Installment+Sales

INSTALLMENT SALES Installment Method Criteria 11. The installment method of recognizing revenue a. should be used only in cases in which no reasonable basis exists for estimating the collectibility of receivables. b. is not a generally accepted accounting principle under any circumstances. c. should be used for book purposes only if it is used for tax purposes. S, S & S d. is an acceptable alternative accounting principle for a firm that makes installment sales. 46. Slick's Used Cars sells pre-owned cars on the installment basis and carries its own notes because its customers typically cannot qualify for a bank loan. Default rates tend to be high or unpredictable. However, in the event of nonpayment, Slick's can usually repossess the cars without loss. The revenue method Slick would use is the: A. Installment sales method. C. Cost recovery method. B. Point of sales method. D. Completed contract method. S, S & T 21. The installment method of recognizing profit for accounting purposes is acceptable if a. collections in the year of sale do not exceed 30% of the total sales price. b. an unrealized profit account is credited. c. collection of the sales price is not reasonably assured. d. the method is consistently used for all sales of similar merchandise. K, W & W 1.

Cash collection is a critical event for income recognition in the AICPA 1193 T- 39 a. b. Cost-recovery method No Yes Installment method No Yes

c. No Yes

d. Yes No

2.

An acceptable method for recognizing profit when the collection of cash is in doubt is the a. Percentage-of-completion method. c. Completed-contract method. b. Installment method. d. Consignment method. CMA 0685 4-35

3.

For financial statement purposes, the installment method of accounting may be used if the a. Collection period extends over more than 12 months. b. Installments are due in different years. c. Ultimate amount collectible is indeterminate. d. Percentage-of-completion method is inappropriate. AICPA 1191 T-6

4.

To properly account for an installment sale, all of the following must be readily determinable except A. The amount of gross profit to be deferred. B. The total cash collected on each year's sales. C. The operating costs to be deferred. D. Costs associated with default and repossession. CMA 1292 2-20

5.

If sales are accounted for using the installment method, which of the following is (are) only recognized in proportion to the cash collected on the sales during the period? A. Sales. B. Sales and cost of sales. C. Sales and cost of sales and selling expenses. D. Sales and cost of sales and administrative expenses. CIA 0595 IV-11

Characteristics 13. When using the installment sales method, a. gross profit is deferred until all cash is received, but revenues and costs are recognized in proportion to the cash collected from the sale. b. gross profit is recognized only after the amount of cash collected exceeds the cost of the item sold. c. revenue, costs, and gross profit are recognized proportionally as the cash is received from the sale of product. d. total revenues and costs are recognized at the point of sale, but gross profit is deferred in proportion to the cash that is uncollected from the sale. S, S & S Installment Receivable Balance 6. Pie Co. uses the installment sales method to recognize revenue. Customers pay the installment notes in 24 equal monthly amounts, which include 12% interest. What is an installment note’s receivable balance six months after the sale? a. 75% of the original sales price. b. Less than 75% of the original sales price. AICPA 1192T-9 c. The present value of the remaining monthly payments discounted at 12%. d. Less than the present value of the remaining monthly payments discounted at 12%. Deferred Revenue 65. Alton, Inc. is a retailer of home appliances and offers a service contract on each appliance sold. Alton sells appliances on installment contracts, but all service contracts must be paid in full at the time of sale. Collections received for service contracts should be recorded as an increase in a

a. b. c. d.

deferred revenue account. sales contracts receivable valuation account. stockholders' valuation account. service revenue account.

K, W & W

Deferred Gross Profit 23. Under the installment sales method, a. revenue, costs, and gross profit are recognized proportionate to the cash that is received from the sale of the product. b. gross profit is deferred proportionate to cash uncollected from sale of the product, but total revenues and costs are recognized at the point of sale. c. gross profit is not recognized until the amount of cash received exceeds the cost of the item sold. d. revenues and costs are recognized proportionate to the cash received from the sale of the product, but gross profit is deferred until all cash is received. K, W & W Realized Gross Profit *. Income recognized using the installment method of accounting generally equals cash collected multiplied by the a. net operating profit percentage. b. net operating profit percentage adjusted for expected uncollectible accounts. c. gross profit percentage. AICPA 0592 T-45, RPCPA 1097 d. gross profit percentage adjusted for expected uncollectible accounts. 7.

