 31, Income summary 240,000
20x1 Deferred gross profit 240,000

Sales 1,000,000
Cost of Sales (600,000)
Deferred gross profit-beg 400,000
Less: Realized gross profit (160,000)
Deferred gross profit-end 240,000
========
ABC’s Dec. 31, 20x1 financial statements will report the following:

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 Income Statement Balance Sheet

Sales 1,000,000 Assets

Cost of Sales (600,000) Installment accounts receivable 600,000
Deferred gross profit-beg 400,000
Less: Deferred gross profit (240,000) Liabilities
Realized gross profit-end 160,000 Deferred gross profit 240,000
=======

The deferred gross profit, being an unearned income, is classified in the balance sheet as
liability.
The gross profit rate based on sales can also be computed using the following formula
below:

Gross profit rate = Deferred gross profit ÷ Installment account receivable

Gross profit rate = 240,000 ÷600,000
Gross profit rate = 40%

Illustration 2: Two periods

ABC Co. uses the "installment sales method." Information on ABC's transactions during
20x1 and 20x2 is shown below:
20x1 20x2
Installment sales 1,000,000 1,200,000
Cost of sales 600,000 660,000
Gross profit 400,000 540,000
Cash collections from:
20x1 sales 400,000 200,000
20x2 sales 480,000

Requirement: Compute for the total realized gross profit in 20x2.

Solution:
Prices and costs change over time, so an entity may have different gross profit rates each
year. When computing for the realized gross profit, the original gross profit rate in a
particular year of sale is applied to the subsequent collections.
The gross profit rates based on sales are computed as follows:
20x1 20x2
Gross profit 400,000 540,000
Installment sales 1,000,000 1,200,000
Gross profit rates based on sales 40% 45%
===== ======
The realized gross profit in 20x2 is computed as follows:

Collections in 20x2 from:

20x1 sales: (200,000 x 40%) 80,000

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20x2 sales: (480,000 x 45%) 216,000
Total realized gross profit in 20x2 296,000
=======
ADDITIONAL ILLUSTRATIONS:

Illustration 1: Computation of GROSS profit rate

ABC Co. uses the "installment sales method." On January 1, 20x3 ABC Co.'s records show
the following balances:

Installment receivable- 20x1 320,000

Installment receivable- 20x2 960,000
Deferred gross profit – 20x1 70,400
Deferred gross profit- 20x2 230,400

On December 31, 20x3, ABC Co.'s records show the following.

Installment receivable- 20x1 -
Installment receivable- 20x2 384,000
Installment receivable- 20x3 1,200,000
Deferred gross profit –20x1 (before adjustment) 70,400
Deferred gross profit-20x2 (before adjustment) 230,400
Deferred gross profit-20x3 (before adjustment) 750,000

Installment sales in 20x3 were made at 33 1/3% above cost.

Requirements:
a. Compute for the installment sale in 20x3.
b. Compute for the cash collections in 20x3.
c. Compute for the total realized gross profit in 20x3.

Solutions:
Requirement (a): Installment sale in 20x3

Basic formula: GPR based on sales = Gross profit ÷sales

Variation: Sales = Gross profi t÷ GPR based on sales

Deferred gross profit- 20x3 (before adjustment) 750,000

Divide by: Gross profit rate based on sales 25%
Installment sale in 20x3 3,000,000
========

Requirement b: Cash collections

Installment receivable – 20x1, Jan. 1, 20x3 320,000
Less: Installment receivable- 20x1, Dec. 31, 20x3 -
Cash collection 20x3 320,000
Installment receivable – 20x2, Jan. 1, 20x3 960,000
Less: Installment receivable- 20x2, Dec. 31, 20x3 (384,000)
Cash collection 20x3 576,000

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Sale in 20x3 3,000,000
Less: Installment receivable-20x1, Dec. 31, 20x3 (1,200,000)
Cash collection in 20x3 1,800,000
Total collections 2,696,000
=========
Requirement c: Total realized gross profit

Gross profit rate = Deferred gross profit÷ installment account receivable

20x1 20x2
Deferred gross profit- 1/1x3 70,400 230,400
Divide by: Installment receivable- 1/1x3 320,000 960,000
Gross profit rate based on sales 22% 24%
==== ====
The gross profit rate based on sales in 20x3 is 25%

Collections in 20x3 from:

20x1 sales: (320,000x22%) 70,400
20x2 sales (576,000x24%) 138,240
20x3 sales: (1.8M X 25%) 450,000
Total realized gross profit in 20x3 658,640
======
Illustration 2: Realized gross profit

On Dec. 31, 20x3, ABC Co.'s records show the following:

Deferred gross profit (before year-aid adjustments) 1,050,800
Installment receivable - 20x2 384,000
Installment receivable - 20x3 1200,000

Gross profit rate in 20x2 is 24% based on sales, while gross profit rate in 20x3 is 33
1/3% based on cost.

Requirement: Compute for the realized gross profit in 20x3.

