Accounting for Installment Sales

-The installment method of accounting is used only when there is no reasonable basis for estimating the degree of
collectability. Under installment accounting, revenue is not recognized at the time a sale is made but rather when cash is
actually collected.*
*Installment Sales = Cash Method
*Percentage of Completion = Accrual Method
Problem Solving Formulas
1. Gross Profit = Sales - COGS
2. Gross Profit % = Gross Profit Sales Price
3. Earned Gross Profit = Cash Collections x Gross Profit %
4. Deferred Gross Profit = Installment Receivable x Gross Profit %
Balance Sheet Presentation
-Deferred Gross Profit is a contra asset that decreases the balance of accounts receivable
-First credit "Deferred Gross Profit" to record the installment sale.
-To record the profit on collection, debit "Deferred Gross Profit" and credit "Realized Gross Profit on Installment Sales."*
*Debiting the deferred gross profit takes it off of the B/S and crediting the realized gross profit on installment sales puts it
onto the I/S.
Cost Recovery Method
-Under the cost recovery method, no profit is recognized on a sale until all costs have been recovered.
1. At the time of sale, the expected profit is recorded as deferred gross profit.
2. Cash collections are first applied to the recovery of product costs.
3. Collections after all costs have been recovered are recognized as profit.
Cost Recovery Method- Comparison to Other Methods
-Similar to the installment sales method in that it may only be used when receivables are collected over an extended
period and there is no reasonable basis for estimating their collectibility.*
*Because no profit is recognized until all costs have been recovered, the cost recovery method is the most conservative
method of revenue recognition.

Installment Sales
Example & Homework Problem
Example:
1.

ABC Corp. sold a piece of real estate on January 2, 2009 for $5,000,000. It had purchased the property in 2002
for $4,500,000 in cash. At that time the land was worth $450,000 and the remainder was attributed to the
building. At the time of the sale, the carrying value of the building was $3,650,000.

The terms of the sale were as follows:

Downpayment
Note Receivable
Interest rate
Length of mortgage
Annual payment

$ 250,000
$4,750,000
10%
20 years
$ 557,933 due at end of each year

The sale has been consummated, the seller's receivable is not subject to future subordination, and the seller has no
continuing involvement with the property. However, because the initial investment is inadequate, the seller must use
the installment method to account for this sale.
REQUIRED: Journal entries needed in 2009, 2010.

Solution to Installment Accounting Example

1.

Gross profit percentage = 18% [(5,000-3650-450)/5000

or $900,000 deferred gross profit divided by $5,000,000 selling price

1/2/09

12/28/09

Cash
250,000
Notes Receivable
4,750,000
Acc'd Depreciation
400,000
Land
Building
Deferred gross profit on installment sale of land
Cash

557,933
Interest revenue
Notes receivable

12/31/09

12/31/10

475,000
82,933

Deferred gross profit {(82,933+250,000)*18%}

Gain on installment sale of land
Cash

59,928
59,928
557,933

Interest Revenue
Note receivable
12/31/10

YEAR

450,000
4,050,000
900,000

466,707
91,227

Deferred gross profit (18% * 91,227)

Gain on installment sale of land

PAYMENT

DWNPYMT
$
250,000
2009
$557,933
2010
$557,933
2011
$557,933
2012
$557,933
2013
$557,933
2014
$557,933
2015
$557,933
2016
$557,933
2017
$557,933
2018
$557,933
2019
$557,933
2020
$557,933
2021
$557,933
2022
$557,933
2023
$557,933
2024
$557,933
2025
$557,933
2026
$557,933
2027
$557,933
2028
$557,933
$ 11,408,660

10.00%
INTEREST
PRINCIPAL
REVENUE

$475,000
$466,707
$457,584
$447,549
$436,511
$424,369
$411,012
$396,320
$380,159
$362,381
$342,826
$321,315
$297,654
$271,626
$242,995
$211,501
$176,858
$138,750
$96,832
$50,722
$6,408,670

$250,000
$82,933
$91,227
$100,349
$110,384
$121,422
$133,564
$146,921
$161,613
$177,774
$195,552
$215,107
$236,618
$260,279
$286,307
$314,938
$346,432
$381,075
$419,183
$461,101
$507,220
$5,000,000

BALANCE
$ 5,000,000
$4,750,000
$4,667,067
$4,575,840
$4,475,491
$4,365,107
$4,243,685
$4,110,121
$3,963,200
$3,801,587
$3,623,812
$3,428,261
$3,213,154
$2,976,536
$2,716,257
$2,429,949
$2,115,011
$1,768,579
$1,387,504
$968,322
$507,221
$0

16,421
16,421

GROSS
BALANCE
PROFIT
DEFERRED
RECOGNIZED PROFIT
$
900,000
$45,000
$855,000
$14,928
$840,072
$16,421
$823,651
$18,063
$805,588
$19,869
$785,719
$21,856
$763,863
$24,042
$739,822
$26,446
$713,376
$29,090
$684,286
$31,999
$652,286
$35,199
$617,087
$38,719
$578,368
$42,591
$535,776
$46,850
$488,926
$51,535
$437,391
$56,689
$380,702
$62,358
$318,344
$68,594
$249,751
$75,453
$174,298
$82,998
$91,300
$91,300
$0
$900,000

Homework Problem:

2.

RVO Corp. sold a piece of real estate on January 2, 2009 for $10,000,000. It had purchased the property in 2001
for $6,500,000 in cash. At that time the land was worth $500,000. At the time of the sale, the carrying value of
the building was $4,500,000.

The terms of the sale were as follows:

Downpayment
Note Receivable
Interest rate
Length of mortgage
Annual payment

$ 500,000
$ 9,500,000
12%
20 years
$ 1,115,866 due at end of each year

The sale has been consummated, the seller's receivable is not subject to future subordination, and the seller has no
continuing involvement with the property. However, because the initial investment is inadequate, the seller must use
the installment method to account for this sale.
REQUIRED: Journal entries needed in 2009, and 2010