Acctg For Special Transaction - Second Lesson PDF

Lesson 2: INSTALLMENT SALES
Objectives:
At the end of the lesson, you will be able to:

a. Know the accounting for installment sales;
b. Prepare journal entries to record installment sales; and
c. Identify the gross profit to be recognized during the year for installment
sales.
Installment sales are widely used by dealers in real estate, home appliances and cars. Installment sales
involves greater risk of non-collection.
Methods of Gross Profit Recognition on Installment Sales
1. Gross Profit is Recognized at the Time of Sale
This method of accounting is usually employed by enterprises which make only a portion
of their sales on installment plan and which often sell these installment contracts to finance
companies.
2. Gross Profit is Recognized in the Period in which Cash is collected
a. Cost Recovery Method- too conservative. This method is probably most applicable in the
sale of services or products of a nature not permitting repossession and when the customer
notes have no fair market value.
b. Gross Profit Realization Method.
c. Installment Method- cash collections is regarded as a partial recovery of cost and a partial
realization of profit in the same proportion that these two elements are present in the
original selling price.
The Installment Method of Accounting
Under the installment method of accounting, the difference between the selling price and the cost of sale
is recorded as deferred gross profit or unrealized gross profit.
Illustration 1. Assume that on March 1, 2020 an installment sale of property costing P60,000 was made.
The selling price was P100,000. A downpayment of P20,000 was required, the balance payable in forty
monthly payments of P2,000 at the end of each month. Using the installment method, what will be the
annual realized gross profit and deferred gross profit during the installment sales period?
Expenses on Installment Sales
Operating expenses incurred in making the sale are to deferred.
Interest on Installment Contracts Receivable
Since the seller must wait for a considerable period of time to collect the full amount, it is customary to
provide for interest on the unpaid balance.
Accounting Procedures Under Installment Method
There are several types of items sold on the installment basis but discussions in this text regarding
installment revolve only around these two basic types of property sold on installment basis, namely:
1. Installment sales of conventional merchandise
2. Installment sales of real estate
a. By a non-dealer (casual sales)
b. By a dealer
Installment sales of conventional merchandise
Sales, receivable and cost of sales should be given separate account designations by affixing the word
“installment” before the account names.
Comprehensive Illustrative Problem
2019 2020
Sales
Regular (on account) 250,000 230,000
Installment-
Down payment 20,000 24,000
Balance (payable within 3 years at the start of each 80,000 96,000
month, apply 36% interest for 3 years)
Cost of Sales
Regular 120,000 130,400
Installment 60,000 69,600
Collections
Accounts Receivable 120,000 130,500
Installment contracts receivable
2019 Sales:
Applying to interest 26,000 18,000
Applying to principal 19,000 26,000
2020 Sales:
Applying to interest - 31,000
Applying to principal - 22,000
Operating Expenses paid 50,000 65,000
Accrued Interest Receivable, Dec. 31
2019 Sales 1,800 1,020
2020 Sales 2,250
Required: The journal entries for Fely Sales Corporation relating to regular and installment sales for 2019
and 2020, assuming the use of the perpetual inventory system.
Allocation of Cost of Goods Sold
A company selling on the installment plan will normally have cash sales and sales on short term credit. If
the company uses periodic or physical inventory method in the determination of cost, then the problem of
proper allocation of the total cost of goods sold among the different types of sales will arise.
Illustration:
Assume that Felipe Company sells merchandise for cash, on short term credit and on the installment
basis. The company employs the periodic inventory method in determining costs. At the end of 2020, the
following information are available:
Cash Sales 150,000

Charge Sales 300,000
Installment Sales 750,000
Merchandise Inventory, Jan. 1 120,000
Purchases 725,000
Freight-in 30,000
Repossessed Merchandise 35,000
Merchandise Inventory, Dec. 31 130,000
Case 1. Cost of goods sold allocated according to the ratio of each type of sales to total sales.
Case 2. Assume that the selling prices for charge sales and installment sales of Felipe Company are
higher than cash sales price by 20% and 25%, respectively.
Case 3. Assume that Felipe Company’s gross profit rate on selling price is 25% on cash sales, 35% on
charge sales, and 37% on installment sales.
Defaults and Repossessions
The repossessed merchandise is subsequently sold after incurring reconditioning costs and at a normal
profit margin. The principal problem in accounting for defaults and repossessions is the determination of
the fair value of the merchandise at the time of repossession.
Illustration 1: Assume the following data with respect to a default and repossession on April 30, 2020:
Installment contracts Receivable, 2020 2,000

