Calculation Under The Installment Sales Method
The installment sales method recognizes revenue and income proportionately as cash is collected. The amount recognized in any period is thus based on two factors:
- The gross profit percentage:
- The amount of cash collected on installment accounts receivable.
Below is an example of calculation of installment sales for years 2009 and 2010.
| 2009 | 2010 | |
|---|---|---|
| Installment sales | $1,200,000 | $1,300,000 |
| Cost on installment goods sold | $840,000 | $884,000 |
| Gross profit | $360,000 | $416,000 |
| Gross profit percentage | 30% | 32% |
| Cash collections | ||
| On 2009 installment sales | $300,000 | $600,000 |
| On 2010 installments sales | $340,000 |
- 2009 income from installment sales calculation:
The income recognized in 2009 equals cash collections in 2009 multiplied by the gross profit percentage in 2009 and is calculated as follows:
- $300,000×30% = $90,000
Such income is shown on the 2009 income statement as 2009 income from installment sales.
- 2009 Deferred Gross Profit calculation:
The deferred gross profit is an A/R contra-account and is the difference between gross profit and recognized income and is calculated as follows:
- $360,000 − $90,000 = $270,000
The deferred gross profit is thus deferred and recognized in income in subsequent periods, i.e. when the installment receivables are collected in cash.
- 2010 income from installment sales is $288,800 and calculated as follows:
| Total 2010 installment sales income | |
|---|---|
| Gross profit recognized | |
| Component relating to 2009 Sales | |
| Cash collections in 2010 from 2009 sales | $600,000 |
| Multiplied by year 2009 gross profit percentage | 30% |
| $180,000 | |
| Component relating to 2010 sales | |
| Cash collections in 2010 from 2010 sales | $340,000 |
| Multiplied by year 2010 gross profit percentage | 32% |
| $108,800 | |
| Total installment sales income recognized in 2010 | $288,800 |
A more comprehensive table would clearly show gross profit and deferred income recognized for each year: 2009 and 2010.
| 2009 | 2010 | |
|---|---|---|
| Installment sales | $1,200,000 | $1,300,000 |
| Cost of installment goods sold | ($840,000) | (884,000) |
| Gross profit | 360,000 | 416,000 |
| Less: Deferred gross profit on installment sales of current year | (270,000) | (307,200) |
| Gross profit recognized on current year's sales | 90,000 | 108,800 |
| Plus: Gross profit recognized on installment sales of prior years | 180,000 | |
| Total gross profit recognized in the year | $90,000 | $288,800 |
Installment sales and the related costs of good sold must be tracked by individual year in order to compute the gross profit percentage that applies to each year. Furthermore, the accounting system must correctly match the cash collections with the specific sales year so that the correct gross profit percentage be applied.
On the balance sheet, "the accounts receivable - installment sales" is classified as current assets if it is due within 12 months of the balance sheet. Otherwise, it is classified as long term assets.
Under the GAAP, the interest component of the priodic cash proceeds is computed separately. In fact, interest payments are not considered when the recognized gross profit is computed on installment sales. Certain procedures differentiate between principal and interest payments on customer receivables.
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