Solution:
Gross profit rate = Deferred gross profit ÷ Installment account receivable

Variation:
Installment account receivable X gross profit rate = DGP
Formula: DGP, beg. — Realized gross profit = DGP, end.
Variation: DGP, beg. — DGP, end. = Realized gross profit

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DGP (before year-end adjustments) 1,050,800
LES.' DGP (after year-end adjustments):
Installment receivable, 20x2 x GPR (384K x 24%) 92,160
Installment receivable,20x3 x GPR
[1.2M x (33½ %+ 1331/3%)] or (1.2M x 25%) 300,000 392,160
Decrease in DGP - Realized gross profit in 20x3 658,640

Illustration 3: Reconstruction of information

ABC Co. has the following information:

20x1 20x2
Installment sales ? ?
Cost of sales 1,560,000 1,824,000
Installment receivable-20x1 800,000 320,000
Installment receivable-20x2 960,000
Gross profit rates based on sales 22% 24%

Requirement: Compute for the total realized gross profit in 20x2.

Collections in 20x2 from:
20x1 sales: (480,000 X 22%) 105,600
20x2 sales: (1,440,000 x 24%) 345,600
Total realized gross profit in 20x2 451, 200

Illustration 4: Reconstruction of information

ABC Co.'s records show the following information
20x1 20x2
Deferred gross profit (adjusted ending balances): 176,000 70,400
from 20x1 sale
230,400
from 20x2 sale 22% 24%
Gross profit rates based on sales
Cash collections from:
20x1 sales 1,200,000 480,000
20x2 sales
1,440,000

Requirements: Compute for the following”

a. Balances of installment receivables on December 31, 20x2.
b. Installment sales in 20x1 and 20x2.

Solutions:
Formula: Gross profit rate = Deferred gross profit ÷ Installment account receivable
Installment account receivable
Variation: Installment account receivable = DGP ÷ Gross profit rate

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Deferred gross profit - 20x1 sale, Dec. 31, 20x2 70,400
Divide by: Gross profit rate in 20x1 22%
Installment receivable - 20x1, Dec. 31, 20x2 — Reqt. (a) 320,000
Add back: Collections (1,200,000 in 20x1 + 480,000 in 20x2) 1,680,000
Installment sale - 20x1 — Requirement (b) 2,000,000

Deferred gross profit - 20x2 sale, Dec. 31, 230,400

Divide by: Gross profit rate in 20x2 24%
Installment receivable - 20x2, Dec, 31, 20x2 — Reqt.(a) 960,000
Add back: Collections from 20x2 sales 1,440,000
Installment sale-20x2-Requirement b 2,400,000

Illustration 5: Deferred gross profit

ABC Co.'s records show the following:
20x1 20X2
Installment sales 2,000,000 2,400,000
Cost of sales 1,560,000 1,824,000
Cash collections from:
20x1 sales 1,200,000 480,000
20x2 sales 1,440,000

Requirement: Compute for the total deferred gross profit on Dec. 31, 20x2

Solution:
Formula: Gross profit rate = Deferred gross profit ÷ Installment account receivable
Variation: Installment account receivable X gross profit rate = DGP
Gross profit rate in 20x1: I(2M -1.56M) ÷ 2M] 22%
Gross profit rate in 20x2: [(2.4M-1.824M) ÷ 2.4M] 24%

Installment sale-20x1 2,000,000

Cash collections (1,200,000 add 480,000) (1,680,000)
Installment Receivable-20x1, Dec. 31, 20x2 320,000
Multiply by: Gross profit rate in 20x1 22%
Deferred gross profit-20x1, dec. 31, 20x2 70,400

Installment sale-20x2 2,400,000

Cash collections (1,440,000)
Installment receivable-20x2 Dec. 31, 20x2 960,000
Multiply by: Gross profit rate in 20x2 24%
Deferred gross profit-20x2 Dec. 31, 20x2 230,400
Total deferred gross profit- Dec. 31, 20x2 300,800
==============
Illustration 6: Cash collection
ABC Co. has the following collection policy on its installment sales:
• 20% down payment
• Balance due as follows: 50% in the year of sale, 30% in the second year, and 20% in
the third year.

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• Installment sales during 20x1, 20x2 and 20x3 were P2,000,000, P2,400,000, and
P3,000,000 respectively.
• Gross profit rates based on sales in 20x1, 20x2 and 20x3 were 22%, 24% and 25%,
respectively.
Requirement: Compute for the total realized gross profits in each of years 20x1, 20x2
and 20x3.