According to the installment method of accounting, gross profit on an installment sale is recognized in income a. on the date of sale. b. on the date the final cash collection is received. c. in proportion to the cash collection. d. after cash collections equal to the cost of sales have been received. AICPA M0595 F-27

Repossessions 8. When assets that have been sold and accounted for by the installment method are subsequently repossessed and returned to inventory, they should be recorded on the books at a. Selling price. b. The amount of the installment receivable less associated deferred gross profit. c. Net realizable value. d. Net realizable value minus normal profit. Gleim

22. The method most commonly used to report defaults and repossessions is: a. provide no basis for the repossessed asset thereby recognizing a loss. b. record the repossessed merchandise at fair value, recording a gain or loss if appropriate. c. record the repossessed merchandise at book value, recording no gain or loss. d. none of these. K, W & W Cost Recovery Method Criteria 8. Drew Co. produces expensive equipment for sale on installment contracts. When there is doubt about eventual collectibility, the income recognition method least likely to overstate income is a. at the time the equipment is completed. c. the cost recovery method. b. the installment method. d. at the time of delivery. AICPA 0591T-8

21. The cost recovery method a. is used only when circumstances surrounding a sale are so uncertain that earlier recognition is impossible. b. is the most common method of accounting for real estate sales. c. is similar to percentage-of-completion accounting. d. is never acceptable under generally accepted accounting principles. S, S & S

33. According to the cost recovery method of accounting, the gross profit on an installment sale is recognized in income: a. after cash collections equal to the cost of sales are received. b. in proportion to cash collections. c. on the date the final cash collection is received. d. on the date of sale. RPCPA 0593 *.

9.

*.

Wren Co. sells equipment on installment contracts. Which of the following statements best justifies Wren’s use of the cost recovery method of revenue recognition to account for these installment sales? a. The sales contract provides that title to the equipment only passes to the purchaser when all payments have been made. b. No cash payments are due until one year from the date of sale. c. Sales are subject to a high rate of return. d. There is no reasonable basis for estimating collectibility. AICPA 0594 F-41 FGH Machinery, Inc. is engaged in the business of selling tractors on installment basis. Under which of the following circumstances should you recommend to FGH the use of the cost recovery method of revenue recognition to account for the installment sales? a. Where there is no reasonable basis for estimating collectibility. b. Where the sales are subject to a high rate of return. c. Where no cash payments are due until one year from date of sale. d. Where the sale contract provides that title to the equipment only passes to the buyer when all payments have been made. RPCPA 1096

47. Bert's Meat Market sells quarters and sides of beef on the installment basis. Losses on receivables are very difficult to predict, and meat products cannot be repossessed. The revenue recognition method used by Bert would be: A. Point of sale. C. Cost recovery. B. Installment sales. D. Completed contract. S, S & T 10 .

Using the cost-recovery method of revenue recognition, profit on an installment sale is recognized A. On the date of the installment sale. B. In proportion to the cash collections. C. After cash collections equal to the cost of goods sold have been received. D. On the date the final cash collection is received. CIA 0597 IV-10

ABC Oil Co. is engaged in extensive exploration for oil in the Cagayan Valley. If upon discovery of oil the company does not recognize any revenue from oil sales until the sales exceed the costs of exploration, the basis of revenue recognition being employed is the a. production basis. c. sales (or accrual) basis. RPCPA 1082 b. cash (or collection) basis. d. sunk cost (or cost recovery) basis.

