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Accounting For Installment Sales

Installment sales allow customers to purchase goods and pay over time through regular installments, with the selling price including interest or finance charges. There are two accounting methods: the Accrual Method recognizes revenue at the time of sale, while the Installment Method recognizes revenue as cash is collected, particularly when there is uncertainty in collection. The choice of method depends on the risk level and the company's accounting policies.

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4 views2 pages

Accounting For Installment Sales

Installment sales allow customers to purchase goods and pay over time through regular installments, with the selling price including interest or finance charges. There are two accounting methods: the Accrual Method recognizes revenue at the time of sale, while the Installment Method recognizes revenue as cash is collected, particularly when there is uncertainty in collection. The choice of method depends on the risk level and the company's accounting policies.

Uploaded by

sluggishyomi23
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Accounting for Installment Sales

1. What are Installment Sales


Installment sales happen when a company sells goods but allows the customer to pay over time
through regular installments. The buyer gets the goods at the time of sale, but the full payment is
collected over several months or years.

2. Features of Installment Sales


The selling price includes the cost of the goods plus interest or finance charges. Payments are
made over a period of time. Legal ownership may or may not transfer immediately, but the buyer
takes possession of the goods upon signing the contract.

3. Two Methods of Accounting


There are two common methods used to account for installment sales:

Accrual Method
Revenue and profit are recognized at the time of sale, even if cash is collected over time.

Installment Method
Revenue and profit are recognized only as cash is collected. This method is used when there is
high uncertainty in collection or when the risk of default is high.

4. Journal Entries Under the Accrual Method

At the time of sale on installment:


Debit Installment Accounts Receivable (total selling price)
Credit Sales Revenue (excluding interest)
Credit Unearned Interest Income (finance charge)

To record cost of goods sold:


Debit Cost of Goods Sold
Credit Inventory

When cash is collected:


Debit Cash
Credit Installment Accounts Receivable

To recognize interest income earned:


Debit Unearned Interest Income
Credit Interest Income

5. Journal Entries Under the Installment Method

At the time of sale:


Debit Installment Accounts Receivable
Credit Inventory (at cost)
No revenue or gross profit is recognized yet.

When cash is collected:


Debit Cash
Credit Installment Accounts Receivable

To recognize gross profit:


Multiply the cash collected by the gross profit rate.
Debit Installment Deferred Gross Profit
Credit Realized Gross Profit

6. Gross Profit Rate


The gross profit rate is computed as:
Gross Profit = Selling Price – Cost
Gross Profit Rate = Gross Profit ÷ Selling Price

This rate is used to determine how much profit to recognize each time a cash installment is
received.

7. Repossessions
If the buyer fails to pay and the item is repossessed, the item is recorded at its fair value. Any
difference between the receivable and the fair value is recognized as a loss or gain.

8. Conclusion
Installment sales allow customers to pay over time, and revenue is recognized based on the
chosen method. The accrual method recognizes revenue upfront, while the installment method
spreads revenue over time as cash is collected. The choice of method depends on the level of risk
and the company’s accounting policies.

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