Solution:
20x1 20x2 20x3
20x1 sales:
Downpayment (2Mx20%)X 22% 88,000
20x1: [(2Mx80%) x 50%]x22% 176,000
20x2: [(2Mx80%) x 30%]x22% 105,600
20x3: [(2Mx80%) x 20%]x22% 70,400
20x2 sales:
Downpayment (2.4Mx20%)X 24% 115,200
20x1: [(2.4Mx80%) x 50%]x24% 230,400
20x2: [(2.4Mx80%) x 30%]x24% 138,240
20x3 sales:
Downpayment (3Mx20%)X 25% 150,000
20x1: [(3Mx80%) x 50%]x25% 300,000
Realized gross profit 264,000 451,200 658,640

Illustration 7: Reconstruction of information

ABC Co’s incomplete records show the following:

20x1 20x2 20x3

Installment sales 2,000,000 2,400,000 ?
Cost of sales ? ? 2,250,000
Gross profit ? ? ?
Gross profit rates ? ? 25%
Collections
From 20x1 sales 1,200,000 480,000 320,000
From 20x2 sales 1,440,000 576,000
From 20x3 sales 1,800,000
Realized gross 264,000 ? 658,640
profit
Requirement: Compute for the cost of sales in 20x2

Solution:
Realized gross profit-20x1 264,000
Divide by: Collections in 20x1 1,200,000

Gross profit rate-20x1 22%

Total realized gross profit in 20x3 658,640

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Realized gross profit in 20x3 from 20x1 sales (320k X 22%) (70,400)
Realized gross profit in 20x3 from 20x3 sales (1.8M X 25%) (450,000)
Realized gross profit in 20x3 from 20x2 sales 138,240

Realized gross profit in 20x3 from 20x2 sales 138,240

Divide by: collections in 20x3 from 20x2 sales 576,000
Gross profit rate-20x2 24%

Installment sales-20x2 2,400,000

Multiply by: Cost ratio in 20x2 (100%-24%) 76%
Cost of sales- 20x2 1,824,000
========
⮚ Observe that the previous problems all revolve arOund the two formulas below
(and their variations):

Realized gross profit = Collection on sale x Gross profit rate

Gross profit rate = Deferred gross profit ÷ Installment account receivable

Repossession
The seller may repossess the good sold in case of default by the buyer. On repossession
date:
a. The repossessed good is debited to an inventory account at "fair value." For
purposes of applying the installment sales method, "fair value" is either:
i. the appraised value of the repossessed good; or
ii. ii. the estimated resale price of the repossessed good less reconditioning costs
and normal profit margin.
b. The carrying amounts of the related installment receivable and deferred gross
profit are derecognized.
c. The difference between (a) and (b) is recognized as gain or loss on repossession.

Pro forma entry

Date Inventory (at fair value) xx
Deferred gross profit (at carrying amount) xx
Loss on repossession (debit balancing figure) xx

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 Installment receivable (at carrying amount) xx
Gain on repossession (credit balancing figure) xx

illustration 1: Repossession — Appraised value

ABC Co. repossessed a good that was previously sold to a defaulting buyer. Relevant
information follows:
● Appraised value of the repossessed good — P6,000.

● Balance of installment receivable — P10,000

● Gross profit rate on the sale 30%.

Requirement: Compute for the gain or loss on repossession

Solution
Date Inventory 6,000
Deferred gross profit (10kX 30%) 3,000
Loss on repossession 1,000
Installment account receivable 10,000

Illustration 2: Repossession — Estimated resale price

Information on ABC Co.'s installment sales is as follows:
20x1 20x2
Sales 200,000 320,000
Cost of sales 160,000 224,000
Gross profit rate 20% 30%
Installment receivable - 20x1 90,000 30,000
Installment receivable - 20x2 144,000

During 20x2, ABC Co. repossessed a property that was sold in 20x1 for P20,000. Prior to
repossession, P5, OOO were collected from the buyer. The repossessed property is
expected to þe resold for P17,000 after reconditioning costs of P3,000. The normal profit
margin is 30%.
Requirements:
Compute for the gain or loss on repossession.
Compute for the total realized gross profit in 20x2.
Compute for the profit recognized in 20x2
Solution:
Requirement a
Date Inventory 8,900
Deferred gross profit (15kX 30%) 3,000
Loss on repossession 3,100
Installment account receivable(20k-5k) 15,000

Estimated resale price 17,000

Reconditioning cost (3,000)
Normal profit margin (17kx30%) (5,100)

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Fair value of repossessed property 8,900
======
The gross profit rate in the year the repossessed good was originally sold is used in
computing for the related deferred gross profit.
Requirements (b) and (c):
The collections in 20x2 are computed as follows:
Realized gross profit from:
20x1 sale (45K x20%) 9,000
20x2 sale (175Kx30%) 52,800
Total realized gross profit in 20x2-Req.b 61,800
Loss on repossession (3,100)
Profit in 20x2-req.c 58,700
======
Illustration 3: Repossession — Fair value after reconditioning costs
Information on a repossessed good from a defaulting buyer is as follows:
● The appraised value (fair value) is P6,000 after reconditioning costs of P500.

● The balance of the installment receivable is P10,000. The gross profit rate on the
sale is 30%.

Requirement: Compute for the following:

a. Gain or loss on repossession.
b. New cost basis of the repossessed inventory.

Solution
Requirement(a)
Date Inventory (exclusing reconditioning cots) 5,500
Deferred gross profit (10K x 30%) 3,000
Loss on respossession (squeeze) 1,500
Installment account receivable 10,000

a) On repossession date, the inventory account is debited at the appraised value of

the repossessed good in its present condition without the further reconditioning
(i.e., 6,000-5,000=5,500).The reconditioning costs are subsequently capitalized
when incurred as follows:
Date Inventory 500
Cash 500

Requirement (b):
The new cost basis of the repossessed inventory is P6,000(i.e., the sum of the debits to
the inventory account.)

