INSTALLMENT SALES ACCOUNTING
IN SOME CASES, THERE ARE CIRCUMSTANCES SURROUNDING A REVENUE TRANSACTIONS SUCH
THAT CONSIDERABLE UNCERTAINTY OF FULL COLLECTION WOULD EXISTS SIMPLY BECAUSE OF
THE INSTALLMENT SALES WHICH NORMALLY HAS A VERY LONG COLLECTION TERMS . THIS
SITUATION CAN OCCUR IF THE SALES IS UNUSUAL IN NATURE OR SALES TO CUSTOMERS WHERE
IN CASE OF DEFAULT OF THIS CUSTOMER, A LITTLE COST OR PENALTY IS CHARGED.
UNDER THIS CIRCUMSTANCES, WHERE UNCERTAINTY OF COLLECTION SUGGEST THAT REVENUE
RECOGNITION SHOULD BE BASED ON THE ACTUAL COLLECTION RATHER THAN THE TIME OF
SALE.
THERE ARE APPROACHES THAT REVENUE RECOGNITION DEPENDS ON COLLECTION.
1. INSTALLMENT SALES
2. COST RECOVERY METHOD
3. CASH METHOD.
INSTALLMENT SALES METHOD
ACCOUNTING FOR INSTALLMENT SALES METHOD IS WHERE AT THE TIME OF SALE the following
entry is made. ( IF USING PERPETUAL INVENTORY METHOD)
THIS IS THE REGULAR ENTRY:
INSTALLMENT ACCOUNTS RECEIVABLE 50,000
INSTALLMENT SALES 50,000
to record sales made on installment.
COST OF INSTALLMENT SALES 25,000
INVENTORY ( USING PERPETUAL) 25,000
to record the cost of the sales made. this is based on qty sold x the cost of the product.
CASH 10,000
INSTALLMENT ACCTS. RECEIVABLE 10,000
to record collection
NOW CONSIDERING THAT IN INSTALLMENT SALES METHOD , THE INSTALLMENT SALES
ACCOUNT IS NOT CONSIDERED A REVENUE YET, AND EVEN THE COST OF SALES FOR
INSTALLMENT SALES this two accounts are REVERSED at the end of the period. THEREFORE
THE CREDIT ENTRY ON THE SALES AND THE DEBIT ENTRY ON COST OF INSTALLMENT SALES
NEED TO BE REVERSED . OF COURSE IF ONLY THESE ACCOUNT WILL BE THE ONE TO BE
REVERSED , THERE IS A DIFFERENCE IN AMOUNT BECAUSE THE DEBIT IS BIGGER THAN THE
COST OF SALES WHICH IS CREDITED, THAT DIFFERENCE IS ACTUALLY THE GROSS PROFIT ,
HENCE , AN ACCOUNT NAME "" deferred gross profit " is to be credited. and will not be a
nominal accounts but a REAL ACCOUNTS OR BALANCE SHEET account .
NOW YOU MAY ASK, HOW TO COMPUTE FOR THE ACTUAL REVENUE OR ACTUAL GROSS PROFIT
THAT WILL BE REFLECTED ON THE PROFIT AND LOSS. BECAUSE THE FACT IS THE GROSS PROFIT
WAS TRANSFERRED TO THE BALANCE SHEET.
IN INSTALLMENTACCOUNTING,THE RECOGNITION OF THE REVENUE IS BASED ON THE AMOUNT
OF COLLECTION OF THAT SALES MADE MULTIPLY BY THE GROSS PROFIT RATIO OF THAT
SALES MADE . BUT SINCE THE GROSS PROFIT WAS CLASSIFIED AS BALANCE SHEET ACCOUNT,
IT IS NECESSARY THAT WHEN A COLLECTION IS MADE, THE EQUIVALENT GROSS PROFIT OF
THAT COLLECTION USING THE GROSS PROFIT RATIO WILL BE TRANSFERRED BACK TO THE
PROFIT AND LOSS UNDER THE ACCOUNT NAME " realized gross profit. , that means if the
SALES was totally collected the deferred or the unrealized gross profit will become zero.
that means revenue is recognized in the profit and loss depending on the amount of collection
multiplied by the gross profit ratio. ( COLLECTIONS X GROSS PROFIT = realized gross profit)
if that is the case. the balance of the unrealized or deferred gross profit if divided by the
gross profit ratio will be equal to the INSTALLMENT SALES RECEIVABLE BALANCE ( deferred
gross profit divide gross profit ratio = RECEIVABLE ) or installment receivable multiplied
by the gross profit is the deferred gross profit appearing on the balance sheet.( RECEIVABLE X
GROSS PROFIT RATIO = DEFERRED GROSS PROFIT )
or the realized gross profit for a particular period divide by the gross profit ratio is equal to
the amount of collections made on the sales. ( REALIZED GROSS PROFIT DIVIDE BY gross profit
ratio = COLLECTIONS )
NOW HOW DO YOU COMPUTE FOR THE GROSS PROFIT RATIO.
