MABINI COLLEGES, INC.

Daet, Camarines Norte

COLLEGE OF BUSINESS ADMINISTRATION & ACCOUNTANCY

1st Sem., S.Y.2021-2022

PrE 6: Accounting for Special Transactions

MODULE 1
Title: Installment Method

Name of Student:
Course/ year:
Class Schedule:

Module Overview:

In this module, you will learn about installment sales. This first module will give you the
overview how the installment sales works in industry which offers installment method. Also, in this
module, the expenses, interest as well as the allocation of cost of goods sold shall be discuss and the
different procedures including the journal entries will be discussed.

Learning Outcomes

After completing this module, you can:

 Understand the concept of installment sales
 Apply procedures in solving problems
 Understand how the installment sales work in the actual world.

LECTURE NOTES
Read this…

Installment Sales-it is special type of credit arrangement which provides for a SERIES of payments over a
period of months or years. It is widely used by dealers in real estate, home appliances, cars and the likes.

The Main Problems

1. When to recognize gross profit
2. Computation of correct net income (loss) using installment method
3. Determination of gain or loss on repossession
4. Correct valuation of installment if there is trade in

The Concept of Gross Profit

Gross profit under the normal way of recognizing it is just SALES less COST OF SALES or COST OF
GOODS SOLD. When the installment sales are being discussed, the formula sales less COS or COGS will
not result to any gross profit, but instead the amount will be credited to DEFERRED GROSS PROFIT.
Comparison:
Under normal recognition Under Installment Method

Sales 100 Sales 100

COS 80 COS 80
Gross Profit 20 Deferred GP 20

Take note the difference. In normal recognition, the gross profit is recorded immediately as component
of income or loss determination. On the other hand, under installment method, the gross profit is not
totally gross profit. It is credited to deferred because under installment sales, revenue is recognize upon
collection or cash receipts.

Methods of Gross Profit Recognition on Sales

Recognized at time of Sales-The normal way of recording the gross profit which is sales less cost of sales
or cost of goods sold.

Recognized when cash is collected- This is the application of the installment method. Where in the
gross profit rate computed shall be multiplied by the cash collected. However, take note that there are
two possible ways in recognizing gross profit when cash is collected. That is by way of COST RECOVERY
METHOD and THE INSTALLMENT METHOD.

Cost Recovery Method-All collections are treated as recovery of cost and once the cost is recovered,
then the succeeding collections will become the gross profit.
Example:
Sales 100 GP rate is 20%
Cost of Sales 80 Collection is 50
GP 20
Under this method, GP rate is 20%. However you will not multiply the 20% to the collection of 50. Why?
Since this is CRM, then the collection will be applied first to the cost of making sales which is 80. If the
cost is 80 and you received 50, did you already recover the cost? The answer is NO. You still need to
recover 30 (80-50) before making any gross profit recognition. For instance, you received another cash
collection of 40. How will you treat it? Since the cost to be recovered stands at 30 and you receive 40,
then, you will recognize a gross profit of 10. How did it happen? You need to recover the 30 first from
the collection of 40, however, 40 is greater than 30 of 10. Therefore the 10 will be now your gross profit.

Installment Method-This method is the combination of cost recovery and gross profit realization, where
in upon collection of cash, there is an amount allocated to cost recovery and the rest is gross profit.

Example:
Sales 100 GP rate is 20%
Cost of Sales 80 Collection is 50
DGP 20

How much is the Deferred Gross Profit?

How much is the Realized Gross Profit?
How much is the Deferred Gross Profit, end?

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The first thing to do in solving installment sales problem is make it a habit to always compute for the GP
rate, where in the formula is DGP or GP divided by the SALES multiply by 100. In this case this is
20/100*100=20%.
1. How much is the deferred gross profit? If the problem is silent, then it is the DGP beginning
being asked or referred to. In this problem since it is silent, then the DGP is 20. Just a simple
sales less cost of sales which is 100-80=20.
2. How much is the realized gross profit? Take note the gross profit has an attached word
REALIZED. It is being attached in order to tell that the business is employing installment sales of
accounting method. The formula for RGP is simply collection times the GP rate. In this case, the
collection is 50 and the GP rate is 20%, 50*20=10.
3. How much is the deferred gross profit ending? The formula is DGP beginning less RGP. In this
problem this is 20-10=10.

To further understand the flow, T account is presented:

Installment Receivable Installment Sales Cost of Inst. Sales

100 100 80
50 ___________________ ___________________
50 100 80

Deferred Gross Profit Realized Gross Profit

10 20 10
___________________ __________________
10 10

The 100 on the installment receivable and installment sales is the recognition of sales. The 50 on credit
side of the installment receivable represents the collection resulting to a debit ending balance of 50. The
80 in the cost of installment sales represents the cost of making sales. The amount of 20 in the deferred
gross profit account is the excess of installment sales of 100 and cost of installment sales of 80. The 10
on the debit side of the deferred gross profit represents the reduction on the account which is the
collection of 50*20%=10 resulting to a balance of 10 which will be recognized if there will be succeeding
collections. The 10 on the realized gross profit account represents the 10 which is already recognized by
multiplying the collection by the GP rate.

