| rstalment Sales Method Chapter 10 Installment Sales Method fearning Objectives | 1. State the applicability of the “installment sales method” of recognizing revenues. |2 Apply the “installment sales method.” Introduction An entity applies PFRS 15 Revenue from Contracts with Customers to account for revenues from contracts with customers. The installment sales method discussed in this chapter is not in accordance with PFRS 15. (Refer to intermediate Accounting Pert 3 for detailed discussion on the revenue recognition principles of PERS 15.) Installment sales method Applicability The “installment sales method” is a special case of revenue recognition that deviates from the revenue recognition principles of PERS 15. This method may be used for taxation purposes or when the entity is a “micro entity” ® and has opted to use the “income tax basis” of accounting. ‘(National Internal Revenue Code “NIRC’ Sec. 49) PA “micro entity” is an entity that has total assets or total liabilities below 3,000,000 (SEC. guideline on SM) Brief history The “installment sales method” has originated from the traditional Us, GAAP and was applied typically by entities providing financing through long-term installment sales of real Property (eg, land) and other assets with relatively high value (e.g., heavy “quipment) when there is uncertainty in the collectability of the Consideration. ie Gross profit rate based on sales = Gross profit + Sales Illustration 1: Journal entries ABC Co. uses the “installment sales method.” On Jan. 1, 20x1, ABC Co. sold a bulldozer costing P600,000 for P1,000,000 Payable as follows: 20% down Payment and balance due in 4 equal annual installments every Dec. 31. Journal entries: Jan.) Cash 200,000 711 | Installment accounts receivable 800,000 Sales 1,000,000 Jan. 1. | Cost of sales 600,000 20a Inventory 600,000 Dec.31, | Cash (BOOK + 4) 200,000 2081 Installment accounts receivable 200,000 » The realized gross profit in 20x1 is computed as follows: Down payment — Jan. 1, 20x1 200,000 Ist installment — Dec. 31, 20x1 200,000 Total collections - 20x1 400,000 Multiply by: Gross profit rate based on sales (1M-600K)+1)__400% Realized gross profit ~ 20x1 160,000 The adjusting entry to record the deferred gross profit is as follows, Dec. 31, | Income summary 240,000 | 20x1 Deferred gross profit © 240,000 || Installment Sales Method _SeRUAESMSM 4a wiSales 1,000,000 Cost of sales (600,000) Deferred gross profit-beg. 400,900” Less: Realized gross profit (160,000) Deferred gross profit - end. ferred gross profit - end. 240,000 's Dec. 31, 20x1 financial statements will report the following; INCOME STATEMENT Installment sales 1,000,000 Costof sales (600,000)} Gross profit 400,000 Less: Deferred gross profit (240,000) Realized gross profit 160,000 BALANCE SHEET ASSETS Installment accounts receivable 600,000 ‘LIABILITIES Deferred gross profit 240,000 The deferred gross profit, being an unearned income, is classified in the balance sheet as liability. » The gross profit rate based on sales can also be computed using the formula below: i = ——Deferred gross profit Gross.profitrame: =i “ iiment docouni SaceivaDe Gross profit rate = 240,000 + 600,000 Gross profit rate = 40% Ilustration 2: Two periods ABC Co. uses the “installment sales method.” Information on ABC’s transactions during 20x1 and 20x2 is shown below: 20x1 20x2 Installment sales 1,000,000 1,200,000 Cost of sales 600,000 660,000 Gross profit 400,000 540,000 Cash collections from: 20x1 sales 400,000 200,000 20x2 sales 480,000 Requirement: Compute for the total realized gross profit in 20x2.i,j Chapter ip Solution; Pric €s and costs change over time, so an entity may have differen, §r0ss profit rates each year. When computing for the Tealizeg Bross profit, the original gross profit rate in a Particular year o¢ sale is applied to the subsequent collections. The gross profit rates based on sales are computed as follows: 20x1 20x2 Gross profit 400,000 7 540,000 Installment sales 1,000,000 1,200,009 Gross profit tates based on sales 40% 45% The realized gross profit in 20x2 is computed as follows: Collections in 20x2 from: 20x1 sales: (200,000 x 40%) 80,000 20x2 sales: (480,000 x 45%) 216,000 Total realized gross profit in 20e2 296 000 profitin20x2 26,000 ADDITIONAL ILLUSTRATIONS: Most board exam problems on installment sales method are designed to test the examinee’s skills in using formulas and their variations and in reconstructing missing information. Use the illustrations below to develop those skills, Illustration 1: Computation of gtoss profit rate 4 ABC Co. uses the “installment sales method.” On January 1, 20x3, ABC Co.'s records show the following balances: Installment receivable - 20x1 320,000 Installment receivable - 20x2 