Installment Sales Flashcards
Scenario: Find the Deferred Gross Profit to be reported by the company on December 31, year 2 with the following data:
Company sold machine to another company for $750,000 on Jan 2, Year 1.
This result in $180,000 gain
On that date, the other company paid $200,000 in cash and signed a $550,000 note bearing 10%
This note is paid in 3 yearly (annual) payment installments of $183,333 starting on Jan 2, Year 2.
Company appropriately accounted for the sale under the installment method.
The other company made a timely payment of the first installment on January 2, Year 2, of $325,000, which included interest of $75,000.
Solution:
Ending Receivable:
$550,000
- 183,333 payment (on Jan 2 year 2)
366,667
GP %: 180,000 gain / $750,000 sale price
= 0.24
Deferred GP: $366,667 ending receivable x 0.24 = 88,000 DGP (answer)
Note: GP % on installment for a sale of an asset is the same as total sales and gross profit from inventory sale. Except it involves the following:
Gain / Sale Price of asset = GP% (compare to Gross Profit / Sales Revenue)
What are the Journal entries on installment sale with the following data:
Sale of installment = $500,000
Cost of goods sold (cost of sale) = $200,000
Total gross profit = $300,000
(a) During first period (i.e. year one at start of installment)?
(b) When cash is collected? (i.e. at $150,000 cash collected)
(c) And when recording realized profit on collection?
Also - what is the GP% needed for J/E on record realized profit?
Journal entires:
At the First Period of sale:
(a) Dr. Installment sale A/R (whole amount) $500,000
Cr. Inventory (at cost) 200,000
Cr. Deferred Gross profit (install sale - inventory cost) 300,000
(b) At Cash collection:
Dr. Cash 150,000
Cr. installment sale a/r 150,000
** Here increase cash and reduce installment sale receivable
(c) when record profit at collection:
GP % = $300,000 profit / $500,000 sale = 0.60 or 60%
Then: $150,000 Cash Collection x 0.60 = $90,000 Gross profit
Dr. Deferred Gross profit 90,000
Cr. Realized Gross profit on installment sale 90,000
*Dr. Deferred gross profit –> reduce deferred gross profit
** Cr. realized gross profit –> recognize and/or increase at each cash collection date
Scenario: Find Year 4 Deferred Gross Profit on company’s balance sheet with the following data below:
Year 3 Year 4
Installment receivables at year-end on Year 3 sales $60,000 $30,000
Installment receivables at year-end on Year 4 sales - 69,000
Installment sales 80,000 90,000
Cost of sales 40,000 60,000
Gross profit = Sales - Cost of sales
Year 3: [$80,000 sales - $40,000 cost of sales] = $40,000 gross profit
Year 4: [$90,000 sales - $60,000 cost of sales] = $30,000 gross profit
Gross profit rate = Gross profit / Sales
Year 3: [$40,000 GP / $80,000 sales] = 50%
Year 4: [$30,000 GP / $90,000 sales] = 33.3%
Year 4 Balance sheet only:
Deferred gross profit= GP rate x Ending AR on Year 3 sales @ 12/31/Y4
= [50% x $30,000]
= $15,000
Deferred Gross profit = GP rate x Ending Ar on Year 4 sales @ 12/31/Y4
= [33.3% x $69,000]
= $23,000
Total deferred gross profit to be reported on Balance Sheet
= $15,000 (year 3 sales) + $23,000 (year 4 sales)
= [$15,000 + $23,000]
= $38,000
Note: Balance Sheet reports accumulated amounts, so it would report one total amount of data from Prior years to Current years.
Pass key: how to present installment sale receivable and deferred gross profit on Balance Sheet with the following data:
Account Receivable = 350,000
Deferred gross profit = 210,000 (* 210,000 = 0.60 GP% x $350,000 receivable) ?
Deferred gross profit is a ____ account to Accounts receivable that ____ the accounts receivable.
Example (on Balance Sheet):
Accounts receivable $350,000
Less: Deferred gross profit - 210,000
————————————– ————
= Ending balance = $140,000
* Deferred gross profit is a CONTRA- account to Accounts receivable that reduces/lowers the accounts receivable.
