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Revenue recognition:
Installment sales
On August 1, Year 1, Parker
Company sells inventory costing
\$240,120 for \$828,000. The sales
will pay \$144,000 down and 19
equal monthlyinstallment
payments, with the first payment
beginning on September 1, Year 1.
Required:
Compute the amount of gross
profit to be recognized for each of
the three years.
Note: Assume that since collection
is not assured (significant
uncertainty), the company has
decided to use the installment
sales method of recognizing
revenue.

Click on the following for more
information:
"Assured Collection (Collectibility)".

In this problem, the collection is not assured. Therefore, the installment sales
method of revenue recognition must be used to compute the amount of gross
profit recognized each year. This method dictates that gross profit will be
recognized as cash is received, not necessarily at the time of sale.
There are three steps to answering the question for each year. First, compute
the gross profit percentage. Second, compute the amount of cash received
each year. Third, compute the amount of gross profit to be recognized each
year.
Step 1:
To compute the gross profit percentage, the gross profit must be calculated.
The gross profit is the difference between the sales and thecost of goods sold.
Therefore,
Gross profit = \$828,000 - \$240,120

= \$587,880
To compute the gross profit percentage, divide the gross profit by the sales
amount. Therefore,
Gross profit percentage =
\$587,880
\$828,000

= 71%
As Parker Company collects cash from this transaction, the gross profit will be
recognized. To calculate the amount of gross profit to be recognized, the
amount of cash to be received each year must be calculated.
Step 2:
Compute the amount of cash received each year.
First, the monthly payments to be received must be computed. As stated in
the problem, the amount of the sale is \$828,000 with a down payment of
\$144,000.
The amount to be paid in equal amounts over the next 19 months equals the
sales price minus the down payment. Therefore,
Amount to be paid = \$828,000 - \$144,000

= \$684,000
Since \$684,000 is to be paid in equal amounts over the next 19 months,
dividing \$684,000 by 19 months will yield the monthly payment:
Monthly payment =
\$684,000
19

= \$36,000
Note: These 19 monthly payments will be received as follows:
Step 3:
Year 1:
The sale occurred on August 1. The first of the monthly payments
began in September. So, as detailed above, not including the down
payment, there were 4 payments made in Year 1.
year 1
= Down payment + Total monthly payment
in year 1

= \$144,000 + (4 \$36,000)

= \$288,000
To compute the amount of gross profit recognized, multiply the cash
received by the gross profit percentage.
Gross profit
recognized in year 1
in year 1
Gross profit
percentage

= \$288,000 71%

= \$204,480
Year 2:
There are 12 monthly payments received in Year 2.
Total cash received in year 2 = 12 months \$36,000

= \$432,000
Gross profit recognized in
year 2
= Cash

Gross profit
percentage

= \$432,000 71%

= \$306,720
Year 3:
In the final year, there will be 3 payments remaining (19 - 4 - 12).
Total cash received in year 3 = 3 months \$36,000

= \$108,000
Gross profit recognized in
year 3
percentage

= \$108,000 71%

= \$76,680