Under PAS 18, sales related to installment sales should have a word INSTALLMENT attached to its
different accounts. Meaning installment sales should be separated from cash sales and regular sales
because the recognition of the gross profit is different from those two.

Gross Profit Realization Method-this is the complete reversal of cost recovery method. In this method,
the gross profit is being realized first before making any cost recovery. This method will not be given
emphasized in this module and the succeeding discussions will focus on cost recovery and installment
method.

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Allocation of Cost of Goods Sold
There are companies who are making cash sales, regular sales and installment sales. The
problem in this type of problem is the allocation of cost of goods sold on each type of sales. The
following can be used to allocate the cost of goods sold:

1. Based on total ratio of each sales-Add all the kinds of sales then get the fraction from it to
allocate cost of goods sold.

Example:

Cost of Goods Sold 780,000 Regular Sales 300,000

Cash Sales 150,000 Installment Sales 750,000

To allocate using the total ratio of each sales:

Cash Sales 150,000 150,000/1,200,000x780,000= 97,500
Regular Sales 300,000 300,000/1,200,000x780,000= 195,000
Installment Sales 750,000 750,000/1,200,000x780,000= 487,500
Total 1,200,000 780,000

2. Base on cash sales-The basis will be the cash sales. Other kinds of sales shall be patterned to
cash sales.

Example:
Cost of Goods Sold 780,000 Regular Sales 300,000
Cash Sales 150,000 Installment Sales 750,000
Regular sales and installment sales selling price is 20% and 25% respectively higher than the
cash sales.

To allocate using the cash sales:

Cash Sales 150,000 150,000/1,000,000x780,000= 117,000
Regular Sales(300/1.20) 250,000 250,000/1,000,000x780,000= 195,000
Installment Sales(750/1.25 600,000 600,000/1,000,000x780,000= 468,000
Total 1,000,000 780,000

3. Base on Gross Profit rate-Use GP rate then the excess is the allocated cost of goods sold.

Example:
Cost of Goods Sold 780,000 Regular Sales 300,000
Cash Sales 150,000 Installment Sales 750,000
The GP rate on cash sales, regular sales and installment sales is 25%, 35% and 37% respectively.

Cash Sales 150,000x25%=37,500 =150,000-37,500= 112,500

Regular Sales 300,000x35%=105,000 =300,000-105,000= 195,000
Installment Sales 750,000x37%=277,500 =750,000-277,500= 472,500
780,000

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Defaults and Repossessions
Defaults arises if customers fails to pay the installment due on the due date.
Repossession occurs when the customers repeatedly defaulted on the installment payments and
the seller take control of the property being sold under installment method.

Once the item is repossessed, it is included on the inventory of the seller. . To compute of gain
or loss on repossessions:

1. Value the Repossessed Merchandise at Fair value:

To get the FV of the repossessed merchandise:
Estimated Selling Price xx
Less: Reconditioning Costs* (xx)
Normal Profit on Selling Price** (xx)
FV of Repossessed Merchandise xx
*-If item is after the repossessed merchandise, deduct to estimated selling price. If before,
ignore it. If the problem is silent, it is after.
**-It is the gross profit on the year in which the repossession happened.

2. To compute for gain or loss on repossession:

FV of the repossessed merchandise xx
Less: Unrecovered Costs* (xx)
Gain or loss on Repossessions xx

*-Unrecovered costs is the computed by multiplying the UNPAID BALANCE of the buyer by the
COST RATIO. Cost ratio is the excess of 100% less the GP rate. Meaning if the GP rate is 20%,
then the cost ratio is 80%. To determine whether gain or loss on repossessions, the mnemonics
will be:
Gain on Repossessions if: FV or Repossessed Merchandise>Unrecovered Costs
Loss on Repossessions if: Unrecovered costs>FV of repossessed merchandise

TRADE IN
It happens when a buyer has an old merchandise to be included as down payment and
the seller agreed to the said scheme.

To compute for the fair value of the traded merchandise:

Estimated Selling Price xx
Less: Reconditioning Costs (xx)
Normal Profit (xx)
FV of the Traded Merchandise xx

The explanation on reconditioning costs and normal profit is already discussed above. The
problem is the basis on the computation of GP rate. You need to adjust the receivable because
there is trade in. To adjust, the following is the formula

Adjusted Installment receivable:

Installment Sales xx
Add: FV of the Traded Merchandise xx
Less: Trade In Allowance (xx)

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Adjusted Ins. Receivable xx

The basis for the payment will be the adjusted installment receivable.

Expenses in Installment Sales

1. Administrative expenses
2. Selling Expenses
3. Loss on Write offs=Write off x Cost ratio
4. Loss on Repossessions

COMPUTATION FOR TOTAL REALIZED GROSS PROFIT

Gross Profit on Regular Sales xx

Add: Gross profit on installment sales* xx
Normal Profit on Repossessed Merchandise** xx
Conversion of DGP to RGP*** xx
Gross Profit on Trade In**** xx
TOTAL REALIZED GROSS PROFIT xx
Less: Expenses***** (xx)
Net Income (Loss) xx

*-The collection times by the GP rate of the installment sales

**-used the GP rate on the year the repossessed merchandise was sold.
***-Conversion happens if the account is fully collected. Meaning from DGP it becomes RGP.
****-gross profit on Trade in transaction is computed as follows:
Down payment-Cash xx
FV of traded Merchandise xx
Collection net of interest xx
Total Collection xx
X GP rate %
RGP from Trade In xx

Other formulas:

To compute for collection for the year

Ending Installment receivable less beginning installment receivable less any unpaid
balance of repossessed merchandise which is sold.