960,000 3 Deferred gross profit - 20x1 70400 0 = Deferred gross profit - 20x2 230,400 On December 31, 20x3, ABC Co.'s records show the following: Installment receivable - 20x1 a Installment receivable - 20x2 384,000rt trstallment Sales Method 429 hsm Installment receivable - 20x3 1,200,000 Deferred gross profit - 20x1 (before adjustment) 70,400 Deferred gross profit - 20x2 (before adjustment) 230,400 Deferred gross profit - 20x3 (before adjustment) 750,000 Installment sales in 20x3 were made at 33 45% above cost. Requirements: a. Compute for the installment sale in 20x3. , Compute for the cash collections in 20x3. ¢ Compute for the total realized gross profit in 20x3. Solutions: Requirement (a): Installment sale in 20x3 . . . Gross profit Basic formula: GPR based on sales ——EE se . Gross profit Variation: Sales GPR based on sales Deferred gross profit - 20x3 (before adjustment) 750,000 Divide by: Gross profit rate based on sales © 25% Installment sale in 20x3 3,000,000 334% GPR based on cast + (100% cost + 33 4% GPR on cost) = 25% GPR based on sales Alternative solution 1; 750K + (33 4% + 133 %4%) = 3,000,000 Alternative solution 2: 750K x (133 A% + 33 4%) = 3,000,000 Requirement (b): Cash collections Installment receivable - 20x1, Jan. 1, 20x3 320,000 Less: Installment receivable - 20x1, Dec. 31, 20x3 - Cash collection in 20x3 320,000. Installment receivable - 20x2, Jan. 1, 20x3 960,000 Less: Installment receivable - 20x2, Dec. 31, 20x3 (384,000) ~Cash collection in 20x3 576,000 Sale in. 20x3 (eee previous solution) 3,000,000 ~Lesh collection in 20x31 1,800,000 Total collections in 20x3 2,696,000 —Chapter 10 430 e rey sing T-accounts: Alternatively, the cash collections may be squeezed using, Tec eewelriesa he eld 2002 Inst reciable- 2003 432 ae Illustration 4: Reconstruction of information a ABC Co.'s records show the following information: 20x1 20x2 Deferred gross profit (adjusted ending balances): from 20x1 sale 176,000 70,400 from 20x2 sale 230,400 Gross profit rates based on sales 22% 24% Cash collections from: 20x1 sales 1,200,000 480,000 20x2 sales 1,440,000 Requirements: Compute for the following: a. Balances of installment receivables on December 31, 20x2. b. Installment sales in 20x1 and 20x2. Solutions: ss z Deferred gross profit rutile: Scross probtrate: Installment account receivable Variation: Installment account receivable = DGP + Gross profit rate Deferred gross profit - 20x1 sale, Dec. 31, 20x2 70,400 Divide by: Gross profit rate_in 20x1 2% Installment receivable - 20x1, Dec. 31, 20x2 - Regt. (a) 320,000 Add back: Collections (1,200,000 it 20x1 + 480,000 in 20x2) 1,680,000 Installment sale - 20x1 — Requirement (b) 2,000,000 Deferred gross profit - 20x2 sale, Dec. 31, 20x2 230,400 Divide by: Gross profit rate in 20x2 24% Installment receivable - 20x2, Dec. 31, 20x2 — Reqt.(a) 960,000 Add back: Collections from 20x2 sales 1,440,000 Installment sale - 20x2 — Requirement (b) 2,400,000.- — pustallment Sales Method ee eee ———— filustration 5: Deferred gross profit ABC Co.'s records show the following: 20x1 20x2 2,000,000 2,400,000 Installment sales Cost of sales 1,560,000 1,824,000 Cash collections from: 20x1 sales 1,200,000 480,000 20x2 sales 1,440,000 Requirement: Compute for the total deferred gross profit on Dec. 31, 20x2. Solution: _ Deferred gross profit a: Gi fi : Formula Gross profit rate Trallment account receivable Variation: Installment account receivable x Gross profit rate = DGP Gross profit rate im 201: [2M - 1.56M) ~ 2M) 22% Gross profit rate in 20x2: {(2.4M - 1.824M) +2.4M| 24% Installment sale - 20x1 2,000,000 Cash collections (1,200,000 + 480,000) (2,680,000) Installment receivable - 20x1, Dec. 31, 20x2 320,000 Multiply by: Gross profit rate in 20x1 22% Deferred gross profit - 20x1, Dec. 31, 20x2 70,400 Installment sale - 20x2 2,400,000 Cash collections (1,440,000) Installment receivable - 20x2, Dec. 31, 20x2 960,000 Multiply by: Gross profit rate in 20x2 24% Deferred gross profit - 20x2, Dec. 31, 20x2 230,400 Total deferred gross profit - Dec. 31, 20x2 . 300,800Chapter 10 434 ee Illustration 6; Cash collection aoa: ABC Co. has the following collection policy on its installment sales: * 20% down payment - © Balance due as follows: 50% in the year of sale, 30% in the second year, and 20% in the third year. Installment sales during 20x1, 20x2 and 20x3 were P2,000,000, 2,400,000 and P3,000,000, respectively. * Gross profit rates based on sales in 20x1, 20x2 and 20x3 were 22%, 24% and 25%, respectively. Requirement: Compute for the total realized gross profits in each of years 20x1, 20x2 and 20x3. Solution: 20x1 20x2 20x3 20x1 sale: Down payment (2M x 20%) x 22% 88,000 20x1: ((2M x 80%") x 50%] x 22% 176,000 20x2: [(2M x 80%) x 30%] x 22% 105,600 20x3: [(2M x 80%) x 20%] x 22% 70,400 20x2 sale: Down payment (2.4M x 20%) x 24% 115,200 20x2: [(2.4M x 80%) x 50%] x 24% 230,400 20x3: [(2.4M x 80%") x 30%] x 24% 138,240 20x3 sale: Down payment (3M x 20%) x 25% 150,000 20x3: [(GM x 80%) x 50%] x 25% 300,000 Realized gross profits 264,000___ 451,200 658,640 "100% less 20% down payment = 80% balancer installment Sales Method pe ppg SN [llustration 7: Reconstruction of information ABCC incomplete records show the following: 20x1 20x2 20x3 “Tpstallment sales 2,000,000 2,400,000 ? Cost of sales ? ? 