Installment Method of Revenue

Recognition

Installment method is a method of revenue

recognition in which gross profit is deferred until
cash from the sale is received. Unlike the cost
recovery method, which defers the profit till the
cash collections exceeds the costs; installment
method recognizes proportionate profit at
receipt of each installment.

Installment method is a conservative method of

revenue recognition. It is only applied in
situations, for example in real estate, when the
risks and rewards are not completely transferred
at the time of sale. It differs from cost recovery
method because in installment method there is
less doubt about collectability of the
installments.

Journal entries
Accounting for installment sales include the
following steps:
 At the time of sale, recognize the revenue and
related cost of goods sold.
 Defer the gross profit on the sale.
 At the end of each period, make a journal entry
to recognize profit equal to the product of the
gross profit rate on the installment sale and the
actual cash collection.

The journal entries are illustrated in the

following example.

Example
You work as an accounting analyst at Goldberg,
LLC. On 1 January 2012, your company sold
some real estate costing $120,000 for
$200,000. After reviewing the terms of the sale,
the CFO concluded that the company would
recognize the revenue using installment sales
method. He asked you to post the journal
entries required at the time of sale.

Just to help you understand the subsequent

accounting treatment of the sale, he asked you
to write down the journal entries you will make
if you receive an installment of $50,000 in 2012
and $70,000 in 2013.
Solution

Following journal entries are required at the

time of sale.
Installment receivables $200,000
Installment sales $200,000
Cost of goods sold $120,000
Inventory $120,000

The related revenue is deferred as follows.

Installment sales $200,000
Cost of goods sold $120,000
Deferred gross profit $80,000

Deferred gross profit is a contra-account to

installment receivables, i.e. it is subtracted from
installment receivables.

The amount of revenue recognized at the

receipt of each installment equals the product of
the gross profit rate on the installment sale and
the amount of installment received.
$200,000 - $120,000
Gross Profit on Sale = = 40%
$200,000

The collections are accounted for as follows.

2012
Cash $50,000
Installment receivables $50,000
2013
Cash $70,000
Installment receivables $70,000

Following adjusting journal entries are needed

to recognize the deferred revenue.

2012
Deferred gross profit $20,000
Gross profit on installment sales $20,000

Where, $20,000 = 40% × $50,000.

2013
Deferred gross profit $28,000
Gross profit on installment sales $28,000

Where, $28,000 = 40% × $70,000.