WHEN YOU ARE ENGAGING IN SELLING A PRODUCT , YOU PURCHASE THAT PRODUCT FROM
OTHER SOURCES FOR RESALE . WHEN YOU ARE TO SELL THAT PRODUCT , YOU MUST ADD A
CERTAIN AMOUNT FROM THE COST OF THE PRODUCT TO ARRIVE AT THE SELLING PRICE.
THE AMOUNT THAT YOU WILL ADD ON THAT COST OF THE PRODUCT IS DEPENDING ON HOW
MUCH YOU WANT TO HAVE A GROSS PROFIT AND THAT GROSS PROFIT WILL ANSWER FOR THE
OPERATING COST AND YOUR NEEDED NET PROFIT.
THE AMOUNT YOU ADD IS THE GROSS PROFIT OF THAT PRODUCT. DIVIDING THAT AMOUNT
YOU ADDED OR THE GROSS PROFIT AGAINST THE SELLING PRICE IS THE GROSS PROFIT RATIO.
DIVIDING THE COST OF THE PRODUCT AGAINST THE SELLING PRICE IS THE COST OF SALES
RATIO.
NOW, IT WOULD BE IMPRACTICAL THAT EVERYTIME YOU PURCHASE A PRODUCT , YOU WILL
THINK OF HOW MUCH YOU HAVE TO ADD TO ARRIVE AT SELLING PRICE. THEREFORE YOU HAVE
SET A COST OF SALES RATIO AGAINST THE SELLING PRICE SO THAT EVERYTIME YOU
PURCHASED A PRODUCT YOU JUST DIVIDE YOU COST TO THIS COST RATIO TO ARRIVE AT
SELLING PRICE., IT'S AUTOMATIC NOW THAT THE COST LESS THE SELLING PRICE IS YOUR
GROSS PROFIT , SO GROSS PROFIT DIVIDE SALES PRICE IS YOUR GROSS PROFIT RATIO.
EXAMPLE
PURCHASED COST 3,300.00 AND YOU KNOW THAT YOUR COST RATIO IS 80%, SO DIVIDE
3,300.00 BY 80%, YOU GET 4,125.00 AS SELLING PRICE.
SELL PRICE 4,125
COST 3,300 80%
GROSS PROFIT 825 20%
This deferred gross profit account though a non assets accounts , can be presented as a
contra accounts of INSTALLMENT ACCOUNTS RECEIVABLE or can be presented as a DEFERRED
ACOUNT ON THE LIABILITIES SIDE . The following are pro forma journal entries and adjusting
entry:
1. SALES ON INSTALLMENT
INSTALLMENT ACCTS. REC 50,000
INSTALLMNET SALES 50,000
2. COST OF THE PRODUCT at 20% mark up on sales price.
COST OF SALES ON INSTALLMENT 10,000
INVENTORY( perpetual)SHIPMENTS( periodic) 10,000
3. EXPENSES OF THE COMPNAY
SELLING AND GEN . EXP 1,000
CASH OR ACCTS. PAY 1,000
4. COLLECTIONS
CASH 20,000
INSTALLMENT REC. 2011 5,000
INST. RECE 2012 10,000
INST RECE 2013 5,000
5. CLOSING OF INSTALLMENT SALE ACCOUNT AND COST OF SALES AND SET UP OF DEFERRED
GROSS PROFIT. FOR SALES THIS PERIOD.
INST. SALES 50,000
COST OF SALES INST. 10,000
DEFERRED GROSS PROFIT 40,000
6. TO RECOGNIZE THE REALIZED GROSS PROFIT BASED ON COLLECTION X GROSS PROFIT
RATIO
DEFERRED GROSS PROFIT 2013 1,000
DEF. GROSS PROFIT 2012 2,000
DEF. GROSS PRFIT 2011 1,500
REALIZED GROSS PROFIT 4,500
7. CLOSING ENTRIES( PERPETUAL INV. METHOD) PERIODIC
REALIZED GROSS PROFIT 4,500 cost of sales/inst(inc/exp). xxx
SELLING AND GEN EXP 1,000 inv. beg xxx
INCOME EXP SUMM 3,500 close beg inv
[Link] summ xxx
purchases xxx
close purch.
