INSTALLMENT SALES
Accounting Theory
In a regular credit sale the collection period is a short period of time and title passes to the buyer at the time of
the sale. In an installment sale the credit arrangement provides for a schedule of payments over a long period of
time and title remains conditional until the debt is paid in full. There may be a down payment. Installment sales
arise from the sale of real estate, merchandise and other personal property.
The long collection period increases the credit risk to the seller so installment agreements contain some form of
title retention by the seller. These can include the following:
Conditional Sales Contracts
The seller retains legal title of the property until the installment collections are received in full.
Hire-Purchase Contracts
The seller leases the property until the final installment (rental) payment is received at which time title is
conveyed for some nominal consideration.
Custodial Arrangements
Legal title to the property is held by a third party trustee until all installment collections are received in
full. This arrangement primarily applies to sales of real estate.
Mortgage or Lien Arrangements
Title passes to the buyer with these agreements; however, the seller can reclaim possession of the property if the
buyer defaults.
Revenue Recognition Principle
Installment sales are concerned with the revenue recognition principle. Revenue is recorded at the time legal
title passes to the buyer. The distinction between a regular sale and an installment sale is the time of legal title
passage and the long collection period. With a sale, legal title passes to the buyer upon the delivery of the goods.
With an installment sale, custody of the property changes, but legal title remains with the seller until the
installment collections are received in full.
A sale should be recorded and profit realized when the sale in the ordinary course of business is transacted
unless the circumstances are such that the collection of the sales amount is not reasonably assured.
Exception Principle
Where receivables are collectible over a long period of time, and, because of the terms of the sale or other
conditions, there is no reasonable basis for determining the assurance of collection, the installment
sales method of accounting may be used.
Matching Principle
Revenue should be recorded when a sales transaction is completed. Also accrual of costs expected to be incurred
and estimated credit losses from such sales should be recorded. The long collection period causes difficulty in
estimating the future costs and credit losses. The installment sales method allows a better matching of revenue
and these expenses. However, the matching process does not extend to other operating expenses such as selling
and administrative costs. Again the exception principle in terms of materiality and conservatism.
Installment Sales Method
Each installment collection is a partial recovery of cost and a partial realization of gross profit in relation to the
percentage that each is to the sales price. Revenue reported as realized gross profit is recorded at the time of
collection, not at the time of the sale.
INSTALLMENT SALES
Bad Debt Losses
An allowance for estimated bad debt losses should, if possible, be recorded in the period of the sale. If the
installment sale receivable becomes uncollectible any additional loss should be recorded in the same manner
that is used for other credit sales. If the value of the property is less than the unrecovered cost and the
realized gross profit an additional loss will have to be recorded. For example:
Equipment for $20,000 was sold with collections to be $4,000 a year for five years. The cost of the
equipment is $15,000 resulting in total gross profit of $5,000. The cost percentage is 75% ($15,000 /
$20,000) and the gross profit percentage is 25% ($5,000 / $20,000). The buyer defaulted after making one
payment. Value of the equipment at the time of default is $7,500. The loss is calculated as follows:
Value of the equipment $7,500
Calculation of Unrecovered Cost
Original Cost $15,000
Payment received $4,000
Cost percentage .75
Recovered cost 3,000
Unrecovered cost $12,000
Calculation of Realized Gross Profit
Payment received $4,000
Gross profit percentage .25
Realized gross profit 1,000
Net investment $13,000
Net value deficiency $5,500
Less cash received in realized gross profit 1,000
Additional Loss $4,500
Accounting Year of Default
Installment sale receivable $16,000
Less deferred gross profit (4,000)
Unrecovered cost $12,000
Less value of the equipment 7,500
Loss current year $4,500
Less realized gross profit prior year (1,000)
Net Loss $3,500
Calculation of Net Loss
Cost $15,000
Less cash received 4,000
Less value of the equipment 7,500
Net Loss $3,500
INSTALLMENT SALES
Defaults and Repossessions
The seller can repossess the property to satisfy the balance owed on installment receivables. When property
is repossessed it is recorded in repossessed merchandise inventory account at its market value at date of
repossession.
