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