31. A sells on the installment basis, with service contracts paid in full at the date of sale. The collections from service contracts should be recorded as an increase in a. Deferred revenue account. c. Valuation account of stockholders’ equity. b. Sales receivable valuation account. d. Service revenue account. RPCPA 0593 Application 26. Winser, Inc. is engaged in extensive exploration for water in Utah. If, upon discovery of water, Winser does not recognize any revenue from water sales until the sales exceed the costs of exploration, the basis of revenue recognition being employed is the a. production basis. c. sales (or accrual) basis. b. cash (or collection) basis. d. cost recovery basis. K, W & W Gross Profit 75. According to the cost recovery method of accounting, gross profit on an installment sale is recognized in income (E) A. After cash collections equal to the cost of sales have been received B. In proportion to the cash collections C. On the date the final cash collection is received D. On the date of sale CPAR Income recognition 25. Under the cost recovery method of revenue recognition, a. income is recognized on a proportionate basis as the cash is received on the sale of the product. b. income is recognized when the cash received from the sale of the product is greater than the cost of the product.

c. income is recognized immediately. d. none of these.

d. Consignee when cash is received from the customer. 13 .

24. A seller is properly using the cost recovery method for a sale. Interest will be earned on the future payments. Which of the following statements is not correct? a. After all costs have been recovered, any additional cash collections are included in income. b. Interest revenue may be recognized before all costs have been recovered. c. The deferred gross profit is offset against the related receivable on the balance sheet. d. Subsequent income statements report the gross profit as a separate item of revenue when it is recognized as earned. K, W & W CONSIGNMENT ACCOUNTING Ownership of Consigned Inventories 23. Goods on consignment should be included in the inventory of S, S & S a. the consignor but not the consignee. c. the consignee but not the consignor. b. both the consignor and the consignee. d. neither the consignor nor the consignee. Inventoriable Costs 11 . Consignor Co. paid the in-transit insurance premium for consignment goods shipped to Consignee Co. In addition, Consignor advanced part of the commissions that will be due when Consignee sells the goods. Should Consignor include the in-transit insurance premium, and the advanced commissions in inventory costs? AICPA 0592 T-23 a. b. c. d. Insurance Premium Yes No Yes No Advanced Commissions Yes No No Yes Revenue/Cost Recognition 31. Revenue is recognized by the consignor when the a. goods are shipped to the consignee. b. consignee receives the goods. c. consignor receives an advance from the consignee. d. consignor receives an account sales from the consignee. 12 .

CIA 0589 IV-27

K, W & W

K, W & W

In accounting for sales on consignment, sales revenue and the related cost of goods sold should be recognized by the a. Consignor when the goods are shipped to the consignee. b. Consignee when the goods are shipped to the third party. c. Consignor when notification is received that the consignee has sold the goods.

DEF is the consignee for 1,000 units of product X for ABC Company. ABC should recognize the revenue from these 1,000 units when A. The agreement between DEF and ABC is signed. B. ABC ships the goods to DEF. C. DEF receives the goods from ABC. D. DEF sells the goods and informs ABC of the sale. CIA 0590 IV-31

*. When goods are consigned out, profits should be recognized by the consignor when the a. Goods are sold by the consignee. b. Goods are received by the consignee. c. Consignee agrees to the terms of the consignment. d. Goods are shipped by the consignor. RPCPA 0577 Prepaid Freight 14 . Jel Co., a consignee, paid the freight costs for goods shipped from Dale Co., a consignor. These freight costs are to be deducted from Jel’s payment to Dale when the consignment goods are sold. Until Jel sells the goods, the freight costs should be included in Jel’s a. Cost of goods sold. c. Selling expenses. b. Freight-out costs. d. Accounts receivable. AICPA 1192 T-12 Journal Entries 15 . ABC Manufacturing Company ships merchandise costing $40,000 on consignment to XYZ Stores. ABC pays $3,000 of freight costs to a transport company, and XYZ pays $2,000 for local advertising costs that are reimbursable from ABC. By the end of the period, three fourths of the consigned merchandise has been sold for $50,000 cash. XYZ notifies ABC of the sales, retains a 10% commission and the paid advertising costs, and remits the cash due ABC. Select the journal entry that appropriately records the notification of sale and the receipt of cash by ABC. CIA 1193 IV-37 $40,000 A. Cash 2,000 Advertising expense 5,000 Commission expense 3,000 Freight expense $50,000 Revenue from consignment sales $43,000 B. Cash 2,000 Advertising expense 5,000 Commission expense $50,000 Revenue from consignment sales