In terms of accounting rules on Installment Sales Receivable: what is the difference in the meaning/definition of “when collectability of installment accounts receivable is reasonably predictable” and the statement “when installment sales are material and there is no reasonable basis for estimating collectability” and “when it is doubtful that the amount due will be collected?”
Statement #1: “When collectability of installment accounts receivable is reasonably predictable.”
This means: Reasonable predicable on collecting installment accounts receivable results in actually recognizing realized Revenue (revenue when it’s earned and realized = revenue where good/service is finished and finally collect the cash and/or A/R)
Statement #2: “When installment sales are material and there is no reasonable basis for estimating collectability.”
This means: Installment sales method is used when the method of installment sales is material (it’s very important for financial reporting purposes and greatly impacts business operations to use the Installment sales method) and installment sales methods’ main purpose is that it is used when a company has no way to determine when cash is really, really going to be collected (hard to estimate when cash is going to be collected). Also: the installment sales method is also used when it’s impossible to establish a reasonable bad debt percentage.
Statement #3: ““when it is doubtful that the amount due will be collected.”
This means: Cost recovery method is used when when it’s doubtful that the amount (sales installment amount) will be entirely collected. You cannot use installment sales method since installment sales focuses on unable to estimate an amount to be collected in determing an amount of bad debt expense whereas Cost recovery focuses it’s doubtful to recover the entire sales amount.
(1) Accounting for installment sale: (for merchandise sales)
Gross profit = ???
Gross profit percentage = ???
Earned gross profit = ???
Deferred gross profit = ???
(2) Note for sale of a fixed asset with cost or carry value and fair value or sales price:
What is Gross profit = ???
What is Gross profit % = ???
Gross profit = Sales - cost of goods sold (COGS)
Gross profit % = Gross profit / sales
Earned gross profit = Cash collections x GP %
= or (Sale installment - ending installment receivable amount) x GP%
Deferred gross profit = Ending installment receivable x GP %
= Or [Beginning Sale installment - Cash collection - any write off] x GP%
FYI - this Formula to help find Earned GP and Deferred GP
Beginning Receivable (Installment receivable or installment Accounts receivable)
Add: New credit sales (A/R sales)
Less: Cash Collection
Less: Write-offs
= Ending Receivable
(2) Note for sale of a fixed asset with cost or carry value and fair value or sales price:
Gross Profit = Sales Price - Cost of asset
Gross Profit % = Gain / Sales Price
Example: Company sold $1,500,000 on machine on installment to another company and the accumuloated cost (book value or carry value) of the machine is 400,000.
Gross Profit (gain)
= $1,500,000 sale price - 400,000 cost
= 1,100,000 GP (gain)
GP% = $1,100,000 gain / $1,500,000 sale price
= 0.733 GP%
What the four steps on calculate installment sale?
Step 1) Find gross profit $$ amount
Example:
$500,000 sale installment
- $200,000 cost of goods sold
= $300,000 total gross profit
Step 2) Find Gross profit percentage
Example: $300,000 GP / $500,000 sale = 0.60 (or 60%)
Step 3) Find earned gross profit $$ amount
(a)
$500,000 sale installment
- $350,000 ending receivable
= $150,000 cash collection
|
$150,000 cash collection x 0.60 GP% = $90,000 Earned GP (or gross profit)
Note: (** When the Ending Receivable is given to you.)
-Or-
Just only
(b) $150,000 cash collection x 0.60 GP% = $90,000 earned gross profit (or gross profit)
(** When only cash collected is given to you)
Step 4) Find deferred gross profit $$ amount
$350,000 ending receivable x 0.60 GP % = 210,000 deferred gross profit
True or False
Cash collection is a critical event for income recognition in the cost-recovery method and Installment sales method.
True
Cost recovery: recognize income (realized gross profit / earned gross profit) when all cash collected in total equal the cost of sale (cost of goods sold).
Installmetn sale: recognize income (realized gross profit / earned gross profit) as a GP % x Cash collection.