2,250,000 Gross profit 2 2 2 Gross profit rates 2 2 25% Collections from 20x1 sales 1,200,000 480,000 320,000 from 20x2 sales 1,440,000 576,000 from 20x3 sales 1,800,000 Realized gross profit 264,000 2 658,640 Requirement: Compute for the cost of sales in 20x2. Solution: Realized gross profit - 20x1 264,000 Divide by: Collections in 20x1 1,200,000 Gross profit rate - 20x1 22% Total realized gross profit in 20x3 658,640 Realized gross profit in 20x3 from 2021 sales (320K x 22%) (70,400) Realized gross profit in 20x3 from 20x3 sales (18M x 25%) (450,000) Realized gross profit in 20x3 from 20x2 sales 138,240 Realized gross profit in 20x3 from 20x2 sales 138,240 Divide by: Collections in 20x3 from 20x2 sales 576,000 Gross profit rate ~ 20x2 24% Installment sales - 20x2 2,400,000 Multiply by: Cost ratio in 20x2 (100% - 24%) 76% Cost of sales - 20x2 1,824,000Chapter 10 Ble 2 cel zt. oe pean ee 4@ Observe that the previous problems all revolve around the two formulas below (and their variations): Realized gross profit = Collectionon sale x Gross profit rate Deferred gross profit Gross profitrate = Installment account receivable Please memorize the formulas and practice applying them, 1am presupposing you are already well-acquainted with the gross profit rate computations and the use of the receivable T-account. Also, if you analyze Illustrations 1 to 7 more closely, you will find out that these are actually just variations to one and the same problem. I have designed it this way so that you will realize that accounting problems all revolve around same basic concepts regardless of how differently they were structured. This is me teaching you how to fish....... because I don’t have a fish to give.O¥ ©¥ Before moving on, I would like to suggest that you go back to, the previous illustrations, cover the suggested solutions, re-solve the problems independently, and then check if you got the correct answer. Also, try figuring out how the other missing information in Illustration 7 can be solved. Here is your guide: 20x1 20x2 20x3 Installment sales 2,000,000 2,400,000 3,000,000 Cost of sales 1,560,000 1,824,000 2,250,000 Gross profit 440,000. 576,000 750,000 Gross profit rates 22% 24% 25% Collections: from 20x1 sales 1,200,000 480,000 320,000 from 20x2 sales 1,440,000 576,000 from 20x3 sales 1,800,000 Realized gross profit 264,000 451,200 658,640_Intallment Sales Method ro Repossession The seller may repossess the good sold in case of default by the buyer. On repossession date: a. The repossessed good is debited to an inventory account at “fait value.” For purposes of applying the installment sales method, “fair value” is either: i, the appraised value of the repossessed good; or ii, the estimated resale price of the repossessed good less reconditioning costs and normal profit margin. b. The carrying amounts of the related installment receivable and deferred gross profit are derecognized. c. The difference between (a) and (b) is recognized as gain or loss on repossession. > Pro-forma entry: Date | Inventory (at “fair value”) xx | Deferred gross profit (at carrying amount) xx | Loss on repossession (debit balancing figure) ax | Installment receivable (at carrying amount) | xx | xx Gain on repossession (credit balancing figure) Illustration 1: Repossession - Appraised value ABC Co. repossessed a good that was previously sold to a defaulting buyer. Relevant information follows: © Appraised value of the repossessed good — P6,000. * Balance of installment receivable — P10,000. * Gross profit rate on the sale ~ 30%. Requirement: Compute for the gain or loss on repossession. Solution: Date | Inventory 6,000 Deferred gross profit (10K x 30%) , 3,000 Loss on repossession (squeeze) 1,000 . Installment account receivable 10,000438 Illustration 2: Repossession — Estimated resale price ; Information on ABC Co’s installment sales is as follows: 20x1 20x2 Sales 200,000 320,000 Cost of sales 160,000 224,000 Gross profit rate 20% 30% Installment receivable - 20x1 90,000 30,000 Installment receivable - 20x2 144,000 During 20x2, ABC Co. repossessed a property that was sold in 20x1 for P20,000. Prior to repossession, P5,000 were collected from the buyer. The