To compute for GP rate previous year:

DGP Beginning x100%

Ins. AR, Beginning

To determine the equal installment in trade in:

Unadjusted AR xx
Less: Cash DP (xx)
FV of traded Merchandise (xx)

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 Adjusted AR xx
Divided by number of installments #
Equal installments xx

The adjusted AR will be the basis for computation of interest if any.

More examples shall be sent via google classroom on power point form.

Learning Activities
Enriching what you have learned

LEARNING ACTIVITY 1
ACCOUNTING FOR INSTALLMENT SALES

The following are given:

2019 2020
Sales: Regular (on account) 250,000 230,000
Installment-Down payment 20,000 24,000
Balance (payable in 3 years with 36% interest for 3 years) 80,000 96,000
Cost of Sales: Regular 120,000 130,500
Installment 60,000 69,600
Collections: Accounts Receivable 120,000 130,500
Installment Receivables:
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 50,000 65,000

Answer the following Questions:

1. Determine the GP rate on 2019 and 2020

2. Determine the ending balance of Installment Accounts Receivable for 2019 and 2020
3. Determine the ending balance of the Deferred Gross profit account for 2019 and 2020
4. Determine the realized gross profit for 2019 and 2020
5. Determine the net income or loss for 2019 and 2020.

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LEARNING ACTIVITY 2

REPOSSESSIONS
CASE 1
X corporation has a normal gross profit on installment sales of 30%. A 2019 sale resulted in a default
early in 2021. At the date of default, the balance of the installment receivable was 24,000 and the
repossessed merchandise has a fair value of 13,500. How much is the gain or loss on repossession?

CASE 2
G started operation at the beginning of 2019, selling home appliances exclusively on the installment
basis. Data for 2018 and 2019 follows;
2018 2019
Installment sales 600,000 750,000
Cost of Installment Sales 420,000 450,000
2018 Installment receivable, end 285,000 22,500
2019 installment receivable, end - 300,000
On May 31, 2019, a 2018 installment account of 37,500 was defaulted and the appliance was
repossessed. After reconditioning at cost of 750, the repossessed merchandise would be price to sell
30,000. How much is the gain or loss on repossession?

LEARNING ACTIVITY 3

TRADE IN
On November 1, 2019, Speed Motor, which maintains a perpetual inventory records sold a new
automobile to Rapids for 6,800,000. The car costs 5,205,000. The buyer paid 30% and received 640,000
allowance on an old car traded, the balance is payable in equal monthly installment payments
commencing the month of sale. The monthly amortization amounts to 240,000 inclusive of 12% interest
on the unpaid amount of the obligation. The car traded in has a wholesale value of 960,000 after
expending reconditioning costs of 180,000. After paying three installments, the buyer defaulted and the
car was subsequently repossessed. When reacquired, the car was appraised to have a fair value of
2,400,000. How much is the realized gross profit on installment sales during the year 2019?

Assessment
Testing how far you have learned

Instruction: Answer what is asked and have your solution in a good form.

AXN Company, a 2 year old company, sells merchandise on an installment basis and cash basis. The trial
balance of December 31, 2019 show the following information:
Debit Credit
Accounts Receivable 5,375,000
Inventory, Jan. 1, 2019 1,750,000
Purchases 13,875,000
Repossessions 75,000

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 Sales 20,250,000

Additional information:
1. Inventory on December 31, 2019 (new and repossessed) amounted to 2,375,000
2. Gross profit rate on cash sales during the two year period was constant at 30%
3. Cash sales during the year was reported at 9,625,000
4. An aged schedule of receivables revealed that 375,000 of the accounts receivable were one year
and older
5. A customer defaulted an account amounting to 193,750 from sale of 2018 occurred during
2019. The related inventory was repossessed during the year
6. Independent computations revealed that unadjusted deferred gross profit for 2018 sales
amount to 1,262,810
7. Total collections on receivable during 2019 amounted to 8,056,250

1. What is the GP rate on 2018 and 2019?

2. How much is the realized gross profit for 2019?
3. How much is the gain or loss on repossession?

Assignment

Look for an issue involving the use of installment method. Analyze it and have your generalization
submitted on google classroom.

Rubrics for the assignment:

Criteria Point
1. Originality 30
2. Correct use of grammar & arrangement 30
3. Quality 30
4. Timeliness 10

References:

Advanced Accounting Part 1 by Pedro Guerrero 2019 edition

Accounting for Special Transactions by Vernon Millan 2019 edition
Practical Accounting 2 by Antonio Dayag 2019 edition
Practical Accounting 2 by Pedro Guerrero 2019 edition