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The installment sales method is one of several approaches used to recognize revenue under the US GAAP, specifically when revenue and expense are recognized at the time of cash collection rather than at the time of sale. [1] Under the US GAAP, it is the principal method of revenue recognition when the recognition occurs subsequently to the sale. [2]
The installment sales method, is used to recognize revenue after the sale has occurred and when sales are stipulated under very extended cash collection terms. [3] In general, when the risk of not being able to collect is reasonably high and when there is no reasonable basis for estimating the proportion of installment accounts, revenue recognition is deferred, and the installment sales method is used. The installment sales method is typically used to account for sales of consumer durables, retail land sales, and retirement property. [3] Under the cost recovery method, another method to recognize income after the sale is made, no profit is recognized until all the costs are recovered. [4]
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: [5]
Below is an example of calculation of installment sales for years 2009 and 2010. [5]
| 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 |
The income recognized in 2009 equals cash collections in 2009 multiplied by the gross profit percentage in 2009 and is calculated as follows:
Such income is shown on the 2009 income statement as 2009 income from installment sales.
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:
The deferred gross profit is thus deferred and recognized in income in subsequent periods, i.e. when the installment receivables are collected in cash.
| 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. [6]
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. [6]
Under the GAAP, the interest component of the periodic 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. [7]
Cash method – The cash method requires that an amount be included in gross income when it is actually or constructively received. The installment method allows greater deferral when the payment is received in the form of a negotiable note. The cash method does not allow for differing between cost recovery and gain.
Accrual method – The accrual method requires income to be recognized as soon as the taxpayer has a right to the income regardless of when the payment is actually received. As such, the taxpayer would have to recognize the full amount of the sale despite the fact that the purchase price may not be paid in full for years.
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive revenue from interest, royalties, or other fees. "Revenue" may refer to income in general, or it may refer to the amount, in a monetary unit, earned during a period of time, as in "Last year, Company X had revenue of $42 million". Profits or net income generally imply total revenue minus total expenses in a given period. In accounting, in the balance statement, revenue is a subsection of the Equity section and revenue increases equity, it is often referred to as the "top line" due to its position on the income statement at the very top. This is to be contrasted with the "bottom line" which denotes net income.
In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in accounting statements of the original cost of the assets to periods in which the assets are used.
Tax deduction is a reduction of income that is able to be taxed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. The difference between deductions, exemptions, and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.
An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period.
Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.
In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 is the International Accounting Standard that deals with cash flow statements.
In business and accounting, net income is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, and taxes for an accounting period.
Bad debt, occasionally called uncollectible accounts expense, is a monetary amount owed to a creditor that is unlikely to be paid and for which the creditor is not willing to take action to collect for various reasons, often due to the debtor not having the money to pay, for example due to a company going into liquidation or insolvency. There are various technical definitions of what constitutes a bad debt, depending on accounting conventions, regulatory treatment and the institution provisioning. In the USA, bank loans with more than ninety days' arrears become "problem loans". Accounting sources advise that the full amount of a bad debt be written off to the profit and loss account or a provision for bad debts as soon as it is foreseen.
A deferral, in accrual accounting, is any account where the income or expense is not recognised until a future date, e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual.
A chart of accounts (COA) is a list of financial accounts set up, usually by an accountant, for an organization, and available for use by the bookkeeper for recording transactions in the organization's general ledger. Accounts may be added to the chart of accounts as needed; they would not generally be removed, especially if any transaction had been posted to the account or if there is a non-zero balance.
The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.
In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. By recognizing costs in the period they are incurred, a business can see how much money was spent to generate revenue, reducing "noise" from timing mismatch between when costs are incurred and when revenue is realized. Conversely, cash basis accounting calls for the recognition of an expense when the cash is paid, regardless of when the expense was actually incurred.
For households and individuals, gross income is the sum of all wages, salaries, profits, interest payments, rents, and other forms of earnings, before any deductions or taxes. It is opposed to net income, defined as the gross income minus taxes and other deductions.
Accounting for leases in the United States is regulated by the Financial Accounting Standards Board (FASB) by the Financial Accounting Standards Number 13, now known as Accounting Standards Codification Topic 840. These standards were effective as of January 1, 1977. The FASB completed in February 2016 a revision of the lease accounting standard, referred to as ASC 842.
A company's tax expense, or tax charge, is the income before tax multiplied by the appropriate tax rate. Generally, companies report income before tax to their shareholder under generally accepted accounting principles (GAAP). However, companies report income before tax to their government under tax law.
Financial statement analysis is the process of reviewing and analyzing a company's financial statements to make better economic decisions to earn income in future. These statements include the income statement, balance sheet, statement of cash flows, notes to accounts and a statement of changes in equity. Financial statement analysis is a method or process involving specific techniques for evaluating risks, performance, financial health, and future prospects of an organization.
In United States income tax law, an installment sale is generally a "disposition of property where at least 1 loan payment is to be received after the close of the taxable year in which the disposition occurs." The term "installment sale" does not include, however, a "dealer disposition" or, generally, a sale of inventory. The installment method of accounting provides an exception to the general principles of income recognition by allowing a taxpayer to defer the inclusion of income of amounts that are to be received from the disposition of certain types of property until payment in cash or cash equivalents is received. The installment method defers the recognition of income when compared with both the cash and accrual methods of accounting. Under the cash method, the taxpayer would recognize the income when it is received, including the entire sum paid in the form of a negotiable note. The deferral advantages of the installment method are the most pronounced when comparing to the accrual method, under which a taxpayer must recognize income as soon as he or she has a right to the income.
Warren Jones Company v. Commissioner of Internal Revenue, 524 F.2d 788 was a taxation decision by the United States Court of Appeals for the Ninth Circuit.
Percentage of completion (PoC) is an accounting method of work-in-progress evaluation, for recording long-term contracts. GAAP allows another method of revenue recognition for long-term construction contracts, the completed-contract method.
A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.