repossessed property is expected to be resold for P17,000 after reconditioning costs of P3,000. The normal profit margin is 30%. Requirements; a. Compute for the gain or loss on repossession. b. Compute for the total realized gross profit in 20x2. ¢. Compute for the profit recognized in 20x2. Solution: Requirement (a): Date | Inventory 8,900 Deferred gross profit (15K x 20%") 3,000 Loss on repossession (squeeze) 3,100 Installment receivable (20K ~ 5K) 15,000, Estimated resale price 17,000 Reconditioning costs (3,000) Normal profit margin (17,000 resale price x 30%) (5,100) “Fair value” of repossessed property 8,900 ©The gross profit rate in the year the repossessed good was originally sold is used in computing for the related deferred gross profit. Requirements (b) and (c); The collections in 20x2 are computed as follows:rl polit Sees Meiod 8 ment receivable - 20x2 installment receivable - 20x1 seg 0000 [75000 Write-off Beg — Write-off 45,000_ Collection Sele _320,000 | 176,000 _ Collection S000, Ean | 144,000_ End Realized gross profit from: =20X1 sale (45K x 20%) 9,000 -20x2 sale (176K x 30%) 52,800 Total realized gross profit in 20x2 — Requirement (b) 61,800 Loss on repossession (3,100) Profit in 20x2 - Requirement (o). 58,700 Illustration 3: Repossession — Fair value after reconditioning costs | Information on a repossessed good from a defaulting buyer is as | follows: © The appraised value (fair value) is P6,000 after reconditioning } costs of P500. © The balance of the installment receivable is P10,000. The gross profit rate on the sale is 30%. Requirement: Compute for the following: a. Gain or loss on repossession. b. New cast basis of the repossessed inventory. | | | | I | Solution: | Requirement ta)s Date | Inventory (exeluding reconditioning costs) ® 5,500 Deferred gross profit (10K x 30%) 3,000 Loss on repossession (squeeze) 1,500 Installment account receivable 10,000 | ‘On repossession date, the inventory account is debited at the appraised value | of the repossessed good in its present condition without the further reconditioning | (Le, 6,000 - 500 = 5,500). The reconditioning costs are subsequently | -Spitalized when incurred as follows: | [= Inventory 500 Cash 500440 Chapter 10 a co Requirement (b): The new cost basis of the repossessed inventory is 6,000 (i.e, the sum of the debits to the inventory account.) Illustration 4: Profit on resale of repossessed inventory ABC Co. uses the “installment sales method.” ABC Co. sold inventory costing 30,000 to a customer for P40,000. After paying 28,000, the customer defaulted and ABC Co. repossessed the good, Upon repossession, the good was appraised at 10,000. ABC Co. subsequently spent P2,000 in reconditioning the good before selling it to another customer for 15,000. The second buyer made total payments of P6,000. Requiremenis: Compute for the following: a. Gain or loss on repossession. b. Realized gross profit from the resale. Solution: Requirement (a): Date | Inventory (appraised value) 10,000 Deferred gross profit (12K x 25%") 3,000 Installment receivable (40K - 28k) 12,000 Gain on repossession (squeeze) 1,000 (GOK — 30K) * 40K] = 25% GFR Requirement (b): Resale price 15,000 Cost of sale (10K appraised value + 2K reconditioning costs) (12,000) Gross profit 3,000 Gross profit rate 20% Collections from the resale 6,000 Multiply by: Gross profit rate a Realized gross profit from the resale 1,200ro | wrzds1 | 48,000 z | 48,000 192,000 21/20x1_ | 16,525 } 15,565 i 176,435, s11i20xt to 3 15,643 160,792 BR | PB ac) ome Prewain nant Plvnrarans ET rstamont Sales Method an a {ilustration 5; Repossession — installments w/ interest ABC Co. uses the installment sales method. On Jan. 1, 20x1, ABC Co. sold inventory costing P180,000 for P240,000 payable as follows: down payment of P48,000 and twelve monthly payments of P16,525 due at the beginning of each succeeding month, The installments include interest of ¥2 of 1% per month. After making three succeeding monthly payments, the customer defaulted and ABC Co. repossessed the inventory. The fair value of the repossessed inventory is P180,000. Requirements: Compute for the following: a. Realized gross profit from the sale. b. Gain or loss on repossession. Solutions: Requirement (a): Realized gross profit from the sale Date | Collections | viet | Interest income | Principal Balance 240,000 Collections pertaining to principal 94,929 Collections pertaining to principal 94,929 Multiply by: Gross profit rate [(240,000 - 180,000) + 240,000] 25% Realized gross profit 23,732 Requirement (b): Gain or loss on repossession Dat te | Inventory 180,000 Deferred gross profit (145,071 x 25%) 36,268 Installment receivable (see amor. table) 145,071 Gain on repossession (squeeze) 71,197442 