C. D.

Cash Revenue from consignment sales Cash Commission expense Revenue from consignment sales

$50,000 $45,000 5,000 $50,000

FINANCIAL STATEMENT PRESENTATION & REQUIRED DISCLOSURES Financial Statement Presentation Deferred Gross Profit 16 . Deb Co. records all sales using the installment method of accounting. Installment sales contracts call for 36 equal monthly cash payments. The amount of deferred gross profit relating to collections 12 months beyond the balance sheet date should be reported in the a. Current liability section as a deferred revenue. b. Noncurrent liability section as a deferred revenue. c. Current asset section as a contra account. d. Noncurrent asset section as a contra account. AICPA, Adapted *.

The Deferred Gross Profit account is a a. Liability account. b. Contra asset account.

c. Contra liability account. d. Either a or b.

20. Deferred gross profit on installment sales is generally treated as a(n) a. deduction from installment accounts receivable. b. deduction from installment sales. c. unearned revenue and classified as a current liability. d. deduction from gross profit on sales.

1.

Answers (A), (C), and (D) are incorrect because cash collections are critical to both the costrecovery and the installment method.

$50,000 2.

REQUIRED: the method of recognizing profit. DISCUSSION: (B) Revenue is to be recognized when it is realized or realizable and earned. If no reasonable basis exists for estimating the degree of collectibility of assts to be received for products, services, or other assets, revenues and gains may be recognized on the basis of cash received. Thus, the installment method or the cost recovery method may be used (APB 10). Answers (A), (C), and (D) are incorrect because they are not acceptable methods for recognizing profit when the collection of cash is in doubt.

3.

REQUIRED: The use of the installment method. DISCUSSION: APB 10, Omnibus Opinion – 1966, reaffirms that profits from sales in the ordinary course of business should usually be recognized at the time of sale unless collection of the sales price is not reasonably assured. When receivables are collected over an extended period and, because of the terms of the transaction or other conditions, no reasonable basis exists for estimating the degree of collectibility, the installment method or the cost-recovery method of accounting may be used. Answers (A) and (B) are incorrect because, regardless of the length of the collection period, sales in the ordinary course of business should usually be recognized at the time of sale unless collectibility is not reasonably assured. Answer (D) is incorrect because the installment method, which is ordinarily used to account for long-term construction contracts.

4.

Answer (C) is correct. The accounting treatment of installment sales recognizes gross profit as cash is received. Gross profit is deferred at the time of sale and recognized as income in the accounting periods in which cash is received. Thus, the accountant must know the amount of gross profit to be deferred, the cash collected each year, and perhaps the costs associated with default and repossession. When goods are repossessed, they are returned to inventory at net realizable value (selling price - costs of completion, reconditioning, and selling) minus normal profit. The interest costs on the funds tied up in receivables are also a consideration. However, no operating costs are deferred as a result of installment sales. Answer (A) is incorrect because the amount of gross profit to be deferred must be known to allocate it over future periods. Answer (B) is incorrect because the amount of cash collected each year is used to allocate gross profit to the proper periods. Answer (D) is incorrect because default and repossession often occur as a result of installment sales.

5.

Answer (B) is correct. Under the installment method, the gross profit on sales (sales - cost of sales) is not recognized until cash is collected. The proportion of cash collected on the sales

RPCPA 0592

K, W & W

REQUIRED: The method(s), if any, under which cash collection is important for recognizing income. DISCUSSION: (B) When receivables are collected over an extended period and no reasonable basis exists for estimating the degree of collectibility, the installment method or the cost-recovery method of accounting may be used. Under the installment method, gross profit recognized during each period of the term of an installment receivable is equal to the gross profit ratio on the installment sales for the period in which the receivable is recognized multiplied by the amount of cash collected on that receivable during the period. The costrecovery method recognizes profit only after collections exceed the cost of the item sold, that is, when the full cost has been recovered. Subsequent amounts collected are treated entirely as realized gross profit.

