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CPA Exam Review Spotlight (FAR): Installment Sales Method

Based on some of the accounting literature I reviewed in preparation of this spotlight on the installment sales method, one of the most challenging issues accountants deal with is the proper recognition of revenue related to the operations of a business concern. While a good number of general rules and guidelines have been developed to facilitate the application of the revenue recognition principle, the multitude of marketing methods for products and services make it difficult to apply the rules consistently across various circumstances. Indeed, there are many ways a sale can be structured. When you think about it, depending on the surrounding circumstances, revenue may need to be recognized at the point of delivery, before the point of delivery, or after the point of delivery.

The installment sales method is one of the tools available to the accountant who is confronted with a situation where revenue will have to be recognized beyond the point of delivery. The recognition of revenue takes place after the point of delivery because there remain significant uncertainties about cash collection at the time of the sale/delivery of a product or a service. Use of the installment method is warranted in circumstances where receivables are to be collected over an extended period of time and there is no justifiable reason for estimating the degree of collectibility. Under the installment sales method of accounting, the gross profit (sales less cost of goods sold) on installment sales is deferred to those periods in which cash is collected. Operating expenses, such as selling and administrative expenses, are treated as expenses in the period incurred. To help you better picture how the installment sales method of accounting works, assume the following facts:

 Year 2013Year 2014Year 2015
Installment sales350,000275,000450,000
Cost of installment sales220,000180,000290,000
Gross profit130,000  95,000160,000
Gross Profit Percentage 37.15% 34.55% 35.55%
Cash Receipts
    From 2013 Sales105,000125,000130,000
    From 2014 Sales 135,000  95,000
    From 2015 Sales 175,000

Only journal entries pertaining to year 2014 will be shown. The entries for 2013 and 2015 are the same, but the entire set of entries for the installment method are illustrated with the 2014 entries.

To record 2014 installment sale
Installment Accounts Receivable, 2014275,000
                                        Installment Sales                                       275,000
To record cash collected on installment receivables
Cash260,000
        Installment Accounts Receivables, 2013                                       125,000
        Installment Accounts Receivables, 2014                             135,000
To record 2014 cost of goods sold on installment
Cost of Installment Sales180,000
                             Inventory (or Purchases)                                       180,000
To close 2014 installment sales and cost of installment sales
Installment Sales 275,000
                            Cost of Installment Sales                                         180,000
                            Deferred Gross Profit, 2014                                         95,000
To record realized gross profit in 2014
Deferred Gross Profit, 201346,437.5 (a)
Deferred Gross Profit, 201446,642.5 (b)
                             Realized Gross Profit                                   93,080
(a) 125,000 x 37.15%
(b) 135,000 x 34.55%

As you may have noticed from the above illustrative example, applying the installment method to accounting is not as difficult as it may appear. Please be kind to use the the comments section below to share your own tips on this topic, to ask clarifying questions, or to share your views on what was discussed.

One Comment

  1. Comment by chinweike:

    The recognition of revenue no doubt pose problems but what else could be more problematic than ‘fair value accounting’? Well done for throwing more light on one of the grey areas of accounting.

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