INV. END XXX
inc. exp summ xxx
set up inv. end
realized g.p. xxx
shipments xxx
expenses xxx
[Link] summ xxxx
LET ME GIVE YOU AN EXAMPLE OF INSTALLMENT SALE METHOD
TAKE NOTE THAT THE PRE TRIAL BALANCE WOULD SHOW YOU THE INSTALLMENT SALES
ACCOUNT AND THE COST OF INSTALLMENT SALES ACCOUNT OF THE CURRENT PERIOD
BECAUSE THE CLOSING OF THAT ACCOUNTS ARE MADE AS PART OF THE ADJUSTING JOURNAL
ENTRIES
THE DEFERRED GROSS PROFIT AND THE INSTALLMENT ACCTS. RECEIVABLE OF PREVIOUS SHALL
BE INDICATED IN THE BALANCE SHEET WITH INDICATION OF WHAT YEAR IT WAS JOURNALIZED
ILLUSTRATIVE EXAMPLE..
A PRE TRIAL BALANCE DEC 31, 2013 APPEARS BELOW
CASH 70,000
INSTALLMENT REC 2013 137,500
INST. REC 2012 30,000
INST. REC 2011 7,500
ACCOUNTS RECEIVBLE 42,500
MDSE INV. BEG 130,000
OTHER ASSETS 120,000
ACCTS PAYABLE 80,000
DEFERRED GROSS PROFIT 2012 112,500
DEF. GROSS PROFIT 2011 24,000
CAPITAL STOCK 212,500
RETAINED EARNINGS 171,000
SALES REGULAR 312,500
INSTALLMENT SALES 800,000
PURCHASES 875,000
COST OF INST. SALES 580,000
COST OF SHIPPED INSTALLMENT GOODS 580,000
EXPENSES 300,000
TOTAL 2,292,500 2,292,500
REQUIRED: 1. CALCULATE THE GROSS PROFIT RATIO OF 2011,2012,2013
2, MAKE THE ADJUSTING ENTRIES, SETTING UP THE DEFERRED GROSS PROFIT AND CLOSING
THE INSTALLMENT SALES ACCOUNT AND THE COST OF INSTALLMENT SALES ACCOUNT.
3. PREPARE PROFIT AND LOSS AND BALANCE SHEET.
AS I HAVE EXPLAINED EARLIER ABOVE , BEFORE YOU CAN COMPUTE THE REALIZED GROSS
PROFIT ,SO THAT AN ADJUSTING ENTRY CAN BE MADE , YOU MUST KNOW THE GROSS PROFIT
RATIO OF THE PRODUCT SOLD, IN THE ABOVE EXAMPLE IT WOULD APPEAR THAT EVERY YEAR
THERE IS DIFFERENT GROSS PROFIT RATIO.
ALSO AS EXPLAINED THE BEGINNING BALANCE OF RECEIVABLE AND THE DEFERRED GROSS
PROFIT ( even those end of the year before adjustment is also a beginning balance ) IS
DIRECTLY RELATED TO EACH OTHER BECAUSE THE RECEIVABLE DECREASES THE SAME AMOUNT
OF THE DEFERRED GROSS PROFIT AS A RESULT OF THE COLLECTION MADE AND BEING
MULTIPLIED TO THE GROSS PROFIT RATIO TO REDUCE THE DEFERRED GROSS PROFIT. THAT
MEANS , IF YOU DIVIDE THE DEFERRED GROSS PROFIT WITH THE COST PROFIT RATIO , THE
ANSWER IS THE BEGINNING LAST YEAR OF THE RECEIVABLE AMOUNT.
NOW CONSIDERING THAT THE ABOVE EXAMPLE DID NOT SPECIFY HOW MUCH COLLECTION WAS
MADE FOR 2011, 2012, A RECONSTRUCTION OF THE installment receivable account must be
made to determine how much collection was made on a particular year..