Mlustration 6: Repossession - Error ie ABC Co. uses the installment sales method. After its first year of operations, ABC had the following balances: Installment sales 37,500 Purchases 25,000 Inventory - new merchandise, Dec. 31, 20x1 2,500 Loss on repossession 4,500 Installment receivable, Dec. 31, 20x1 20,000 During the year, ABC Co. repossessed an inventory sold to a defaulting buyer. The inventory had an appraised value of P1,500. However, this was not recorded, Instead, the janitor/bookkeeper of ABC Co. erroneously accounted for the repossession as a debit to “Loss on repossession” and a credit to “Installment receivable” for the unpaid balance. This came to light when the security guard made an audit. The janitor and the guard were classmates in college when they took up BS Accountancy. Sadly, they did not graduate because they only studied half-heartedly and failed in Advanced Accounting 1.8 Requirement: Compute for the correct amount of gain or loss on repossession. Solution. Date | Inventory 1,500 Deferred gross profit (4,500 x 40%(bly 1,800 Loss on repossession (squeeze) 1,200 Installment receivable 4,500 ‘The balance of the installment receivable is equal to the unadjusted loss on repossession of P4,500. This is because the janitor recorded the repossession as a debit to “Loss on tepossession” equal to the balance of the receivable. ‘Installment sales 37,500 Cost of goods sold: Inventory, beg. (first yer oF operations) oaer { installment Sales Method 443 testa _ Purchases Repossessed inventory Total goods available for sale Inventory, end. (new & reposesei) (2,500 +1,500) (4,000) Gross profit Gross profit rate (15,000 + 37,500) Trade-ins Aseller may accept from a buyer a trade-in of old merchandise as part payment for the sale of new merchandise. Trade-ins under the “installment sales method” are accounted for as follows: a. The traded-in merchandise is debited to inventory at “fair value.” For purposes of applying the installment sales method, “fair value” is either: i, the appraised value of the traded-in merchandise; or ii, the estimated resale price of the traded-in merchandise less reconditioning costs and normal profit margin. b. The seller gives the buyer a trade-in value for the old merchandise. The trade-in value is the amount that is treated as part payment of the new merchandise being sold. There is no accounting problem if the trade-in value is equal to the fair value in (a) above. If this is not the case, the seller recognizes cither an over allowance or an under allowance for the difference, > If the trade-in value is greater than the fair value, the difference is debited to an “Over allowance” account. The over allowance is deducted from the sale price when computing for the gross profit rate. > If the trade-in value is less than the fair value, the difference is credited to an “Under allowance” account. The under allowance is added to the sale price when computing for the ross profit rate. Di ___paalipneeneet arrangeChapter 19 44 sh Pro-forma entry: see Date | Inventory - traded-in (at “fair value") xx “y Over allowance (if Trade-in value > FV) ax Installment receivable (balancing figure) XX Installment sale Xx Under allowance (if Trade-in value 5K FV) 2,000 Installment receivable (squeeze) ®) 13,000 Installment sale 20,000, | whe installment receivable can also be computed as ‘Sale price less Trade-in Value’ (20K ~ 7K = 13,000). hair value of old merchandise traded-in 5,000 Collections 7,000 Total 12,000 Multiply by: Gross profit rate © 33.33% Realized gross profit in year of sale 0 Sale price 20,000 Less: Over allowance (2,000) Adjusted sale price 18,000 Cost of sale (12,000) Adjusted gross profit 6,000 Adjusted gross profit rate 33.33% £0 If the trade-in value is “sobra, Cawaspter 10 | Case 3: Under allowance | ABC Co. grants the customer a trade-in value of P2,500 for the old | merchandise. Subsequent collections during the year amount to | P7,000, . ee Requirement: Compute for the realized gross profit in the year of sale. Solution: Date | Inventory - traded-in 5,000 | Installment receivable (squeeze) 17,500 Installment sale 20,000 Under allowattce (2.5K trade-in val. The total cost of goods is computed as follows: Inventory - Jan. 1, 20x2 . 