When have a CPA exam problem that looks like this:
Year 2 Year 1
Sales $2,500,000 $1,000,000
Accounts receivable:
2002 sales 900,000
2001 sales 540,000 600,000
Deferred gross profit:
2002 sales 252,000
2001 sales 108,000 120,000
(a) Why do you not combine Account receivables’ 2002 sales and 2001 sales under Year 2 (800,000 + 350,000); Deferred G.P.’s 2002 and 2001 sales under 2 ($150,000 + 112,000?
(b) Also: how come in this scenario, you do not have: Sales minus A/R then divided by total sales for either year 1 or year 2?
(a) The installment sales for Year 1 and Year 2 must be accounted for separately because the gross profit percentage for
Year 1:
2001 sales: $108,000 DGP / $540,000 A/R = 20% GP%
and
2001 sales: $120,000 DGP / $600,000 A/R = 20% GP%
is different than the gross profit percentage for
Year 2:
2002 sales: $252,000 DGP / $900,000 A/R = 28% GP%
Combing them is the wrong methology to get the GP % for year 1 and year 2 because GP % focuses on the data that occured in 2001 and 2002 not when it’s under a Year 1 column and/or a Year 2 column.
(b) Why do not have Sales minus A/R then divide by Sales i.e.
Year 2 sales of $1,500,000 and the ending accounts receivable for Year 2 of $900,000, and then div1ding the difference by the sales of $1,500,000 [($1 ,500,000- $900,000)1$1 ,500,000 = 40%].
Reason: The gross profit percentage cannot be calculated using this methodology.
Gross profit % is calcualted via only this way:
Sales - Cost of sales = GP –> Then: GP / Sales = GP %.
In this problem: the DGP is already given to you along with the (ending) A/R amounts that all you need to do is just DGP / Ending AR = GP%
What is the formula to find the Deferred Gross Profit when you have the following variables?
Installment receivable (beginning)
Cash collections
Write offs
GP % rate
Installment receivable (beginning)
- Cash collections
- Write offs
= Ending Receivable
x GP % rate
Deferred GP
Scenario: Find the Realized gross profit to be reported on income statement for year-end with the following data:
Yard Company sold a planet to Grass Inc for $2,500,000 on Jan 2, year 1
On that date (Jan 2, year 1), plant’s carry cost = $1,000,000
Also, Grass Inc gave Yard company $250,000 in cash and a $2,250,000 note on 12% interest rate.
This $2,250,000 is payable in 4 annual payment of $562,500
On Dec 31, year 1, Grass Inc paid 570,000 that includes interest.
Yard company uses Installment Sale method to record revenue.
Yard company:
On Jan 1, year 1 - collected first cash payment of $250,000
On Dec 31, year 1 - collected $562,500 payment (not include interest since Interest income is reported separately)
Therefore:
Gross Profit = $2,500,000 sale price - $1,000,000 cost = 1,500,000 GP
GP % = $1,500,000 GP / 2,500,000 sale price = 0.60
Realized Gross Profit = Cash collections in current period (year) x GP %
= [($250,000 on Jan 1 year 1) + ($562,500 on Dec 31 year 1)] x 0.60
= ($250,000 + $562,500) x 0.60
= 812,500 x 0.60
= 487,500 realized gross profit (answer)
Note: in this scenario you only focus is on the Sale price, the cost, the cash collected payments. Do not include the Interest income in determing Realized Gross Profit or the Deferred Gross profit no matter if problem gives you like here this $$$ payment that is for principal and interset amount combined.
For finding the Realized Gross profit and Deferred gross profit amount use the cash payments collected instead. Ignore any info about here’s a payment received that is for principal and interest included. (For example: This $2,250,000 is payable in 4 annual payment of $562,500. On Dec 31, year 1, Grass Inc paid 570,000 that includes interest.)