THE LAST YEAR BALANCES OF INSTALLMENT RECEIVABLE ARE AS FF:
2011 75,000
2012 375,000
IT IS ASSUMED THAT THE ENDING DEFERRED GROSS PROFIT THIS YEAR IS THE LAST YEAR
ENDING BALANCE ALSO BECAUSE THAT BALANCE IS BEFORE ADJUSTING ENTRIES.
GROSS PROFIT RATIO IS COMPUTED AS FF::
FOR 2011 DEFERRED GROSS PROFIT 24,000
DIVIDE INST. RECEIVABLE beg 75000
equals 32% gross profit ratio
FOR 2012 deferred gross profit per trial balance 112,500
divide receivable beg. 375,000
equals 30%
FOR 2013
INSTALLMENT SALES AMOUNT 800,000
COST OF INSTALLMENT SALES 580,000
GROSS PROFIT 220,000
220,000 DIVIDE 800,000 EQUALS 27.5%
DIVIDE INSTALLMENT SALES AMOUNT 800,000
THE ADJUSTING JOURNAL ENTRIES.
1. IS TO ADJUST THE DEFERRED GROSS PROFIT FOR 2011, 2012 BY KNOWING THE
COLLECTION MADE FOR 2011, 2012 THIS YEAR.. THIS IS HOW TO RECONSTRUCT THE
RECEIVABLE TRANSACTIONS SINCE THERE IS NO DATA ON HOW MUCH WAS COLLECTED FOR
2011, 12 .
SINCE THE ENDING RECEIVABLE AND THE BEGINNING RECEIVABLE IS GIVEN , AND THE ENDING
BALANCE IS SMALLER THEREFORE THERE IS A CREDIT MADE ON THE RECEIVABLE ACCOUNT
WHICH REPRESENT COLLECTION., HENCE THAT REDUCTION IS THE COLLECTION ITSELF.
2011 2012
BEG RECEIVABLE 75,000 375,000
ENDING BALANCE 7,500 30,000
EQUALS COLLECTION 67,500 345,000
FOR 2013
INSTALLMENT SALES MADE 800,000
BALANCE END OF THE YEAR 137,500
EQUALS COLLECTION 662,500
JOURNAL ENTRIES ADJUSTING:
1. INSTALLMENT SALES 800,000
COST OF INSTALLMENT SALES 580,000
DEFERED GROSS PROFIT 2013 220,000
to recognize the deferred gross profit in view of the closing of sales and the cost of sales
2. DEFERRED GROSS PROFIT 2011 ( 67,500 X 32%) 21,600
DEFERRED GROSS PROFIT 2012( 345,000X 30%) 103,500
DEFERRED GROSS PROFIT 2013 ( 662,500 X 27.5%) 182,187.50
REALIZED GROSS PROFIT 307,287.50
to recognize the realized gross profit and reducing the deferred gross profit.
3. cost of sales 130,000
beg. inventory 130,000
to close beg inventory
4. COST OF SALES 875,000
PURCHASES 875,000
to close purchases to cost of sales
5. INVENTORY 150,000
COST OF SALES 150,000
to set up ending inventory
CLOSING ENTRIES.
1. INCOME EXP SUMMARY 855,000
COST OF SALES 855,000
to close cost of sales account
2. REALIZED GROSS PROFIT 307,287.50
SALES 312,500.00
SHIPMENT OF INST. SALES 580,000.00
INCOME EXP. SUMM 1,199,787.50
to close income account
3. INCOME EXP SUMMARY 378,750.00
OPERATING EXPENSES 378,750.00
to close expense account.
4. retained earnings 33962.50
income exp summ 33,962.50
to transfer net loss to retained earnings.
=====================================================================
IN INSTALLMENT SALES , IT WOULD BE COMMON THAT A DEFAULT ON PAYMENT CAN HAPPEN
AND REPOSSESSIONS OF THE PRODUCT IS NECESSARY
IN THE BALANCE SHEET , THERE EXIST A RECEIVABLE FOR THAT CUSTOMER AND A DEFERRED
GROSS PROFIT FOR THAT PRODUCT. SINCE THE PRODUCT WILL BE REPOSSESSED , THE
BALANCE OF THE RECEIVABLE AND THE DEFERRED GROSS PROFIT HAS TO BE CLOSED.
THE DIFFERENCE BETWEEN THE RECEIVABLE AND THE DEFERRED GROSS PROFIT IS ACTUALLY
THE COST OF THE PRODUCT ITSELF BECAUSE ANY REDUCTION ON THAT RECEIVABLE DUE TO
COLLECTION , THE DEFERRED GROSS PROFIT IS ALSO CORRESPONDING REDUCED BY APPLYING
THE PROFIT RATIO ON THAT COLLECTION.