7 350,000 Purchases 2,775,000 Repossession ____ 15,000 Total goods available for sale 3,140,000 Inventory - Dec. 31, 20x2 (new and repossessed) (475,000 Cost of goods sold - Regular and Installment 2,665,000 > The cost of goods sold on regular sales is computed as follows: Regular sales 1,925,000 Multiply by: Cost ratio on regular sales (100% -30%) 70% Cost of goods sold ~ Regular 1,347,500 » The cost of goods sold on installment sales is computed as follows: : Cost of goods sold - regular and installment 2,665,000 Cost of goods sold - regular sales (1,347,500) Cost of goods sold - Installment sales in 20x2 1,317,500 ® The gross profit rate on the 20x2 installment sales is computed as follows: Installment sales in 20x2 2,125,000 Cost of goods sold - installment sales in 20x2 (1,317,500) Gross profit - Installment sales in 20x2 807,500 Gross profit rate - Installment sales in 20x2 38% ——= » The gross profit rate on the 20x] installment sales is computed as follows: Deferred gross profit - 20x1 sales, Jan. 1, 20x2 270,000 Installment receivable - 20x1 sales, Jam.1y-20x2, 600,000yy _tnstliment Sales Method a xe ross profit rate ~ Installment sales in 20x 45% y The collections in 20x2 from installment sales in 20x1 and 20x2 are computed as follows: ‘Inst, receivable - 20x1 Inst. receivable - 20%2 inna 600,000 38,750 Write-off 486,250 Collections Inst. Sales 2,125,000 | 1,125,000 Collections [75.000 rain [1.000.000 12/31%2 y The total realized gross profit is computed as follows: Collections in 20x2 from: 20x] installment sales: (486,250 x 45%) 218,813 20x2 installment sales: (1,125,000 x 38%) 427,500 20x2 regular sales: (1,925,000 x 30% given) 577,500 Total realized gross profit in 20x3 1,223,813 | Requirement (b): Gain or loss on repossession Date | Inventory — repossessed (see trial balance) 15,000 Deferred gross profit (38,750 x 45%) 17,438 6,312 Loss on repossession (squeeze) | Installment receivable 38,750 Cost recovery method Under the “cost recovery me! gross profit or interest income is from the sale exceed the cost of the inventory séld. PERS 15. (See also ‘Commeutary on old thod”* of traditional US GAAP, no recognized until the total collections “This method deviates from the principles of | accounting’ in Chapter 8.) Illustration: Cost recovery method ABC Co, uses the “cost recovery method.” On Jan. 1, 20x1, ABC Co, sold inventory costing 2280,000 to a customer for 500,000 Payable as follows: 100,000 down payment and balance due in 4 equal annual payments every Dec. 31.Chapter 10, 450 1 st cccstioumet Requirement: Compute for the realized gross profit (RGP) in years 20x1 through 20x4, Solution. 20x1 20x2 20x3 20x4 Cumulative collections 200,000 300,000 400,000 500,000 Cost of goods sold 280,000 280,000 _280,000__280,000__ Excess collection 20,000 120,000 220,000 RGP in previous yrs. * (20,000) _ (420,000) RGP in current yr. ~ 20,000 100,000 _100,000 i Variation: *v5 ie | What if the installments include imputed interest, can ABC Co, _Tecognize interest income in 20x1? Answer: No. Under the “cost recovery method,” neither gross profit nor interest income is recognized until the collections exceed the cost of goods sold. Chapter 10: Summary ¢ — Realized gross profit = Gross profit rate x Collection on sale Gis piept nate Deferred gross profit ° 1 - P Installment account receivable e Repossession: Date -| Inventory (at “fair value”) xx Deferred gross profit xx Loss on repossession (squeeze) xx | Installment account receivable xx * Trade-in: If trade-in value exceeds fair value, the excess is an over allowance, which is deducted from sales when computing for the gross profit rate. The fair value of the traded-in merchandise is treated as part of the collections it the year of sale when computing for the realized | gross profit.Installment Sales Method = 451 pROBLEMS PROBLEM 1: TRUE OR FALSE 1. Under the “installment sales method,” realized gross profit is equal to gross profit rate multiplied by collection on sale. Under the “installment sales method,” : “ the deferred gross profit at any given point of time may be determined by multiplying the balance of receivable by the gross profit rate. Fact pattern: Monkey Co. uses the “installment sales method.” Monkey buys a banana for P2 and sells it for P10. 3. If Monkey collects P1 from the sale, Monkey's realized gross profit is PO.50. 4. If the ending balance of Monkey’s installment receivable is P5, the deferred gross profit is P4. If the ending balance of Monkey’s installment receivable is P3, the total collections during the period must be P7. PROBLEM 2: MULTIPLE CHOICE - THEORY 1. Groovy Co., a big corporation domiciled in the Philippines, enters into a 3-year contract with a customer. At contract inception, Groovy assesses the customer's ability and intention to pay the consideration in the contract and concludes that the collectability of the consideration is significantly uncertain. For financial reporting, Groovy should do all of the following except a. not recognize any revenue until the criteria under PFRS 15 are met. b. recognize any consideration received from the contract as c ey. the contract in subsequent periods using the guidance in PFRS 15. 