Scenario: Find the Cash collection amount and Realized Gross profit for year ended on December 31, Year with the following data:
Here are the following information is available for Year 1:
Installment accounts receivable, December 31, Year 1 $1,200,000
Deferred gross profit, December 31, Year 1
(before recognition of realized gross profit for Year 1) $680,000
Gross profit on sales 45%
Step 1) DGP before recognized Realized GP / GP % = Sales Installment
$680,000 / 0.45 = 1,511,111
Step 2)
Sales 1,511,111
- A/R End - 1,200,000
= cash collected 311,111
x GP % x 0.45
= Realized GP $140,000 (answer)
Alternative:
GP % x Ending Receivable = DGP (new)
0.45 x 1,200,000 = $540,000 DGP new
$540,000 DGP New
- 680,000 DGP Old
= 140,000 RGP (answer)
Another way to look at this:
OLD DGP 680,000
- New RGP - 140,000
New DGP 540,000
Scenario: Find the Deferred GP / Deferred revenue on Dec. 31, Year Balance Sheet with the following:
Company sales and collects for year 1 were $75,000 and $23,000 respectively.
Uncollectible accounts receive of $10,000 were written off during year 1
Company’s gross profit rate is 40%.
Installment Receivable 75,000
- Collections (cash) -23,000
- Write off -10,000
= End Receivable (12/31/Y1) 42,000
x GP Rate x 0.40
= Deferred revenue (Gross profit) 16,800
Scenario: find the Installment receivable for a Balance sheet ending on Decembe 31, year 2 for ABC Company with the following data below:
Year 1 Year 2
Sales $2,000,000 $2,800,000
Gross profit realized on sales made in:
Year 1 175,000 70,000
Year 2 - 230,000
Gross profit % 30% 40%
Solution: For this scenario, remember on a balance sheet to report any account (like receivables or even accumulated depreciation) is that the $$ amounts for a Balance Sheet accounts are accumulative is that they include prior periods’ $$ amounts + current $$ amounts.
Therefore, to find Installment Receivable on 12/31/Year 2’s balance sheet:
(1) Find Year 1 year-end Installment receivable:
$175,000 RGP / 30% GP% = $583,333 cash collection.
[Note: Remember this formula below
Sales installment
- Ending Receivable
= Cash collection
x GP%
= Realized Gross Profit]
So: then, we:
$2,000,000 sales (installment receivable)
- 583,333 cash collection
= $1,416,667 Ending Installment receivable
(2) For year 2, year-end Balance sheet Installment receivable (Dec. 31. year 2)
$1,416,667 installment receivable (Beg - year 2)
+ 2,800,000 sales (year 2)
= $4,216,667 new installment receivable @ Year-2 Beg.
Then:
$70,000 RGP / 0.30 GP %
= $233,333 cash collection
$230,000 RGP / 0.40 GP %
= $575,000 cash collection
Then:
4,216,667 Year-2 Beg. receivable
- 233,333 cash collection
- 575,000 cash collection
= 3,408,334 year 2 ending receivable (answer)
So, FYI:
ABC Company
Balance Sheet
As of December 31, Year 2
Year 2 Year 1
Installment Receivable 3,408,334 1,416,667
Scenario: Find the Deferred Gross profit on Dec 31 year 2 balance sheet with the following data:
ABC Company sold used machine for $125,000.
Used machine’s depreciated cost or book value is 65,000
The XYZ company who bought this used machine paid 35,000 in cash and signed a $90,000.
This note is pad in 3 installments of $30,000 annually (per each year) beginning on Jan 15 year 2.
XYX company made its first payment on Jan 15, year 2 of $45,000 including 15,000 interest.
Amount realized $125,000
Adjusted basis -65,000
Gain recognized 60,000
Gross profit % (60,000 / 125,000) = 0.48
Amount realized $125,000
Less: collections in Year 1 (35,000)
Less:
Principal collected in Yr. 2
(45,000- 15,000 interest*) (30,000)
Balance to be received 60,000 End receiv.
x GP % x 0.48
Deferred gross profit $28,800
* Interest is recorded separately as Interest income. This interest income is not included or added back in to determine Deferred Gross Profit or Realized Gross profit.
FYI - On 12/31/Year 2 Balance Sheet
Installment Sale Receivable 60,000
Less: Deferred Gross Profit (28,800)
Balance $31,200
