CHAPTER 5 Revenue Recognition and Profitability Analysis 307 (concluded) Repossessed inventory ..................................................... 420,000 Deferred gross profit ....................................................... 180,000 Installment receivable ................................................... 600,000 Cost Recovery Method. In situations where there is an extremely high degree of uncertainty regarding the ultimate cash collection on an installment sale, an even more conservative approach, the cost recovery method , can be used. This method defers all gross profit recognition until the cost of the item sold has been recovered. The gross profit recognition pattern applying the cost recovery method to the Belmont Corporation situation used in Illustration 5–A3 is shown below. Date Cash Collected Cost Recovery Gross Profit Recognized Nov. 1, 2016 $200,000 $200,000 $ –0– Nov. 1, 2017 200,000 200,000 –0– Nov. 1, 2018 200,000 160,000 40,000 Nov. 1, 2019 200,000 –0– 200,000 Totals $800,000 $560,000 $240,000 The cost recovery method defers all gross profit recognition until cash equal to the cost of the item sold has been received. implicitly by deferring gross profit until cash is collected. If the cash never is collected, the related deferred gross profit never gets included in net income. To illustrate, assume that in the example described in Illustration 5–A3 , the Belmont Corporation collected the first payment but the customer was unable to make the remaining payments. Typically, the seller would repossess the item sold and make the following journal entry: This entry removes the receivable and the remaining deferred gross profit and records the repossessed land in an inventory account. This example assumes that the repossessed land’s current fair value is equal to the net receivable of $420,000. If the land’s fair value at the date of repossession is less than $420,000, a loss on repossession is recorded (debited). The journal entries using this method are similar to those for the installment sales method except that $40,000 in gross profit is recognized in 2018 and $200,000 in 2019. The cost recovery method’s initial journal entry is identical to the installment sales method. When payments are received, gross profit is recognized only after cost has been fully recovered. Make Installment Sale: November 1, 2016 Installment receivables ................................................................ 800,000 Inventory ................................................................................. 560,000 Deferred gross profit ............................................................. 240,000 To record installment sale. Collect Cash: November 1, 2016, 2017, 2018, and 2019 Cash ............................................................................................. 200,000 Installment receivables ........................................................... 200,000 To record cash collection from installment sale. November 1, 2016 and 2017 No entry for gross profit. November 1, 2018 Deferred gross profit .................................................................. 40,000 Realized gross profit .............................................................. 40,000 To recognize gross profit from installment sale. November 1, 2019 Deferred gross profit .................................................................. 200,000 Realized gross profit .............................................................. 200,000 To recognize gross profit from installment sale.
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