4. apply the “installment sales method.Chapter 10 452 a 2. Which of the following methods of recognizing revenue is in accordance with the principles of the PFRSS? a Installment sales method Cost recovery method (Taditional) a. Yes Yes b. No Yes c Yes No d. No No 3. Which of the following equations is incorrect regarding the installment sales method? a. Realized gross profit = Gross profit rate x Collection * b. Ending receivable = Sale price - Collection c. Deferred gross profit = Ending receivable x Gross profit rate d. Gross profit rate = Ending receivable + Deferred gross profit 4, Merchandise received as trade-in is recognized at a. trade-in value. ¢. current cost. b. fair value. 4d. original cost. 5. Cash collection is a critical event for income recognition in the Installment sales method Cost recovery method (Traditional) a. Yes Yes b. No Yes c. Yes . No d. No No (AICPA) PROBLEM 3: MULTIPLE CHOICE -— COMPUTATIONAL Installment sales method 1. Lunch Co. uses the “installment sales method,” Lunch Co.'s records show the following balances:jnstallment accounts receivable ~ Jan. 1, 20x1 installment sales 1,000,000 Cost of sales 800,000 Installment accounts receivable - Dec. 31, 20x1 600,000 How much are the realized gross profit in 20x] and the deferred ross profit on Dec. 31, 20x1, respectively? a, 80,000; 60,000 ¢. 60,000; 80,000 b. 80,000; 120,000 . 120,000; 80,000 2. Dinner Co. uses the “installment sales method.” Dinner Co.’s records show the following balances: Installment receivable — beg. . Deferred gross profit (before year-end adjustment) 200,000 Collections during the year 400,000 Gross profit rate based on sales 20% How much is the ending balance of the installment receivable? a. 1,000,000 b. 800,000 , 600,000 d. 400,000 Fact pattern Silent Night Co. uses the “installment sales method.” Silent Night sells an inventory costing P750,000 for P1,000,000. 3. If Silent Night Co. reports deferred gross profit of P200,000 at year-end, how much are the total collections during the year? a. 800,000 b. 600,000 c. 200,000 d. 50,000 4. IfSilent Night Co. reports deferred gross profit of P200,000 at year-end, how much is the realized gross profit during the year? a. 800,000 b. 600,000 c. 200,000 d. 50,000 5. IfSilent Night Co. recognizes realized gross profit of P220,000, how much is the ending balance of deferred gross profit? @, 200,000 b. 75,000 €,50,000 .30,000Chapter 10 454 eee 6. IfSilent Night Co. recognizes realized gross Sie aE PLEL O00, ef how much is the ending balance of the receiva a. 280,000 b, 250,000 ¢. 200,000 d. 50,000 7. IfSilent Night Co. recognizes realized gross profit of P160,000, how much are the total collections? a. 720,000 b. 640,000 ¢. 360,000 d. 250,000 8, Home Co. reported deferred gross profits of P200,000 and 60,000 at’ the beginning and end of the year, respectively. Home Co. consistently made sales at a 25% gross profit rate, How much were the total collections during the year? a. 480,000 b. 560,000 c. 580,000 d. 620,000 9. Yellow Co.'s records on December 31, 20x2 show the following information: Accounts receivable 313,750 Deferred gross profit (before adjustment) 38,000 Analysis of the accounts receivable reveal the following: Regular accounts 207,500 20x1 installment accounts 16,250 20x2 installment accounts 90,000 Sales on an installment basis in 20x1 were made at 30% above cost, and in 20x2, at 33%4% above cost. Expenses paid rel ating to installment sales in 20x2 were P1,500. How much is the 20x2 profit from installment sales? a. 9,750 b, 10,250 ¢. 11,750 d. 13,350 (aicpa) Use the following information for the next three questions: Auto Co. uses the “installment sales method.” Auto Co.’s records show the following: .Installment Sales Method ze! Se ___ 88 a= eee —_____ 20x1 20x2_ 2033 inallment sales 300,000 375,000 360,000 Cost of sales 225,000 285,000 252,000 Deferred gross profit, end. bal. 20x1 52,500 15,000 = 20x2 54,000 9,000 20x3 72,000 (AICPA) ‘ 10. How much is the total installment receivable on Dec. 31, 20x3? a. 277,500 b. 279,500 c. 287,500 d. 297,500 11. How much are the total collections in 20x3? a. 356,700 b. 365,700 c. 367,500 d. 376,500 12, How much is the total realized gross profit in 20x3? a. 56,000 b. 69,000 c. 76,000 d. 96,000 Repossession Use the following information for the next two questions: The Bass Co., on September 30, 20x1, sold for ?48,000 a piano costing P30,000. The down payment was P4,800 and an equal amount was to be paid at the end of each succeeding month. Monthly interest of 1% yield rate was to be charged on the unpaid balance of the installment contract, with payment applying first to accrued interest and the balance to principal. After paying a total of P19,200, the customer defaulted and the piano was correspondingly repossessed on February 28, 20x2, at