Question

(Revenue recognition- installment sales)The Garcia Corp is a real estate developer. In Year 1, it sold a house to Michael Sukul for $200,000, in return for five yearly installments of $40,000 each, plus interest. The first installment was paid at the time of sale. The house cost Garcia $115,000 to build. Compute the revenue and cost of sales that Garcia would recognize each year from Year 1 to Year 5 if it used.

A. Immediate recognition at time of sale

B. The installment method

C. The cost recovery method

Answer 1

Revenue is the income of any individual and this is a part of P&L as incomes are shown in the P&L. This is very important that revenue is recognized carefully and as per GAAP to report accurate revenue for the period. Below are the methods that are used for recognition of revenue.

1. Immediate recognition

In this method revenue is recorded at the time the house is sold, this does not matter that whether the revenue is received in cash or is yet due for payment. If Garcia use this method to recognize revenue at the time sale has taken place then she will record the revenue and COGS as below.

Revenue that will be recognized will be the sale price that is $200000.

COGS that will be recognized will be 115000

Since the complete revenue is recognized here, complete cogs has to be recognized in same period also.

2- Installment method.

In this method only that part of revenue is recognized that is actually paid by Michael. In this method revenue is not recorded in the period the house is sold but the cash receipts that are received in different years will be identified as revenue.

If installment method is used then the below will be reported every year.

Revenue: - 200000/5=40000

COGS: - 115000/5=23000

Since the revenue is recognized at the time the receipts are received, than the COGS will have to be recorded at the same time.

3--- The cost recovery method

In this method, no revenue is recognized until the COGS is recovered and the receipts are directly expensed off for the COGS and then when the Cost is recovered than the remaining revenue is recognized as revenue.

Below table shows how much is to be recognized in revenue and how much will go to the COGS. When the cost of 115000 is recovered, from that year revenue will start recognizing.

Cost is recover in 3^rd year and after that revenue will start recognizing.