UNIT THREE

3.1
3.1 INSTA
INSTALLM
LLMENT SALES
3.1.1Introduction
3.1.1
A sale of goods or services on the installment plan generally provides for a cash down payment and
a series of additional monthly payments. Because payments extend over a long period, the
seller customarily charges interest and carrying charges on the unpaid balance of installment
receivables. Revenue from installment sales is recorded in the same manner as from regular
sales, unless the collection of the installment receivable is not assured and there is no reasonable
basis for estimating the probability of collection. If the accrual basis of accounting is not considered
appropriate, an alternative method of revenue recognition such as the installment method or the
recovery method which will be discussed later must be used. Business enterprises that sell goods
on the installment plan may use the installment method of accounting only when accrual
accounting is not considered appropriate. The installment method is widely used for income tax
purposes because it postpones the payment of income taxes until installment receivables are collected.
However, the installment method is not acceptable for financial accounting unless considerable
doubt exists as to the collectibles of the receivables and a reasonable estimate of doubtful accounts
expense can‟t be made.

Under the installment method, the seller recognizes gross profit on sales in proportion to the
cash collected. If the rate of gross profit on installment sales is 40%, each birr of cash collected
on the installment receivables represents 40 cents of gross profit and 60 cents of cost recovery.
Repossessions are common under the installment sales method because this method is used only
when there is substantial uncertainty of collection.
3.1.2 Definition
Goods purchase by buyer by paying a small amount of the total amount of goods at the time
of purchase of goods and agrees to pay the remaining amount in equal installm
installments in equal interval of
time is known as installment
installment. The first tim
time pay
payment is known as “dow
down pay
payment”
ment”. In installment sales,
the risk and rewards are transferr
transferred to the buy
buyer.
3.2 Cos
Cost Of Installmen
llmentt Sales
les
The cost of merchandise sold on installment basis is called cost of installment
installment sales. It is
obtained by adding net purchases in the merchandise inventory
inventory beginning and subtracting
merchandise inventory
inventory ending
ending.

3.3
3.3 Unreali
nrealized Gros
ross Profit
Unrealized gross profit is referred to the total gross profit
profit from the sale of mercha
merchandi
ndise on
installme
installment basis which has not been collecte
collected. It is als
also known as “Deferr
“Deferred Gross Profit”.
Profit”.
3.4
3.4 Realized Gross
ross Profit
The profit on sale on merchandise on installment basis collected during the period out out of
total unr
unrealized gross profit is called realiz
realized gross profit. In other words, it is the profit
which has been collecte
collected during the peri
period.
od.

Compu
Computtatio
tion Of Cost Of Ins
Installme
lment Sales:
Merchandise inventory
inventory (beginning) XXX
Add: Net purchases during the period
period XXX
Merchandise available for sale
sale XXX
Less: Merchandise inventory
inventory (ending) (XXX)
XX)
Cost of installment sales
sales XXX

Com
Computation
ion Of Unrea
realiz
lized Gross
ross Profit
rofit (D. G.P.) :
Unrealized gross profit (D.G
(D.G.P.) = Installment sales – Cost of installment sal
sales

Com
Computation
ion Of Unr
Unreal
ealized Gross
ross Profit Rate (D. G. P. %):
Unrealized gross profit Rate (D.G
(D.G.P. %) = Unrealized gross profit X 100
Insta
Installment sales

3.5 Computation Of Cash Collection:

Cash collection (current year) = Installment sal
sales – Installment accounts
receivable (ending)