Illustration 4: Profit on resale of repossessed inventory

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ABC Co. uses the "installment sales method." ABC Co. sold inventory costing P30,000 to a
customer for P40,000. After paying P28,OOO, the customer defaulted and ABC Co.
repossessed the good. Upon repossession, the good was appraised at P10,000. ABC Co.
subsequently spent P2,000 in reconditioning the good before selling it to another
customer for P15,000. The second buyer made total payments of P6,000.
Requirements: Compute for the following:
a. Gain or loss on repossession.
b. Realized gross profit from the resale.

Solution
Req.a
Date Inventory (appraised value 10,000
Deferred gross profit (12k x 25%) 3,000
Installment receivable (40k-28k) 12,000
Gain on repossession (squeeze) 1,000
[(40k-30K÷40K]=25%GPR
Req. b
Resale price 15,000
Cost of sale (10k appraised value + 2k reconditioning cost (12,000)
Gross profit 3,000
Gross profit rate 20%

Collections from the resale 6,000

Multiply by: gross profit rate 20%
Realized gross profit from the resale 1,200

Illustration 5: Repossession — installments w/ interest

ABC Co. uses the installment sales method. On Jan. 1, 20x1, ABC Co. sold inventory
costing P180,000 for P240,OOO payable as follows: down payment of P48,OOO and
twelve monthly payments of P16,525 due at the beginning of each succeeding month.
The installments include interest of 1/2 of 1% per month. After making three succeeding
monthly payments, the customer defaulted and ABC Co. repossessed the inventory. The
fair value of the repossessed inventory is P180,000.

Requirements: Compute for the following:

a. Realized gross profit from the sale.
b. Gain or loss on repossession.

Solutions
Date Collections Interest Principal Balance
income
1/1/20x1 240,000
1/1/20x1 48,000 - 48,000 192,000
2/1/20x1 16,525 960 15,565 176,435

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 3/1/20x1 16,525 882 15643 160,792
4/1/20x1 16,525 804 15,721 145,071
Collections pertaining to principal 94,929

Collections pertaining to principal 94,929

Multiply by: Gross profit rate(240K-180K)÷240k 25%
Realized gross profit 23,732
=====
Req. b: Gain or loss on repossession
Date Inventory 180,000
Deferred gross profit (145,071x 25%) 36,268
Installment receivable (40k-28k) 145,071
Gain on repossession (squeeze) 71,197

Illustration 6: Repossession — Error

ABC Co. uses the installment sales method. After its first year of operations, ABC
had the following balances:
Installment sales 37,500
Purchases 25,000
Inventory - new merchandise, Dec. 31, 20x1 2,500
Loss on repossession 4,500
Installment receivable, Dec. 31, 20x1 20,000

During the year, ABC Co. repossessed an inventory sold to a defaulting buyer. The
inventory had an appraised value of 1,500. However, this was not recorded. Instead, the
janitor/bookkeeper of ABC Co. erroneously accounted for the repossession as a debit to
"Loss on repossession" and a credit to "Installment receivable" for the unpaid balance.
This came to light when the security guard made an audit. The janitor and the guard
were classmates in college when they took up BS Accountancy. Sadly, they did not
graduate because they only studied half-heartedly and failed in Advanced Accounting.
Requirement: Compute for the correct amount of gain or loss repossession.
Solution:
Date Inventory 1,500
Deferred gross profit (4,500x40%) 1,800
Loss on repossession (squeeze) 1,200
Installment receivable 4,500
The balance of the installment receivable is equal to the loss on repossession of P4,500,
This is because the janitor recorded the repossession as a debit to "Loss on repossession"
equal to the balance of the receivable.

Installment sales 37,500

Cost of goods sold:
Inventory beg. 0
Purchases 25,000
Repossessed inventory 1,500
Total goods available for sale 26,500

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Inventory end(2,500+1,500) (4,000) (22,500)
Gross profit 15,000
Gross profit rate (15,000÷37,500) 40%

Trade-ins
A seller may accept from a buyer a trade-in of old merchandise as part payment for the
sale of new merchandise. Trade-ins under the "installment sales method" are accounted
for as follows:
a. The traded-in merchandise is debited to inventory at "fair value." For
purposes of applying the installment sales method, "fair value" is either:
i. The appraised value of the trade-in merchandise; or
ii. the estimated resale price of the traded-in merchandise less reconditioning
costs and normal profit margin.
b. The seller gives the buyer a trade-in value for the old merchandise. The
trade-in value is the amount that is treated as part payment of the new
merchandise being sold. There is no accounting problem if the trade-in
value is equal to the fair value in (a) above. If this is not the case, the seller
recognizes either an over allowance or an under allowance for the
difference.
⮚ If the trade-in value is greater than the fair value, the difference is debited to an
"Over allowance" account. The over allowance is deducted from the sale price
when computing for the gross profit rate.
⮚ If the trade-in value is less than the fair value, the difference is credited to an
"Under allowance" account. The under allowance is added to the sale price when
computing for the gross profit rate.
Pro forma entry
Date Inventory-traded in (at fair value) xx
Over allowance (if traded in >FV) xx
Installment receivable (balancing figure) xx
Installment sale xx
Under allowance (if trade-in value<FV) xx

Illustration: Trade-in
ABC Co. uses the "installment sales method." merchandise costing P12,000 to a customer
for P20,000. ABC accepts sold merchandise as trade-in. The old merchandise's fair value
is P5,000.
Case1: Trade in value equal to fair value
ABC Co. grants the customer a trade-in value of P5,000 for the old merchandise.
Subsequent collection during the year amount to P7,000.