during the accounting period determines the proportion of the gross profit on those sales that is recognized during the period. Hence, both sales and cost of sales are deferred. Answer (A) is incorrect because sales and cost of sales are recognized in proportion to cash collections. Answer (C) is incorrect because only the gross profit (sales - cost of sales) is deferred on sales for which cash has not yet been collected. Answer (D) is incorrect because only the gross profit (sales - cost of sales) is deferred on sales for which cash has not yet been collected. 6.

7.

8.

REQUIRED: The balance of an installment note 6 month after sale. DISCUSSION: (C) The balance of an installment note receivable equals the unpaid principal. The difference between the gross receivable and the unpaid principal equals interest. Thus, the balance of the note is equal to the present value of the remaining payments discounted at the contract interest rate. Answers (A) and (B) are incorrect because the balance will be greater than 75% of the price. Because early payments contain a greater interest component than later payments, the sum of the principal components of the first six payments will be less than 25% of the price. Answer (D) is incorrect because the principal balance equals the present value of the remaining payments. REQUIRED: The timing of recognition of gross profit on an installment sale. DISCUSSION: (C) When receivables are collected over an extended period and no reasonable basis exists for estimating the degree of collectibility, the installment method may be used. Under the installment method, gross profit recognized during each period of the term of an installment receivable is equal to the gross profit ratio on the installment sales for the period in which the receivable was recognized, multiplied by the cash collected on that receivable during the period. Hence, gross profit is recognized in proportion to the cash collections received. Answers (A) and (B) are incorrect because gross profit on installment sales should be recognized in proportion to the cash collections received. Answer (D) is incorrect because the cost-recovery method recognizes income after cash collections equal to the cost of sales have been received. REQUIRED: The recorded amount of repossessed assets accounted for by the installment method. DISCUSSION: (C) Repossessed assets returned to inventory should usually be recorded at their net realizable value minus normal profit. Net realizable value is the selling price minus costs of completion, reconditioning, and reselling. Sales profit should be recognized upon resale.

Answer (A) is incorrect because, if repossessed goods are recorded at selling price, a loss would occur upon resale if reconditioning or selling costs were incurred. Answer (B) is incorrect because the installment receivable minus the associated deferred gross profit is usually not equal to the net realizable value of the asset. Answer (C) is incorrect because recording at net realizable value precludes recognition of profit upon resale. 9.

REQUIRED: The best justification for the cost-recovery method. DISCUSSION: (D) APB 10 states that revenues ordinarily should be accounted for when a transaction is completed, with appropriate provision for uncollectible accounts. However, when “there is no reasonable basis for estimating the degree of uncollectibility,” either the installment method or the cost-recovery method may be used. The cost-recovery method recognizes profit only after collections exceed the cost of the item sold. Answer (A) is incorrect because passage of title is not a recognition criterion. Answers (B) and (C) is incorrect because neither a delayed due date nor a high rate of return necessarily indicates that collectibility cannot be reasonably estimated.

10.

Answer (C) is correct. Under the cost-recovery method, no revenue is recognized until cash payments by the buyer exceed the seller's cost of the merchandise sold. This method is appropriate when collection of the revenue is very uncertain. Answer (A) is incorrect because the accrual basis recognizes revenue on the date of the installment sale. Answer (B) is incorrect because the installment basis recognizes revenue in proportion to the cash collections. Answer (D) is incorrect because, after the cash collections equal the cost of sales, revenue is to be recognized for any further collections.

11.

REQUIRED: The item(s) included in a consignor’s inventory costs. DISCUSSION: (C) Inventoriable costs include all costs of making the inventory ready for sale. Costs incurred by a consignor on the transfer of goods to a consignee are costs necessary to make the inventory ready for sale. Consequently, they are inventoriable. Thus, the in-transit insurance premium is inventoried. The advanced commissions constitute a receivable or prepaid expense, not an element of inventory cost. Answer (A) is incorrect because the advanced commissions constitute a receivable, not an element of inventory cost. Answer (B) is incorrect because the in-transit insurance premium is inventoried. Answer (D) is incorrect because the in-transit insurance premium is inventoried, but the advanced commissions constitute a receivable, not an element of inventory cost.