which time it was estimated to have a value of 16,800 on a depreciated cost basis, Bass Co. uses a perpetual inventory system and records the total deferred gross profit at the time of sale. 13. How much was the realized gross profit at the end of 20x1? a.7,200 c. 6,764 b.7.039 d. 6489 (RPCPA)ee ___ Chapter 10 14. How much was the gain or loss on the repossession in 20x2? a.1,927 ©.2,124 b. 1,867 d. 1,678 (PCPA) Use the following information for the next two questions: Cloudy Co, uses the installment sales method of accounting. Information on Cloudy’s past operations follows: 20x1 20x2 20x3 Installment sales 300,000 405,000 495,000 Cost of sales 210,000 243,000 321,750 Gross profit rate 30% 40% 35% Installment accounts receivable, Dec. 31 - From 20x1 installment sales 180,000 135,000 60,000 - From 20x2 installment sales 300,000 195,000 - From 20x3 installment sales 390,000 In 20x3, a customer defaulted. Accordingly, the merchandise with an estimated value of P15,000 was repossessed. The sale was made in 20x1 and the unpaid balance on the date of repossession was P22,500. 15. How much was the total realized gross profit in 20x3? a. 98,400 d. 79,500 ¢. 89,400 d. 94,500 (alcra) 16. How much was the gain (loss) on the repossession in 20x3? a. (690) b. 690 c. (750) d. 750 (AICPA) Trade-in Use the following information for the next two questions: Dawn Co. uses the installment sales method. Dawn Co. sells merchandise costing 20,000 for P32,000 and accepts old merchandise with fair value of P12,000 as trade-in. Dawn Co:installment Sales Method ———eewa — 157 gives the. customer a trade-in yalue of P8,000 for the old merchandise and subsequently collects P12,000. 47, The journal entry to record the sale, including the traded-in merchandise, includes a a. debit to “under allowance” of P4,000. b. debit to “over allowance” of P4,000. c. credit to “under allowance” of P4,000. d. credit to “over allowance” of 24,000. 18. How much is the realized gross profit? a. 6,857 b. 8,888 ¢. 10,667 d. 12,400 Cost recovery 19, Sound Co. uses the “cost recovery method.” The records of Sound Co. show the following information on a sale made on December 31, 20x1: - Carrying amount of goods sold 4,000,000 Consideration from sale: Cash down payment 600,000 10% Note payable 5,400,000 6,000,000 The 10% note payable is due in nine annual installments of 600,000 beginning December 31, 20x2. The December 31, 20x2 installment was paid as scheduled, together with interest of 540,000, What amount of income should Sound Co. recognize in 20x2 from the sale and the financing? a. 540,000 b. 1,440,000. 1,960,000 d.0 (aicrA) 0. Cold Breeze Co. uses the “cost recovery method.” Relevant information follows: 20x1 20x2 Sales 20,000 ane Cost of sales 16,000 18, Cash collections:a 458 Chapter 10 - from 20x1 sales 14,000 6,000 - from 20x2 sales 24,000 How much is the gross profit recognized by Cold Breeze in 20x27 a. 4,000 b. 6,000 ec. 10,000 do caicpay PROBLEM 4: FOR CLASSROOM DISCUSSION Installment sales method 1. Ring Co. uses the “installment sales method.” Information on Ring Co.'s sales and collections is as follows: 20x1 20x2 Installment sales 1,000,000 1,300,000 Cost of sales 700,000 845,000 Collections: - from 20x1 sales 500,000 300,000 - from 20x2 sales 650,000 Requirements: a. Compute for the realized gross profit in each of the years 20x1 and 20x2. b. Compute for the balance of the installment receivable at the end of each of the years 20x1 and 20x2. c. Compute for the deferred gross profit at the end of each of the years 20x1 and 20x2. Repossession 2. Morning Co. uses the “installment sales method.” Information on Morning's sales is as follows: 20x1 20x2 Sales 150,000 240,000 Cost of sales 120,000 168,000 Installment receivable - 20x1, Dec. 31 90,000 30,000 Installment receivable - 20x2, Dec. 31 180,000> nstalient Sales Method we we Jn 20%2, Morning Co. repossessed a property that was sold in 20x1 for £25,000. Total collections from this sale were P12,000. Morning Co. expects to resell the property for P15,000 after reconditioning, costs of P2,000. The normal profit margin from resale of repossessed inventory is 30%. Requirements: 2, Compute for the gain or loss on repossession. b. Compute for the total realized gross profit in 20x2. c, Compute for the profit recognized in 20x2. Trade-in 3, Post Meridian (PM) Co. uses the “installment sales method.” PM Co. sells new merchandise costing ?10,000 to a customer for P16,000. PM Co. accepts old merchandise with fair value of P3,000 as trade-in and gives the customer a trade-in value of P4000. PM Co. subsequently collects ?6,000 from the customer. Requirements: a. Prepare the journal entry to record the sale. >. Compute for the realized gross profit in the year of sale.