Requirement: Compute for the realized gross profit in the year sale.
Solution:
Date Inventory-traded-in 5,000

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 Installment receivable 15,000
Installment sale 20,000

Fair value of old merchandise traded-in 5,000

Collections 7,000
Total 12,000
Multiply by: Gross profit rate (20k-12k)÷20K 40%
Realized gross profit in year of sale 4,800

The fair value of the merchandise traded-in is part of the collections in the year of sale
computing for the realized gross profit.
Case2: Over allowance
To induce sale, ABC Co. grants the customer a trade-in value of P7,000 for the old
merchandise. Subsequent collection during the year amount to P7,000.
Requirement: Compute for the realized gross profit in the year sale.
Solution:
Date Inventory-traded-in 5,000
Overallowance(7ktrade-in value>5kFV) 2,000
Installment receivable 13,000
Installment sale 20,000
The installment receivable can also be computed as Sale price less trade in value (20K-
7K=13,000)
Fair value of old merchandise traded in 5,000
Collections 7,000
Total 12,000
Mutiply by gross profit rate 33.33%
Realized gross profit in year of sale 4,000

Sale price 20,000

Less: Over allowance (2,000)
Adjusted sale price 18,000
Cost of sale (12,000)
Adjusted gross profit 6,000
Adjusted gross profit rate 33.33%

Case 3: Under allowance

ABC Co. grants the customer a trade-in value of P2,500 for the old merchandise.
Subsequent collection during the year amount to P7,000.

Requirement: Compute for the realized gross profit in the year sale.
Solution:
Date Inventory-traded-in 5,000
Installment receivable 17,500
Installment sale 20,000
Under allowance (2.5Ktrade-in,5KFV) 2,500

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Fair value of old merchandise traded-in 5,000
Collections 7,000
Total 12,000
Multiply by Gross profit rate 46.67%
Realized gross profit in year of sale 5,600

Installment sale 20,000

Add: Under allowance 2,500
Adjusted sale price 22,500
Cost of sale (12,000)
Adjusted gross profit 10,500
Adjusted gross profit rate 46.67%

Allocation of Cost of goods sold

A seller that makes both "regular" and "installment" sales may need to allocate the cost
of goods sold between the two sales.

Illustration 1: Relative cash price equivalents

ABC co. recognizes revenue from its regular sales at the point of sale and uses the
"installment' sales method" for its installment sales. Information at year-end is as
follows:
Regular sales 1,000,000
Installment sales 2,400,000
Cost of goods sold 1,200,000
The installment price is higher than the regular price by 20%.
Requirement: Compute for the allocation of the cost of goods sold.
Solution:
Cash sale prices Fraction Allocation of COGS
Regular sales 1M 1/3 400,000
Installment sales (2.4M÷120%) 2M 2/3 800.000
Totals 3M 3/3 1,200,000

Illustration 2: Consistent mark-up on regular sales

ABC Co. recognizes revenue from its regular sales at the point of sale and uses the
"installment sales method" for its installment sales. ABC's trial balance on Dec. 31, 20x2
is shown below:
Debit Credit
Installment receivable-20x1 sales 75,000
Installment receivable-20x2 sales 1,000,000
Inventory, Jan. 1, 20x2 350,000
Purchases 2,775,000
Repossessed inventory (at appraised value) 15,000
Deferred gross profit-20x1 sales, jan. 1, 20x2 270,000
Regular sales 1,925,000

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Installment sales 2,125,000

Additional Information:
● Installment receivable-20x1 sales, jan 1, 20x2 600,000

● Inventory, Dec. 31 20x2 (new and repossessed) 475,000

● Consistent gross profit rate on regular sales 30%

● Installment receivable from 20x1 sales written-off

In 20x2. The related inventory was repossessed in 20x2 38,750
Requirements: Compute for the following:
a. Total realized gross profit in 20x2 from regular and installment sales.
b. Gain or loss on repossession.
Solutions:
Requirement (a): Total realized gross profit in 20x2
⮚ The total cost of goods is computed as follows:
Inventory - Jan. 1, 20x2 350,000
Purchases 2,775,000
Repossession 15,000
Total goods available for sale 3,140,000
Inventory - Dec. 31, 20x2 (new and repossessed) (475,000)
Cost of goods sold - Regular and Installment 2,665,000

