306 SECTION 1 The Role of Accounting as an Information System This is a contra account to the installment receivable. The deferred gross profit account will be reduced as collections are received until all profit has been recognized. 37 Collect Cash: November 1, 2016 Cash ............................................................................................ 200,000 Installment receivables ........................................................... 200,000 To record cash collection from installment sale. Deferred gross profit .................................................................. 60,000 Realized gross profit .............................................................. 60,000 To recognize gross profit from installment sale. The second set of entries records the collection of the first installment and recognizes the gross profit component of the payment, $60,000. Realized gross profit gets closed to income summary as part of the normal year-end closing process and is included in net income in the income statement. Journal entries to record the remaining three payments on November 1, 2017, 2018, and 2019, are identical. At the end of 2016, the balance sheet would report the following: Installment receivables ($800,000 2 200,000) ...................... $600,000 Less: Deferred gross profit ($240,000 2 60,000) .................. (180,000) Installment receivables (net) .................................................. $420,000 The net amount of the receivable reflects the portion of the remaining payments to be received that represents cost recovery (70% 3 $600,000). The installment receivables are classified as current assets if they will be collected within one year (or within the company’s operating cycle, if longer); otherwise, they are classified as noncurrent assets. The income statement for 2016 would report gross profit from installment sales of $60,000. Sales and cost of goods sold associated with installment sales usually are not reported in the income statement under the installment method, just the resulting gross profit. However, if those amounts aren’t included in the income statement in the period in which the installment sale is made, they need to be included in the notes to the financial statements, along with the amount of gross profit that has not yet been recognized. Additional Consideration A company uses the installment method because it can’t reliably estimate bad debts. Therefore, the company doesn’t explicitly recognize bad debts or create an allowance for uncollectible accounts in the installment method. Rather, bad debts are dealt with 37Accountants sometimes initially record installment sales in separate entries: Installment receivables ..................................................................................................................... 800,000 Installment sales ........................................................................................................................... 800,000 To record installment sales. Cost of installment sales .................................................................................................................. 560,000 Inventory ...................................................................................................................................... 560,000 To record the cost of installment sales. Then at the end of the period, the following adjusting/closing entry is needed: Installment sales ............................................................................................................................... 800,000 Cost of installment sales .............................................................................................................. 560,000 Deferred gross profit on installment sales.................................................................................... 240,000 The text entries concentrate on the effect of the transactions and avoid this unnecessary procedural complexity. (continued)
Spiceland_Inter_Accounting8e_Ch05
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