The uncollected receivable balance and the deferred gross profit are removed from the accounts. The net of
those two amounts is the unrecovered cost. The market value of the property minus the unrecovered cost is
the resulting gain or loss on repossession.
The property may be in need of repairs and other restoration costs. Costs of repairs and restoration of the
repossessed property are recorded in repossessed merchandise inventory account. Resale of the repossessed
property should be accounted for in the same manner as regular sale transactions.
Repossessed Merchandise Reporting
Repossessed merchandise inventory is reported on the balance sheet as a current asset. Gain or loss on
repossession is reported on the income statement. If a provision had been made for losses on doubtful
accounts the loss on repossession should be charged to allowance for doubtful accounts.
Interest on Installment Receivables
When interest is charged on the installment sale receivables each collection consists of a reduction in
principal and interest income. The installment payments can be a fixed amount each period and amortized
on a direct reduction basis. The installment payments can also decrease over future periods when interest is
charged on the beginning receivable balance whereby there is a constant reduction of principal in each
successive period. The principal payment remains fixed over the installment period while the interest
payments decrease.
Installment Sale of Merchandise
In the chart of accounts separate accounts should be set up to distinguish installment sales of merchandise.
Accounts receivable, sales and cost of sales should be designated as either regular sales or installment sales.
This is especially important when journal entries are made at the end of the year reclassifying the
installment sales from sales and cost of sales accounts to deferred gross profit on installment sale accounts.
Installment accounts receivable and deferred gross profit on installment sales should include in the account
title the year of the sale. Gross profit should be recorded as recognized each period based on the current
collections of the installment accounts receivable.
Balance Sheet Reporting
Installment accounts receivable from the sale of merchandise are classified as current assets. Regular
accounts receivable are reported with regular accounts receivable allowance for doubtful
accounts. Installment accounts receivable follow the regular accounts receivable and are reported for each
year of installment sales. An allowance for installment accounts receivable should be reported with the
installment accounts receivable.
Even though the installment sales have a long collection period the installment accounts receivable are
classified as current assets because they meet the definition of current assets. Current assets are those
which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle
of business. Installment transactions generate an operating cycle which includes collection of the accounts
even if the collection period is longer than one year. This operating cycle concept applies only to normal
business operations. An installment sale transaction that is unrelated to the normal business operations
should be reported in the other assets section of the balance sheet. An example would be an infrequent sale
of real estate or fixed asset.
INSTALLMENT SALES
Installment deferred gross profit on installment sales from the sale of merchandise are classified as current
liabilities. They should be reported under the heading deferred revenues for each year of installment sales.
The normal business operating cycle concept provides the basis for classification as a current liability.
Installment transactions generate an operating cycle which includes recognizing the profit even if the
collection period is longer than one year. This operating cycle concept applies only to normal business
operations. An installment sale transaction that is unrelated to the normal business operations should be
reported in the other liabilities section of the balance sheet. An example would be an infrequent sale of real
estate or fixed asset.
Income Statement Reporting
If installment sales are not material in terms of total sales the realized gross profit on installment sales can
be reported after gross profit on regular sales. Total gross profit on regular sales and installment sales is
then reported.
If installment sales are material in terms of total sales the income statement should include separate
columns, one for regular sales and one for installment sales. The total of installment sales and cost of
installment sales is reported on the accrual basis as if the installment sales were regular sales. The income
statement would report accrual basis gross profit for both regular sales and installment sales. After the total
gross profit in the installment sales column, adjustments would be reported to remove the gross profit on
current year installment sales that are deferred to future years and to add the gross profit on prior year
installment sales that are realized in the current year.
Small Business is the Engine that Drives our Economy. The Men and Women who Work to make our Country Great
Should be Recognized for their Achievement and Courage in Very Difficult Economic Times.