⮚ The cost of goods sold on regular sales is

Regular sales 1,925,000
Multiply by: Cost ratio on regular sales (100% - 30%) 70%
Cost of goods sold — Regular 1,347,500
========
⮚ The cost of goods sold on installment sales is follows:
Cost of goods sold - regular and installment 2,665,000
Cost of goods sold regular sales (1,347,500)
Cost of goods sold - Installment sales in 20x2 1,317,500

⮚ The gross profit rate on the 20x2 installment sales is computed as follows:
Installment sales in 20x2 2,125,000
Cost of goods sold - installment sales in 20x2 (1,347,500)
Gross profit - Installment sales in 20x2 807,500
Gross profit rate - Installment sales in 20x2 38%

⮚ The gross profit rate on the 20x1 installment sales is computed as follows:
Deferred gross profit - 20x1 sales, Jan. 1, 20x2 270,000
Installment receivable - 20x1 sales, Jan, 1, 20x2 600,000

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Gross profit rate - Installment sales in 20x1 45%

⮚ The collections in 20x2 from installment sales in 20x1 and 20x2 are computed as
follows:

Installment receivable – 20x1 (600,000-38750-75,000) = 486,250

Installment receivable – 20x2 (2,125,000-1000,000) = 1,125,000
⮚ The total realized gross profit is computed as follows:
Collections in 20x2 from:
20x1 installment sales: (486,250x 45%) 218,813
20x2 installment sales: (1,125,000 X 38%) 427,500
20x2 regular sales: (1,925,000x 30% given) 577,500
Total realized gross profit in 20x3 1,223,813

Req. b: Gain or loss on repossession

Date Inventory-repossessed 15,000
Deferred gross profit (38750x45%) 17,438
Loss on repossession (squeeze) 6,312
Installment receivable 38,750

Cost recovery method

Under the "cost recovery method"* of traditional US GAAP, no gross profit or interest/
income is recognized until the total collections from the sale exceed the cost of the
inventory sold.

Illustration: Cost recovery method

ABC Co. uses the "cost recovery method," On Jan. 1, 20x1, ABC Co. sold inventory costing
P280,000 to a customer for P500,000 payable as follows: P100,000 down payment and
balance due in 4 equal annual payments every Dec. 31.
Requirement: Compute for the realized gross profit (RGP) in years 20x1 through 20x4.

Solution
20x1 20x2 20x3 20x4
Cumulative collections 200,000 300,000 400,000 500,000
Cost of goods sold 280,000 280,000 280,000 280,000
Excess collection - 20,000 120,000 220,000
RGP in previous years - (20,000)
(120,000)
RGP in current year - 20,000 100,000 100,000

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Variation:
What if the installments include imputed interest, can ABC Co. recognize interest income
in 20x1?
Answer: No. Under the cost recovery method, neither gross profit nor interest income is
recognized until the collections exceed the cost of goods sold.

MODULE SUMMARY

● Realized gross profit= Gross profit X collection on sale

● Gross Profit rate= Deferred gross profit

Installment Account Receivable

Repossession:
Date Inventory (at fair value) xx
Deferred gross profit xx
Loss on repossession (squeeze) xx
Installment account xx
receivable
● Trade-in: If trade-in value exceeds fair value, the excess is an over allowance,
which is deducted from sales when computing for the gross profit rate. The fair
value of the traded-in merchandise is treated as part of the collections in the year
of sale when computing for the realized gross profit.

INSTALLMENT SALES
If collectability of the note is REASONABLY ASSURED, ACCRUAL METHOD should be
applied. In this topic the entire amount of GP becomes part of the net income.

If the collectability of the note is NOT REASONABLY ASSURED, INSTALLMENT

METHOD should be applied

COMPUTATION OF NET INCOME:

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 Gross Profit (GP) on Regular Sales P xxx
Realized Gross Profit (RGP) on Installment Sales xxx

TOTAL RGP P xxx

Less: Expenses
1) Selling Expenses P xxx
2) Loss on Repossession
3) Loss on Write-off xxx (

xxx)
NET INCOME P

xxx

*GP on Regular Sales *RGP on Installment Sales

Sales Pxxx Collection P xxx
Less: Cost of Regular Sales (xxx) Multiplied by GP rate ( xxx)
GP ON REGULAR SALES P xxx RGP ON INSTALLMENT P xxx
SALES

Installment Accounts Receivable

IAR, beginning (prior xxx xxx Collections

year)
or
Installment sales xxx Repossessed
(current year) accounts
or IAR
defaulted
xxx Write-off
IAR, ending xxx

1) Gain or Loss on Repossession

COMPUTATION OF FV OF REPOSSESSED MERCHANDISE:

Estimated Selling Price P xxx

Reconditioning cost ( xxx)
Normal Profit xxx)
Cost to sell (

xxx)
FV OF REPOSSESSED MERCHANDISE AFTER
RECONDITIONING COST P xxx

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 * If it is BEFORE reconditioning cost, IGNORE the amount of reconditioning
cost.
* If the problem is SILENT if the estimated selling price is before
or after recondition cost, deduct the reconditioning cost
* If the problem says ESTIMATED WHOLESALE VALUE or
APPRAISED VALUE, the normal profit should not be deducted
anymore.

