Installment Sales Method

Question 1

An entity sells an item where cash collections will take longer than one year. What are the three ways this entity can report its revenue on this sale?

Answer 1

Under normal conditions, the sale will be recognized when the earnings process is substantially complete.

If significant uncertainty exists as to collection, the entity should recognized revenues using the installment sales method.

if collection is highly doubtful, the entity should recognize revenues using the cost recovery method.

Question 2

An entity buys an item for $1,400 and sells it for $2,000, resulting in a $600 gain.

If either the installment sales method or the cost recovery method is being utilized, how is this $600 initially recorded?

Answer 2

under both the $600 gain is reported as a deferred gain which is a contra asset to the $2,000 receivable

A/R 2,000
Deferred gain 600
Asset 1,400

Question 3

An entity buys an item for $1,400 and sells it for $2,000, resulting in a $600 gain.

What is the gross profit percentage?

Answer 3

600/2000 = 30%

Question 4

An entity buys an item for $1,400 and sells it for $2,000, resulting in a $600 gain. GP % - 30% The installment sales method is applied. During the year, the entity collects $400 in cash, leaving $1,600 in the receivable balance.

What should the entity report as its gain on this sale in this first year, and what is balance in the deferred gain account?

Answer 4

400 cash received x 30% GP% = 120 gain recognized

1600 receivable x 30% GP% = $480 deferred gain remaining

Question 5

An entity buys an item for $1,400 and sells it for $2,000, resulting in a $600 gain. The Cost recovery method is applied. During the year, the entity collects $500 in cash, leaving $1,500 in the receivable balance.

What should the entity report as its gain on this sale in this first year, and what is balance in the deferred gain account?

Answer 5

no gain is recognized until the amount equal to the cost is received.

$600 is still a deferred gain

Question 6

An entity buys an item for $1,400 and sells it for $2,000, resulting in a $600 gain. The Cost recovery method is applied. During year 1, the entity collects $500 in cash, so that no gain is recognized. In year 2, the entity collects $950 for a total of $1,450.

What should the entity report as its gain on this sale in this second year, and what is balance in the deferred gain account?

Answer 6

1,400 cost - 1,450 cash received = 50 gain

600 deferred gain - 50 gain = 550 deferred gain remaining