OR
Cash collection = Down payment + Installments received

Com
Computation
ion Of Real
ealized Gros
ross Profi
rofit (R.G.P.)
.P.) :
Realized gross profit (R.G
(R.G.P.) = Cash collection x Unrealized gross profit rate
3.6 Computation Of Loss On Default:
If the buy
buyer is unable to pay
pay the further installments and the seller is unable to repos
repossess
his goods from the buyer, it is said to be default.
default.
Installment accounts receiv
receivable cancelled XXX
Less:
ess: D.G.P. for go (Installment accounts receivable cancelled
cancelled x D.G
D.G.P. %) (XXX)
XXX)
Loss on default (XXX)
3.7 Computation Of Gain Or Loss On Repossession:
If the buy
buyer is unable to paypay the further installments and the seller repossesses his goods
from the buyer, it is said to be repossession of merch merchaandise.
ndise.
Installment accounts receiv
receivable cancelled XXX
Less:
ess: D.G.P. for go (Installment accounts receivable cancelled cancelled x D.G
D.G.P. %) (XXX)
XX)
Book value XXX
Less: Merchandise repossessed at fair market value.... alue.... (XXX)
XXX)
Gain/loss on repossession XXX/
XX/(XXX)
General Entries Under Perpe rpetual Systemtem:
o Purchased Merchandise on Account:
Merchandise DR. (with amount of purchases)
Accounts paypayable CR. (with amount of paya payable
ble)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----
 o Sold Merchandise on Installment Basis:
Installment accounts receiv
receivable DR. (amount receivable as installment)
Installment sales
sales CR. (amount of instal
installlment
ment sale
saless)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----

o Cash Collection on Installment Basis / Down Payment Received:

C as h DR. (with amount of cash collecti collection)
Installment accounts receiveceiv able CR.
CR . (amount of c a sh coll
collect
ection)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----

o Payment to Suppliers:
Accounts paypayable DR. (with amount of cash paid)
Cash
ash CR. (with amount
amount of cash
cash pai
paid)
-------------------------
---------------------------------------------------
-------------------------- -----------------------------------------------------
---------------------------------------------------------

o Expense Paid During the Period:

Expenses
Expenses DR. (with amount of expenses paid
paid)
Cash
ash CR. (with amount of cash pai
paid)

Adjusting
ting Entries
ies Under Perpe
rpetual S ystem :
o Recording Cost of Goods Sold:
Cost of installmen
installment sales DR. (amount of cost of installment sales)
Merchandise CR.
CR. (amount of cost of goods sold)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----

o Recording Unrealized Gross Profit (D.G.P.):

Installment sales
sales DR. (with amount of installment sales) sales)
Unrealized gross profit (D.G (D.G.P.) CR. (amount of D.G.P.)
Cost of installmen
installment sal
sales CR. (amount of cost of sales les)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----
o Recording Realized Gross Profit (R.G.P.):
Unrealized gross profit (D.G (D.G.P.) DR. (with amount of realize
realized d gros
ross profit)
Realized gross profit (R.G(R. G . P .) CR.
CR . (with amount of R.G
R.G . P .)
--------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
----

o Recording Loss on Default:

Unrealized gross profit (D.G
(D.G.P.) DR. (with amount of D.G
D.G.P. on defaul
default)
Loss on default DR. (with amount of loss on default)
Installment accounts receiv
eceivable CR.
CR. (installment A/R canc
ancelle
elled)
Exam
Examp pl e 1
Ali Company
Company deals in radio and television sets. It sells those sets on installment basis. The
The
summary of transactions for the year ended 31 December 1995 is as follows:
1) Purchase on account Rs.
Rs. 103,500
2) Installment sales Rs.
Rs. 125,000
3) Cost of installment sales Rs. 100,000
4) Collection of installment accounts receivabl
receivable Rs. 90,000
5) Payment to accounts payable Rs. 95,000
6) Selling expenses paid Rs.
Rs. 1,200
7) General expenses paid Rs . 2,300
8) Repossessed merchandise at fair market
market value
lue Rs.
Rs. 3,000
9) Installment accounts receivable written off by repossession Rs. 10,500
REQU
REQUIIREDRED
Give journal entries for the year ended 31st December 1995 including
cluding adjusting
adjusting and closing
closing
ent
entries
ies.
S O LU T I O N 1 :
Computation of Unrealized Gross Profit (DGP):
Unrealized gross profit = Installment sales – Cost of installmen
installment sales
Unrealized gross profit = 125,000 – 100,000
Unrealized gross profit = 25,000

Computation of Unrealized Gross Profit Rate (DGP%):

Unrealized gross profit rate = Unrealiz
Unrealized
ed gross profit x 100
Installment sale
sales
Unrealized gross profit rate = 25,000
25,000 x 100
125,000
Unrealized gross profit rate = 20%

Computation of Realized Gross Profit (RGP):

Realized gross profit
profit = Cash coll
collection
ection X DGP%
Realized gross profit
profit = 90,000 x 20%
Realized gross profit = 18,000

Computation of Gain or Loss on Repossession:

Installment accounts receiv
receivable cancelled 10,500
Less: Unrealized gross profit (10,500 x 20%) (2,100)
Book value 8,400
Less: Merchandise repossessed at fair market value 3,000
Loss on repossession 5,400
 ALI COMPA
MPANY
GENERAL
GENERAL JOURNAL
Date Parti
Particula
culars P/R Debit Cred
Credit
1 Mercha
Merchandi
ndise 103,500
Accounts payable
yable
(To rec
record the merchandise purc
purchase
hased on 103,500
account)
ount)
2 Installment acc
accounts rece
receivable 125,000
Installment
Installment sale
sales
(To record the good sold on installment basis)
3 Cas
Cash 90,000
Installm
Installment
ent accounts rec
receivable
eivable 125,000
95,000

95,
95,000

(To record the cash collected on installment

installment
basis
basis)
4 Accounts pay
payable
Cas
Cash
(To rec
record the payment to suppli
suppliers)
ers)
5 Selling expense
expenses
Cas
Cash
(To record the selling expenses paid)
aid)
6 General expense
xpenses
Cas
Cash
(To rec
record the general expenses paid)
ALI COMPA
MPANY
ADJUSTING
ADJUSTING ENTRI
ENTRIES
Date Parti
Particula
culars P/R Deb
Debit C r e di t
1 Cost of installme
installment sale
sales 100,000
Merchandise
Merchandise 100,000
(To record the cost of installment sales)
2 Installment sales 125,000
Cost of insta
installment sales 100,000
Unrealized gross profit 25,000
(To adjust the unrealized gross profit)
3 Unrealize
Unrealized gros
gross profit 18,000
Realized gross profit 18,000
(To adjust the realiz
realized gross profit)
4 Merchandise reposse
possesse
ssed 3,000
Unrealized gross profit
2,100
Loss on repossession 5,400
Installment accounts recreceivabl
eivable 10,500
 (To adjust the repossession of mercha
merchandise)

ALI COMPA
COMPANY
CLOSING
G ENTRI
OSIN ENTR I ES
Date Partic
Particulars P/R Debit
bit Credi
Credit
1 Expense and revenue summary
summary 8,900
Selling expenses 1,200
General expense
expenses 2,300
Loss on repossession 5,400
(To close the all
all expense account
counts)
2 Realized gross profit 18,000
Expense and reverevenue sum
summary 18,000
(To close the all income account
accounts)
3 Expense and revenue summary 9,100
Capital 9,100
(To close the expense and revenue summary
summary
account)
ount)
Exam
Examp pl e 2
The selected balances of ABC Installment Sales Co. are as fol
follows:
lows:
2007 – Jan. 1 2007 – Dec.31
Installment accounts receiv
receivable - 2005 90,000
90,000 -
Installme
Installment accounts
ccounts rec
receivable
eivable – 2006
2006 285,000
285,000 135,000
Installment accounts rec
receiva
eivable – 2007 - 337,500
Deferred gross profit – 2005 22,500
22,500 18,750
Deferred gross profit – 2006 85,500
85,500 85,500
Installment sales
sales - 450,000
Cost of installment sal
sa l es - 306,000
Repossessed merchandise
merchandise - 12,000
Installment accounts rec
receiva
eivable – 2005 cancelled on
reposs
repossession
ssion - 15,000
REQU
REQUIIRED
RED
a) Gro
Gross profit reali
realized during 2007.
2007.
b) General Journal entries including adjusting entries during 2007.

S O LU T I O N 2
Computation of Unrealized Gross Profit (DGP) (2007):
Unrealized gross profit = Installment sales – Cost of installmen
installment sales
Unrealized gross profit = 450,000 – 306,000
Unrealized gross profit = 144,000
Computation of Unrealized Gross Profit Rate (DGP%):
Unrealize
Unrealized gross profi
profit rate
rate (2007) = Unrealized gross profit x 100
Installme
Installment sales
Unrealized gross profit rate (2007) = 144,000
144,000 x 100
450,000
Unrealized gross profit rate (2007)= 32%

x
Unrealize
Unrealized gross profi
profit rate
rate (2006) = Unrealized gross profit (Beg) 100
Installment A/R (Beg)
Unrealized gross profit rate (2006) = 85,500
285,000 x
Unrealized gross profit rate (2006)= 30% 100