12.

REQUIRED: The basis for recognition of sales revenue and related costs of goods sold for goods on consignment. DISCUSSION: (C) Under a consignment sales arrangement, the consignor ships merchandise to the consignee who acts as agent for the consignor in selling the goods. The

goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignor’s inventory count. Sales revenue and the related cost of goods sold from these consigned goods should be recognized by the consignor only when the merchandise is sold and delivered to the ultimate borrower. Accordingly, recognition occurs when notification is received that the consignee has sold the goods. Answer (A) is incorrect because, at the date of shipment, the goods are still the property of the consignor. Answers (B) and (D) are incorrect because the consignee does not recognize sales revenue or cost of goods sold for these goods. The consignee recognizes commission revenue only when the goods are sold and delivered to the third party. 13.

Answer (D) is correct. Under a consignment sales arrangement, the consignor ships merchandise to the consignee who acts as agent for the consignor in selling the goods. The goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignor's inventory count. Sales revenue and the related cost of goods sold from these consigned goods should only be recognized by the consignor when the merchandise is sold and delivered to the final customer. Accordingly, recognition occurs when notification is received that the consignee has sold the goods. Answer (A) is incorrect because the revenue has not been realized or earned at this time and should not be recognized. Answer (B) is incorrect because the revenue has not been realized or earned at this time and should not be recognized. Answer (C) is incorrect because the revenue has not been realized or earned at this time and should not be recognized.

14.

REQUIRED: The consignee’s classification of freight costs paid by the consignee on behalf of the consignor. DISCUSSION: The consignee should debit consignment-in for the freight costs. Consignment-in is a receivable-payable account used by consignees. It represents the amount payable to the consignor if it has a credit balance. If it has a debit balance, it reflects the amount receivable from the consignor. Before consigned goods are sold, expenditures chargeable to the consignor are recorded in the consignment-in account as receivable. After the consigned goods are sold, the consignee’s net liability to the consignor is reflected in the account. Answers (A), (B), and (C) are incorrect because the freight costs constitute a receivable.

15.

Answer (B) is correct. ABC debits the cash received $43,000 [$50,000 sales - $2,000 advertising - (.10 x $50,000) sales commission]. The advertising and commission expenses are debited for $2,000 and $5,000, respectively. Finally, $50,000 of gross revenue is credited. Answer (A) is incorrect because the freight was paid earlier in the period and would have been recorded then by a credit to cash and a debit to inventory. Thus, the freight costs will be released to income via cost of goods sold. Answer (C) is incorrect because the 10%

commission and the advertising costs are ignored in this answer. Answer (D) is incorrect because the reimbursable advertising costs are ignored in this answer. 16.

REQUIRED: The reporting of deferred gross profit relating to collections beyond that balance sheet date. DISCUSSION: (C) Under the installment method, a credit sale is recorded by debiting a receivable and crediting inventory and deferred gross profit. Revenue is recognized only when cash is collected. Because the essence of an installment sale is an equal change in receivables and inventory, the deferred gross profit account serves to reduce the asset valuation to the unrecovered cost of goods sold. Accordingly, deferred gross profit account serves to reduce the asset valuation to the unrecovered cost of goods sold. Accordingly, deferred gross profit functions as an asset valuation (contra account). The installment receivables (and related valuation accounts) should be classified in the current asset section of the balance sheet if they are collectible within the operating cycle. All of Deb Co.’s installment contracts are for 36 months. They are apparently related to normal operations and should be classified as current. Answers (A) and (B) are incorrect because deferred gross profit is not a liability. It does not entail a probable future sacrifice of economic benefits. Answer (D) is incorrect because the installment receivables are current assets.