Installment Method of Revenue Recognition

Installment method is a method of revenue recognition in which gross profit is deferred until cash from the sale is received. Unlike the cost recovery method, which defers the profit till the cash collections exceeds the costs; installment method recognizes proportionate profit at receipt of each installment.

Installment method is a conservative method of revenue recognition. It is only applied in situations, for example in real estate, when the risks and rewards are not completely transferred at the time of sale. It differs from cost recovery method because in installment method there is less doubt about collectability of the installments.

Journal entries

Accounting for installment sales include the following steps:

The journal entries are illustrated in the following example.

Example

You work as an accounting analyst at Goldberg, LLC. On 1 January 2012, your company sold some real estate costing $120,000 for $200,000. After reviewing the terms of the sale, the CFO concluded that the company would recognize the revenue using installment sales method. He asked you to post the journal entries required at the time of sale.

Just to help you understand the subsequent accounting treatment of the sale, he asked you to write down the journal entries you will make if you receive an installment of $50,000 in 2012 and $70,000 in 2013.

Solution

Following journal entries are required at the time of sale.

Installment receivables$200,000
Installment sales$200,000
Cost of goods sold$120,000
Inventory$120,000

The related revenue is deferred as follows.

Installment sales$200,000
Cost of goods sold$120,000
Deferred gross profit$80,000

Deferred gross profit is a contra-account to installment receivables, i.e. it is subtracted from installment receivables.

The amount of revenue recognized at the receipt of each installment equals the product of the gross profit rate on the installment sale and the amount of installment received.

Gross Profit on Sale =$200,000 - $120,000= 40%
$200,000

The collections are accounted for as follows.

2012

Cash$50,000
Installment receivables$50,000

2013

Cash$70,000
Installment receivables$70,000

Following adjusting journal entries are needed to recognize the deferred revenue.

2012

Deferred gross profit$20,000
Gross profit on installment sales$20,000

Where, $20,000 = 40% × $50,000.

2013

Deferred gross profit$28,000
Gross profit on installment sales$28,000

Where, $28,000 = 40% × $70,000.

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