5. COMPUTATION OF GAIN (LOSS) ON REPOSSESSION:

FV of Repossessed Merchandise P xxx

Less: Unrecovered cost
1) IAR-defaulted P xxx
Less: DGP related to receivables (

xx)
or
2) IAR x cost ratio x (
x
x xxx)
GAIN (LOSS) ON REPOSSESSION P

xxx

* If Unrecovered Cost > FV or Repossessed Merchandise = LOSS ON

REPOSSESSION

Repossessed Merchandise @ FV xxx

DGP xxx
Loss on Repossession xxx
IAR – defaulted xxx
Gain on Respossession (if any) xxx
* If Unrecovered Cost < FV of Repossessed Merchandise = GAIN

ON REPOSSESSION Journal entry:

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6. Write-off

Regular Sales

Allowance on Doubtful accounts x

x
x
Accounts Receivable xxx
Installment Sales

DGP x
x
x
Loss on Write-off xxx
IAR xxx

7. Deferred Gross Profit

COMPUTATION OF DEFERRED GROSS PROFIT:

Installment Sales P xxx

Cost of Installment Sales ( xxx)
DGP P xxx

DGP
RGP (Collection x GP rate) xx xxx DGP,
x beginning
DGP on Repossessed xx
Merchandise x
DGP on Write-off xx
x
xxx DGP, ending

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 REFERENCES:

BOOKS:

Millan, Zeus Vernon B. (2020).Accounting for Special Transactions and

Business Combinations , Bandolin Enterprise ,Baguio City.

Ballad,Win Lu,(2019). Partnership and Corporation Accounting ,Domdame Publication

Sampaloc, Manila, Philippines

Dayag, Antonio J. (2019).Advanced Financial Accounting and Reporting

Part I and II , GIC Enterprise, Claro M. Recto Manila, Philippines.

De Jesus, Paul Anthony (2019). Advanced Financial Accounting and

Reporting , GIC Enterprise, Claro M. Recto Manila, Philippines.

Guerrero, Pedro (2019). Advanced Financial Accounting and Reporting ,

GIC Enterprise, Claro M. Recto Manila, Philippines.

Philippine Financial Reporting Standards (PFRSs), Philippines: Financial Reporting

Standards Council (FRSC

WEBSITE REFERENCES:

http://www.iasplus.com/
http://www.picpa.com.ph/

Assessment
MODULE ACTIVTY/ASSESSMENT

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I.MULTIPLE CHOICE: THEORY/PROBLEMS
1. When the consideration receivable from an installment sale is discounted, the gross
profit rate is computed
a. based on the present value of the consideration receivable.
b. based on the undiscounted installment sale price
c. a or b
d. none of these

2. When the consideration receivable from an installment sale is discounted, realized

gross profit is computed
a. based on collections pertaining to the principal
b. based on the total collection during the period
c. a or b
d. none of these

3. Under the installment sales method, when merchandise previously sold is

repossessed, the repossessed merchandise is recorded at
a. fair value c. current cost
b. original cost d. any of these

4. For purposes of applying the installment sales method, “fair value” is

a. the appraised value of the repossessed property or traded-in merchandise
b. the estimated selling price of the repossessed property or traded-in merchandise
less reconditioning costs and normal profit margin, at date of repossession or
date of trade-in.
c. a or b
d. none of these

5. Gain or loss on repossession is computed as

a. the fair value of the repossessed property less the sum of the balance in deferred
gross profit and the balance in the defaulted installment account receivable
b. the sum of the fair value of the repossessed property and the balance in the
defaulted installment account receivable less the balance in deferred gross profit
c. the difference between the fair value of the repossessed property and the balance
in deferred gross profit
d. the sum of the fair value of the repossessed property and balance in deferred
gross profit less the balance in the defaulted installment account receivable

6. Merchandise received as trade-in is recognized at

a. fair value c. current cost
b. original cost d. any of these

7. Under an installment sale where merchandise is received as “trade-in,”

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 a. the fair value of merchandise traded-in is considered as part of collections when
determining the realized gross profit in the year of sale.
b. the trade-in value of merchandise traded-in is considered as part of collections
when determining the realized gross profit in the year of sale.
c. neither the fair value nor the trade in value affects the computation of realized
gross profit.
d. none of these

8. The excess of the trade-in value over the fair value of a traded-in merchandise in a
sale accounted for under the installment sales method represents
a. over allowance c. no allowance
b. under allowance d. small allowance

9. Under the installment sales method, an “over allowance” is

a. treated as addition to the installment sale price when computing for the gross
profit rate.
b. treated as reduction to the installment sale price when computing for the gross
profit rate.
c. not accounted for
d. none of these

10. Under the cost recovery method,

a. the initial collections on the sale are treated as recovery of the cost of the
inventory sold. Thus, no gross profit or interest income is recognized until total
collections from the sale equals the cost of inventory sold.
b. the initial collections on the sale are treated as recovery of the cost of the
inventory sold. Thus, no gross profit is recognized until total collections from the
sale equals the cost of inventory sold. However, interest income may nonetheless
be recognized.
c. a or b
d. none of these