Gross Profit Rate, 2020 Sales 30%
Estimated market value of repossessed merchandise 1,200
Required:
1. The loss on repossession.
2. The journal entry to record the repossession.
Illustration 2. Assume the following account balances on December 31, 2020 before adjustments have
been made:
2020
January 1 December 31
Installment contracts receivable, 2019 60,000 30,000
Installment contracts receivable, 2020 70,000
Deferred Gross Profit, 2019 18,000 17,400
Deferred Gross Profit, 2020 35,000
Installment sales 2020 100,000
A repossession of an item sold in 2019 is made during 2020. The unpaid balance at the time of
repossession is P 2,000.
Required:
1. The realized gross profit for 2019 and 2020 sales recognized on Dec. 31, 2020.
Trade-ins
Companies using installment sale plans sometimes find it necessary to accept merchandise traded-in as
part of the down payment.
Net realizable value- the value of the old merchandise traded-in after the provisions of expected
reconditioning expenses cost of disposal and a normal profit upon its resale.
Case 1. Trade-in value is equal to actual value. Assume that on April 1, 2020, the Motor Sales Company
sells a car for an installment price of P145,000. The car costs P100,000. The customer is allowed a trade-
in value of P45,000 for his old car. He makes a downpayment of P40,000 and the balance to be paid in
twelve equal installments is P5,000 each. It is estimated that the old car can be sold for P70,000 after
incurring reconditioning expenses estimated at P11,000. The company usually makes a gross profit of
20% on resale.
Required: The journal entry to record the sale of the new car.
Case 2. Trade-in value is greater that net realizable value. The seller sometimes grants a customer trade-
in value greater than the fair market value or net realizable value of the item received from him as a special
inducement to the customer.
Overallowance is the excess of the trade-in value granted over the net realizable value of the used
merchandise. The amount of the overallowance may be recorded either as a charge to Over Allowance
on Trade-in account or as a reduction from Installment Sales account to arrive at a valid amount for the
net sales price.
Illustration: Assume that a stereo component with a cost of P 12,000 is sold for P 17,000. A used sterio
component is accepted as a trade-in at a valuation of P 6,000. The seller expects to spend P 250 to
recondition the used merchandise before reselling it for P 5,000. The seller expects a 15% profit from the
sale of the used merchandise.
Required:
1. The amount of overallowance.
2. The journal entry to record the sale.
3. The gross profit rate.
Financial Statements Presentation

Repossessed Merchandise is an addition to Purchases in determining cost of goods sold. Traded-in
Merchandise is treated in the same manner. Shipments on Installment sales, which is used in the periodic
inventory system, is deducted from the cost of goods available for sale, Gain (Loss) on Repossession is
presented in the income statement as an adjustment to realized gross profit and the resulting balance is
labeled as Total Realized Gross Profit after adjustment for gains (losses) on Repossession.
Installment Contracts Receivable is usually classified as part of current assets.
Repossessed merchandise account is presented in the Statement of Financial Position as a current asset,
as an inventory account. Traded-in merchandise is likewise treated as such.
Installment Sales of Real Estate
Casual Sales
Illustration. Assume that on October 1, 2020, Mr. Marco Ruiz sold for P100,000 a parcel of land acquired
for P60,000. The contract of sale called for a downpayment of P 20,000 and the issuance of a note for the
balance. Payment of the balance entails 24 monthly installment of P 4,723.79 each starting on November
1, 2020. The interest is at the annual rate at 36% and is applied to the unpaid principal balance.
Required: The journal entries to record the sale.
Installment Sale of Real Estate by a Dealer
Sale by a company engaged in buying and selling of real estate.
Illustration. Assume the following data for the FilEstate Realty, Inc. in 2016.
Total selling price of lots 1,000,000

Total cost of lots:
Acquisition cost 150,000
Improvement costs 450,000 600,000
Gross Profit 400,000
Sales made during the year (lot no. 1) 35,000

Collection during the year including interest of P 5,000 12,000
Required: The journal entries to record the sale.

References: Practical Accounting 2, Antonio J. Dayag, 2013 Edition
Volume 1 Advanced Accounting, Principles and Procedural
Applications, 2017 Edition, Pedro P. Guerrero & Jose F.
Peralta
Volume 1 Advanced Accounting, Principles and Procedural
Applications, 2013 Edition, Pedro P. Guerrero & Jose F.
Peralta

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Lesson 2: INSTALLMENT SALES

At the end of the lesson, you will be able to:

Cash Sales 150,000

Installment contracts Receivable, 2020 2,000

Financial Statements Presentation

Total selling price of lots 1,000,000

Sales made during the year (lot no. 1) 35,000

Required: The journal entries to record the sale.

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