Unrealize
Unrealized gross profi
profit rate
rate (2005) = Unrealized gross profit (Beg)
Installment A/R (Beg)
Unrealized gross profit rate (2005) = 22,500
90,000
Unrealized gross profit rate (2005)= 25%

Computation of Cash Collection:

Cash collect
collection
ion (2007) = Installm
nstallment sales
sales – Installment accounts receiv
receivable (end
(ending
ing)
Cash collection (2007)
(2007) = 450,000 – 337,500
Cash collection (2007)
(2007) = 112,500
Cash collect
collection
ion (2006) = Installment A /R (Beg
(Be ) – Installment A/R (End)
g
Cash collection (2006)
(2006) = 285,000 –– 135,000
Cash collection
collection (2006) = –
150,000

Cash collect
collection
ion (2005) = Installment A/R (Beg) – Installment A/R (End) –
Installment A/R cance
cancelle
lled
Cash collection (2005)
(2005) = 90,000 – 0 – 15,000 Cred
Credit
Cash collection (2005)
(2005) = 75,000
Debit
Debit
Date 450,000 450,000
Computation
1 of Realized Gross Profit:
Realized gross profit
profit = Cash collection X DGP%
Realized gross profit
profit (2007) = 112,
112,500 x 32% 36,000337,500
Realized gross profit
profit (2006) = 150,
150,000 x 30%
45,000 112,500
Realized gross profit
profit (2005) = 75,
75,000 x 25%
2
Total realized gross profit = 18,750 150,000
75,
75,000
Computation of Gain or Loss on Repossession:
Installment accounts receiv
receivable cancelled 15,000
Less: Unrealized gross profit (15,000 x 25%) (3,750)
Book value 11,250
Less: Merchandise repossessed at fair market value (12,000)
Gain on repossession 750

ABC INSTALL
INSTALLMENT SAL
SALES CO.
GENERAL
ENERAL JOURNAL
JOURNAL
Date Parti
Parti cula
cula rs P/ R Cred
Credit
1 Installment accoun
accounts receiv
receivable (2007)
Installment sales
D e bi t 306,000
(To rec
record the good sold on install
installment basis
basis)
Cash
Installment accounts receivable
receivable (2006) 306,000
2
 Installment
Installment acco
accounts
unts receivable (200
(2007 )
Installment accounts receivable
receivable (2005)
(To record the cash collected on installment
installment
basis
basis)
ABC INSTALL
INSTALLMENT SALSALES CO.
ADJUSTING
ADJUSTING ENTRI
ENTRIES
Parti
Particula
culars P/R
Cost of installme
installment sale
sales
Merchandise
Merchandise
(To record the cost of installment sales)
Installment sales
Cost of insta
installment sales
Unrealized gross profit (2007)
(2007)
(To adjust the unrealized gross profit)
Unrealize
Unrealized gros
gross profit (2007)
Unrealized gross profit (2006)
Unrealized gross profit (2005)
Realized gross profit
(To adjust the realized gross profit)
Merchandise reposse
possesse
ssed
Unrealized gross profit (2005)
Gain on repossession
Installment accounts receivable
receivable (2005)
(To adjust the repossession of mercha
merchandise)
INCOME
OM E S T A T E M E N T
Sales
Sales XXX
Less: Cost of goods sold (XXX)
XX)
Gross profit XXX
Add: Realized gross profit (RG(RGP) XXX
Total gross profit XXX
Less: Operating expenses (XXX)
XX)
Net profit XXX
B A LA N C E S H E E T
Assets (Rupees)
(Rupees) Equities (Rupees)
Current Assets: Liabilities:
C as h XXX Accounts pay payable
XXX
Accounts rec
receivable XXX Other liabilities
XXX
Installment A/R (1st year) XXX Total liabiliti
liabilities XXX
XXX
Installment A/R (2nd year) XXX
Merchandise inventory
inventory XXX Owner‟s Equity:
Other current asset
assets XXX Capital
Capital XXX
Total current asset
assets XXX Add: Net profit XXX
Add: D.G.P (1st year)
dd: D.G XXX
Fixed Assets: Add: D.G.P (2nd year)
dd: D.G XXX
Land XXX Tota
Total owne
owner‟s equity
equity
XXX
Other fixed assets XXX
Total fixed assets XXX
Total assets XXX Tota
Total equities XXX
XXX
–
–