Question

The Big Red Company sold merchandise to a customer for 500,000 on January 1^st, 2004 with a cost of 100,000. A payment of 100,000 is due at date of sale and annual payments of 100,000 due each succeeding January. The expected collectibility is exceptionally uncertain. Use the installment method of accounting and the cost recovery method to journalize the necessary entries.

Answer 1

Solution

Big Red Company

Installment method of accounting:

Date	Account Titles and Explanation		Debit	Credit
1-Jan-04	Installment Receivables		$500,000
	Installment Sales			$500,000
	(To record merchandise sold on installment)
	Cost of goods sold		$100,000
	Inventory			$100,000
	(to record cost of goods sold)
	Installment Sales		$500,000
	Cost of goods sold			$100,000
	Deferred Revenue			$400,000
	(To record related revenue deferred)
	To account for collections -
Jan-04	Cash		$100,000
	Installment Receivables			$100,000
	(To record collection at the time of sale)
2004	Deferred Gross Profit		$80,000
	Gross profit on installment sales			$80,000
	(To record deferred gross profit, $100,000 x 80%)
Jan-05	Cash		$100,000
	Installment Receivables			$100,000
	(To record cash collections from installment sale)
2005	Deferred Gross Profit		$80,000
	Realized gross profit			$80,000
	(To record gross profit from installment sale)
Jan-06	Cash		$100,000
	Installment Receivables			$100,000
	(To recoed cash collections from installment sale)i
Jan-07	Cash		$100,000
	Installment Receivables			$100,000
	(To record cash collections from installment sale)
	Deferred Gross Profit		$80,000
	Realized gross profit			$80,000
	(To record gross profit from installment sale)
Jan-08	Cash		$100,000
	Installment Receivables			$100,000
	(To record cash collections from installment sale)
	Deferred Gross Profit		$80,000
	Realized gross profit			$80,000
	(To record gross profit from installment sale)

Working:

Given information –

Installment sales - $500,000

Cost of inventory sold = $100,000

Gross profit = $400,000

Gross profit % = $400,000/$500,000 = 80%

Gross profit recognition installment sales method
Date	Cash Collected	Cost	Gross Profit
Jan-04	$100,000	$20,000	$80,000
Jan-05	$100,000	$20,000	$80,000
Jan-06	$100,000	$20,000	$80,000
Jan-07	$100,000	$20,000	$80,000
Jan-08	$100,000	$20,000	$80,000
Total	$500,000	$100,000	$400,000

Cost Recovery Method:

Analysis of profitability of transaction:

Sales revenue $500,000

Cost of sales   $100,000

Gross profit    $400,000

Profit is deferred and not recognized until all cost is recovered.

	2004	2005	2006	2007	2008
Cash Collected	$100,000	$100,000	$100,000	$100,000	$100,000
Cost of goods sold	$100,000	0	0	0	0
gross profit realized	0	$100,000	$100,000	$100,000	$100,000

Journal Entries –

Journal Entries -
Date	Account Titles and Explanation		Debit	Credit
Jan-04	Installment Receivables		$500,000
	Inventlry			$100,000
	Gross profit			$400,000
	(To record installment sale)
Jan-04	Cash		$100,000
	Installment Receivable			$100,000
	(To record collection of cash)
1-Jan	Cash		$100,000
	Installment Receivable			$100,000
	(To record cash collection)
	Deferred Gross Profit		$100,000
	Realized Gross Profit			$100,000
	(To record gross profit realized)
1-Jan-06	Cash		$100,000
	Installment Receivable			$100,000
	(To record cash collection)
	Deferred Gross Profit		$100,000
	Realized Gross Profit			$100,000
	(To record gross profit realized)
1-Jan-07	Cash		$100,000
	Installment Receivable			$100,000
	(To record cash collection)
	Deferred Gross Profit		$100,000
	Realized Gross Profit			$100,000
	(To record gross profit realized)
1-Jan-07	Cash		$100,000
	Installment Receivable			$100,000
	(To record cash collection)
	Deferred Gross Profit		$100,000
	Realized Gross Profit			$100,000
	(To record gross profit realized)