THAT MEANS , IF THAT PRODUCT IS REPOSSESSED , THE RECEIVABLE IS CLOSED AND THE
DEFERRED GROSS PROFIT IS CLOSED , THE DIFFERENCE IS THE ORIGINAL COST OF THAT
PRODUCT. NOW , CONSIDERING THAT THE PRODUCT UNDERGO DEPRECIATION DUE TO WEAR
AND TEAR THAT INVENTORY MAY NOT BE ANYMORE REALISTIC, HENCE A PROPER VALUATION IS
NECESSARY, WHERE IS EITHER GAIN OR LOSS MAY OCCUR DUE TO REPOSSESSIONS.
EXAMPLE:
INVENTORY 5,000
DEFERRED GROSS PROFIT 10,,000
INST. RECEIVABLE 15,000
THEREFORE , A PROPER VALUATION ON THE RETURNED PRODUCT IS NEEDED. THE FOLLOWING
MAY BE THE BASIS.
1. THE FAIR MARKET VALUE., IF MORE THAN THE COST , HENCE A GAIN, IF LESS, THEN A LOSS
ON REPOSSESSIONS
2. THE BOOK VALUE OR THE COST, NO GAIN NOR LOSS
3. RESALE VALUE LESS RECONDITIONING COST PLUS NORMAL PROFIT
4. NO MORE VALUE, A TOTAL LOSS.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
TRADE INS
PRODUCTS BEING TRADED IN AS PART OF PAYMENT FOR THE NEW PRODUCT PURCHASED
SHOULD BE RECORDED AT VALUES AFTER RECONDITIONING COST , WILL MAKE THE PRODUCT
REALIZE A NORMAL GROSS PROFIT ON IT SSALE.
AS TO INDUCE A SALES , AN OVERALLOWANCE IS GIVEN ON THE PRODUCT BEING TRADE IN.
THIS OVERALLOWANCE AMOUNT MAY BE RECORDED AS A SEPARATE ACCOUNT AND DEDUCT ON
THE SALES FIGURE ON TEH PROFIT AND LOSS OR MAYBE APPLIED ON THE SALES FIGURE .
EXAMPLE:
A PRODUCT COSTING 5,000.00 IS SOLD AT 8,000. A USED SIMILAR PRODUCT IS ACCEPTED AS
PARTIAL PAYMENT FOR 1,000. THE USED PRODUCT CAN BE RESOLD AT 1,500.00 AFTER
REPAIR COST OF 400.00 THE COMPANY WANTS A 20% GROSS PROFIT ON TEH RESALE OF THE
USED CAMERA.
IF THAT CAN BE SOLD AT 1500.00
THE MARK UP IS 20% x 1500 ( 300.00)
THEREFORE COST IS 1,200.00
less THE REPAIR COST ( 400.00)
cost to value the trade in 800.00
ACTUAL COST ACCEPT AS TRADE IN 1,000.00
OVER ALLOWANCE 200.00
the entry is :
INVENTORY TRADE IN 800
TRADE IN OVER ALLOWANCE 200
INST. RECE 7,000
INSTALLMENT SALES 8,000
COST OF INST. SALES 5,000
INVENTORY 5,000
======================================================================
INTEREST ON INSTALLMENT RECEIVABLE
when interest is calculated , the interest revenue should be accounted for separately, that is,
each payment received is separated into interest revenue. the interest revenue should be
recorded on accrual basis.
EXAMPLE :
On Oct end , a lot is sold costing 200,000.00 for 300,000.00 . a 75,000 down was made and
the balance payable in monthly installment with first payment due end nov. payable in 75
months. the monthly installment is 3,000 a month plus 12% interest on the unpaid balance
ENTRIES
CASH 75,000
Notes receivable 225,000
REAL ESTATE 200,000
DEFERRED GROSS PROFIT 100,000
November
Cash 5,250.00
notes rece 3,000
interest income 2,250
dec. 31
cash 5,220.00
notes rec 3,000.00
interest 2,220.00
to record collection in dec. with a principal balance of 222,000 x 1% =2220.00
deferred gross profit 27,000
realized gross profit 27,000
to record the realized gross profit for the collection of 81,000 x .33.333.% mark up
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