Topic 2: Installment Sales

Learning Objectives

State the applicability of the installment sales method of recognizing revenues.

Apply the installment sales method.

Introduction

An entity applies PFRS 15 Revenue from Contracts with Customers to account for revenues from
contracts with customers. The installments sales method is not in accordance with PFRS 15. The
installment sales method has originated from the U.S. GAAP.

The installment sales method is a special method of recognizing revenue. This method may be used
for (1) taxation purposes or (2) when the entity is a micro entity and has selected the income tax basis
of accounting.

Accounting Procedures

Under the installment sales method, the gross profit from an installment sale is initially deferred and
subsequently realized on a piecemeal basis as the installment payments are received using the
following formula:

Realized gross profit = Collection on sale x Gross profit rate*

*Gross profit based on sales = Gross profit / Sales

Illustrations

Illustration 1: Journal entries

XYZ Co. is a company selling parcels of land. XYZ Co. uses the installment sales method. On
Jan. 1, 2021. XYZ Co. sold a land costing ₱600,000 for ₱1,000,000 payable as follows: 20% down
payment and balance due in 4 equal annual installments every Dec. 31.

Journal entries:

Jan. 1, Cash 200,000

2021 Installment accounts receivable 800,000
Sales 1,000,000
Jan. 1, Cost of sales 600,000
2021 Inventory 600,000
Dec. 31, Cash (800,000 / 4) 200,000
2021 Installment accounts receivable 200,000

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The realized gross profit in 2021 is computed as follows:

Down payment – Jan. 1, 2021 200,000

1st installment – Dec. 31, 2021 200,000
Total collections – 2021 400,000
Multiply by: Gross profit rate based on sales [(1M - 600K) / 1M] 40%
Realized gross profit - 2021 160,000

To record the deferred gross profit at the end of the year, the following adjusting entry is
made:

Dec. 31, Income summary 240,000

2021 Deferred gross profit* 240,000

*Sales 1,000,000
Cost of sales (600,000)
Deferred gross profit - beg. 400,000
Less: Realized gross profit (160,000)
Deferred gross profit - end 240,000

XYZ’s Dec. 31, 2021 financial statements will report the following:

Income Statement Balance Sheet

Installment sales 1,000,000 ASSETS
Cost of sales (600,000) Installment accounts receivable 600,000
Gross profit 400,000
Less: Deferred gross profit (160,000) LIABILITIES
Realized gross profit 240,000 Deferred gross profit 240,000

The deferred gross profit is an unearned income and classified in the balance sheet as a
liability.

The gross profit rate based on sales can also be computed using the following formula:

Deferred gross profit

Gross profit rate =
Installment account receivable
= 240,000 / 600,000
= 40%

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Illustration 2: Two periods

XYZ Co. uses the “installment sales method.” Information on XYZ’s transactions during 2021
and 2022 is as follows:

2021 2022
Installment sales 1,000,000 1,200,000
Cost of sales 600,000 660,000
Gross profit 400,000 540,000
Cash collections from:
2021 sales 400,000 200,000
2022 sales 480,000

Requirement: Compute for the total realized gross profit in 2022.

Solution:
Prices and costs change over time, so an entity may have different gross profit rates each
year. When computing for the realized gross profit, the original gross profit rate in a particular
year of sales is applied to the subsequent collections.

The gross profit rates based on sales are computed as follows:

2021 2022
Gross profit 400,000 540,000
Installment sales 1,000,000 1,200,000
Gross profit rates based on sales 40% 45%

The realized gross profit in 2022 is computed as follows:

Collections in 2022 from:

2021 sales: (200,000 x 40%) 80,000
2022 sales: (480,000 x 45%) 216,000
Total realized gross profit in 2022 296,000

Illustration 3: Cash collection

XYZ Co. has the following collection policy on its installment sales:
• 20% down payment
• Balance due as follows: 50% in the year of sale, 30% in the second year, and 20% in
the third year.
• Installment sales during 2021, 2022 and 2023 were ₱2,000,000, ₱2,400,000 and
₱3,000,000 respectively.
• Gross profit rates based on sales in 2021, 2022 and 2023 were 22%, 24% and 25%
respectively.

Requirement: Compute for the total realized gross profits in each of years 2021, 2022, and
2023.

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Solution:
2021 2022 2023
2021 sale:
Down payment (2M x 20%) x 22% 88,000
2021: [(2M x 80%*) x 50%] x 22% 176,000
2022: [(2M x 80%) x 30%] x 22% 105,600
2023: [(2M x 80%) x 20%] x 22% 70,400

2022 sale:
Down payment (2.4M x 20%) x 24% 115,200
2022: [(2.4M x 80%) x 50%] x 24% 230,400
2023: [(2.4M x 80%) x 30%] x 24% 138,240

2023 sale:
Down payment (3M x 20%) x 25% 150,000
2023: [(3M x 80%) x 50%] x 25% 300,000
Realized gross profits 264,000 451,200 658,640
*100% less 20% down payment = 80% balance

Illustration 4: Reconstruction of information

ABC Co.’s incomplete records show the following:

2021 2022 2023
Installment sales 2,000,000 2,400,000 ?
Cost of sales ? ? 2,250,000
Gross profit ? ? ?
Gross profit rates ? ? 25%
Collections:
from 2021 sales 1,200,000 480,000 320,000
from 2022 sales 1,440,000 576,000
from 2023 sales 1,800,000
Realized gross profit 264,000 ? 658,640

Requirement: Compute for the cost of sales in 2022.

Solution:
Realized gross profit - 2021 264,000
Divide by: Collections in 2021 1,200,000
Gross profit rate - 2021 22%

Total realized gross profit in 2023 658,640

Realized gross profit in 2023 from 2021 sales (320,000 x 22%) (70,400)
Realized gross profit in 2013 from 2023 sales (1.8M x 25%) (450,000)
Realized gross profit in 2023 from 2022 sales 138,240

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 Realized gross profit in 2023 from 2022 sales 138,240
Divide by: Collections in 2023 from 2022 sales 576,000
Gross profit rate - 2022 24%

Installment sales - 2022 2,400,000

Multiply by: Cost ratio in 2022 (100% - 24%) 76%
Cost of sales - 2022 1,824,000

The following formulas and their variations are very important when solving problems in
installment sales:

Realized gross profit = Collection on sale x Gross profit rate

Deferred gross profit

Gross profit rate =
Installment account receivable

Primary reference used: Accounting for Special Transactions (Advanced Accounting 1) 2021 Edition
by Zeus Vernon B. Millan.

Note: This module shall be used for classroom learning purposes only and shall not be distributed
outside the class.

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