Chapter 6 INSTALLMENT SALES Introduction Generally, the point of sale is the point of revenue revenue recognition. And among the exceptions exceptions to the point of sale realization concept is the installment installment method. Under this method, income is recognized recognized when collections are made, because the uncertainty of collecting accounts accounts to be receive over an extended period of time may suggest the postponement of revenue recognition recognition until the probability probability of collection can be reasonably reasonably estimated. GROSS PROFIT RECOGNITION ON INSTALLMENT SALES Installment sales may be regarded as calling for special treatment whereby gross prot is related to the periods in which the installment receivables are collected rather than to the periods in which the receivable receivable are created. he infow o cash !collections" !collections" rather than the time of sale become the criterion for revenue recognition. Accounting for installment method or installment basis could be best illustrated by providing for the recognition of gross prot in proportion to collections. Under this method, collections are regarded as both return of cost and realization of prot in the ratio in which these two factors are found in the original sales price. In applying the installment method in the accounts, the di#erence between the contract sales price and the cost of goods sold is recorded as deerred gross prot. his balance balance is recognized recognized as revenue revenue periodically periodically in the proportio proportion n that the cash collections in the period bear to sales price. $tated di#erently, di#erently, the original gross prot percentage on the sales is applied to periodic collections in arriving at the amounts to be recognized as revenue. At the end of each period a deferred gross prot balance remains on the boo% and is e&ual to the gross prot percentage applied to the balance of installment receivables as to this date. GROSS PROFIT RATE $ince, collections become the criterion for revenue recognition in installment method of accounting' determination determination of gross prot rate is rate is an important factor to compute the realized gross prot to be reported for a period. Gross prot rate may be computed based on the data provided. provided. (ormally, it may be computed by dividing the gross prot by the installment sales. )owever, if this formula is not applicable, gross prot rate may also be computed by dividing the deferred gross prot !beginning" by installment accounts receivable !beginning"' or by dividing the deferred gross prot !end" by the installment accounts receivable !end". REALIZED GROSS PROFIT he installment installment method of accounting accounting recognizes recognizes prots prots at the point point of collections, collections, thus realized prot is based on amount collected. *rdinarily, realized gross prot
may be computed by multiplying the gross prot rate by the amount collected. It should be pointed out that in case of defaulted contract, collections should be net of any unpaid balance on defaulted contract. )owever, if this formula is not applicable, realize gross prot may be computed by determining the di#erence between the deerred gross prot (beore adjustment) and deerred gross prot (ater adjustment). Deferred Gross Prot As stated earlier, the installment method of accounting recognizes prots at the point of collection. If realized prot is based on amount collected, the deferred gross prot is based on unpaid balance. he deferral of gross prot is, in e#ect, the deferral of sales revenue accompanied by the deferral of cost of goods sold related to such sales revenue. o compute the deferred gross prot at the beginning of a period (beore adjustment), installment accounts receivable at the beginning of the period should be multiplied by the related gross prot rate' and the deferred gross prot at the end of the period (ater adjustment) is e&ual to installment accounts receivable multiplied by the related gross prot rate. Trade-Ins In certain sales on the installment plan, companies will accept a trade+in as part of payment on a new contract. he trade+in is recorded at the value allowed. re&uently, as a special sales inducement, an allowance is given on the trade+in, which is, in e#ect, a reduction in the sales price. Under such circumstances, the trade+in should be recorded at no more than the company would pay on its purchase' the di#erence between the amount allowed and the value of the article to the company should be reported either as charge to an over allowance account or as a reduction in installment sales. In either case, the gross prot on installment sales should be regarded as the di#erence between the cost of goods sold and net sales, the total installment sales less any trade+in over allowance. Defauts and Re!ossessions -efault on an installment contract and subse&uent repossession of the goods sold calls for an entry on the boo%s of the seller that reports the merchandise reac&uired, cancels the installment receivable together with the related deferred gross prot balance, and records the gain or loss on repossession. As in the case of goods ac&uired by trade+in, the repossessed article should be recorded at an amount that will permit a normal gross prot on its resale. Interest on Insta"ent Contracts Installment contract fre&uently provide for a charge for interest on the balance due. he interest charge is ordinarily payable with the installment payment that reduces the principal. Although interest is included in the payment, use of the installment method re&uires that only that portion of a payment which reduces the principal balance of the installment contract receivable should be considered in computing the realized gross prot.
