Flashcards in Installment Sales & Cost Recovery Method Deck (7)
What is the installment method of profit recognition?
The installment method is used when an item is sold on credit and will be paid over a period of time in the future and the amount that will actually be collected is not certain. Under this method, profit is recognized only when the cash is received from the customer. The installment method is a conservative approach to the recognition of profit when the collectibility of future amounts is uncertain. A receivable is recognized as soon as the sale takes place, but a valuation account is used as well.
How is interest on an installment receivable accounted for?
When interest is charged on the outstanding amount of the receivable, it has no impact on profit recognition. Any interest received is accounted for and recorded separately from the collection of the cash for the sale. Interest received is accounted for as interest revenue.
How does the cost recovery method of profit recognition differ from the installment method?
Like the installment method, all of the profit on the sale is deferred at the time of the sale. However, the cost recovery method is more conservative because the seller recognizes no gross profit until the amount of cash that has been collected exceeds the cost of the sale.
Using the installment sales method, when is gross profit recognized in income?
When cash is received, it is multiplied by the gross profit percentage to arrive at the correct proportion of gross profit to be recognized.
Using the cost recovery method, when is gross profit recognized in income?
After cash collections equal to the cost of sales have been received.
What is the cash collected on an installment sale multiplied by in order to recognize income?
Gross profit percentage