II. PROBLEM SOLVING:

1. BUCOLIC RURAL Co. uses the installment method. Information on BUCOLIC’s
transactions during 20x1 and 20x2 is shown below:
20x1 20x2

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 Installment sales 2,000,000 2,400,000
Cost of sales 1,200,000 1,320,000
Gross profit 800,000 1,080,000
Cash collections from:
20x1 sales 800,000 400,000
20x2 sales 960,000

How much is the total realized gross profit in 20x2?

a. 160,000
b. 432,000
c. 592,000
d. 642,000

Use the following information for the next three questions:

INNOCUOUS HARMLESS Co. uses the installment method. On January 1, 20x3,
INNOCUOUS Co.’s records show the following balances:

Installment receivable - 20x1 800,000

Installment receivable - 20x2 2,400,000
Deferred gross profit - 20x1 176,000
Deferred gross profit - 20x2 576,000

On December 31, 20x3, INNOCUOUS Co.’s records show the following balances before
adjustments for realized gross profit:
Installment receivable - 20x1 -
Installment receivable - 20x2 960,000
Installment receivable - 20x3 2,400,000
Deferred gross profit - 20x1 176,000
Deferred gross profit - 20x2 576,000
Deferred gross profit - 20x3 1,500,000

Installment sales in 20x3 were made at 331/3 above cost.

2. How much is the installment sale in 20x3?

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 a. 4,836,000
b. 5,800,000
c. 6,000,000
d. 7,200,000

3. How much is the total cash collections in 20x3?

a. 5,840,000
b. 1,440,000
c. 3,600,000
d. 5,640,000

4. How much is the total realized gross profit in 20x3?

a. 984,600
b. 1,241,200
c. 1,520,000
d. 1,421,600

5. DEMOTIC POPULAR Co. uses the installment method. The following information was
taken from the incomplete records of DEMOTIC Co.:
20x1 20x2 20x3
Installment sales 4,000,000 4,800,000 ?
Cost of sales ? ? ?
Gross profit ? ? ?
Gross profit rates ? ? 25%
Collections:
from 20x1 sales 2,000,000 1,200,000 800,000
from 20x2 sales 2,400,000 1,440,000
from 20x3 sales 3,600,000
Realized gross profit 440,000 ? 1,421,600

How much is the cost of sales in 20x2?

a. 2,840,000
b. 3,248,000
c. 3,648,000
d. 3,946,000

Use the following information for the next three questions:

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THRALL SLAVE Co. uses the installment method. Information on installment sales in
20x1 and 20x2 is shown below:

20x1 20x2
Sales 400,000 640,000
Cost of sales 320,000 448,000
Gross profit rate 20% 30%
Installment receivable - 20x1 180,000 60,000
Installment receivable - 20x2 288,000

During 20x2, THRALL Co. repossessed a property which was sold in 20x1 for ₱40,000.
Prior to repossession, ₱10,000 were collected from the buyer. The estimated resale price
of the repossessed property was ₱34,000 after reconditioning costs of ₱6,000.

6. How much is the gain or loss on repossession?

a. 17,800
b. 6,200
c. 12,800
d. 5,400

7. How much is the total realized gross profit in 20x2?

a. 123,600
b. 352,000
c. 117,400
d. 90,000

8. How much is the profit recognized in 20x2?

a. 123,600
b. 352,000
c. 117,400
d. 90,000

Use the following information for the next three questions:

ARNZQUIN Co. sells household furniture both on cash and on installment basis. For each
installment sale, a contract is entered into whereby the following terms are stated:
a. A down payment of 25% of the installment selling price is required and the
balance is payable in 15 equal monthly installments.
b. Interest of 1% per month is charged on the unpaid cash sales price equivalent at
each installment.
c. The price on installment sale is equal to 110% of the cash sales price.

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For accounting purposes, installment sales are recorded at contract price. Any unpaid
balances on defaulted contracts are charged ton uncollectible accounts expense. Sales of
defaulted merchandise are credited to uncollectible accounts expense. Interests are
recorded in the period earned. For its first year of operation ending December 31, 20x1,
the books of the company showed the following:

Cash sales ₱378,000

Installment sales 794,970
Merchandise inventory, Jan. 1 174,180
Cash collections on installment contracts:
Down payment, including defaulted contract 198,750
Installment payments, including interest
of ₱27,758.52 (average of six
monthly installments on all
contracts, except on defaulted
contracts) 238,023

A contract amounting to ₱3,300 was defaulted after the payment of 3 installments.

9. The gross profit rate based on total sales at cash sales price equivalent is:
a. 33.75% c. 37.00%
b. 36.34% d. 40.88%

10. The total interest earned for the first four months on the defaulted contract is:
a. 60.94 c. 72.07
b. 69.30 d. 80.85

11. The realized gross profit for the year 20x1 is:
a. 151,335.35 c. 249,674.52
b. 161,789.16 d. 291,355.96

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