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Flashcards in Revenue Recognition Deck (11):

Lane Co., which began operations on January 1, 20x5, appropriately uses the installment method of accounting. The following information pertains to Lane's operations for 20x5:
Installment sales $1,000,000
Regular sales 600,000
Cost of installment sales 500,000
Cost of regular sales 300,000
General and administrative expenses 100,000
Collections on installment sales 200,000
The deferred gross profit account in Lane's December 31, 20x5 balance sheet should be

A. $150,000
B. $320,000
C. $400,000
D. $500,000

1. get GPM

Sales = 1
Cost =.5
GMP =.5%

2. Get amount of sales in A.R

3. Deferred GP because it wasn't collected yet
800*.5 GPM = 400$

C. $400,000


During year 1, Fleet Co.'s trademark was licensed to Hitch Corp. for royalties of 10% of net sales of the trademarked items. Returns were estimated to be 1% of gross sales. On signing the licensing agreement, Hitch paid Fleet $75,000 as an advance against future royalty earnings. Gross sales of the trademarked items during the year were $600,000. What amount should Fleet report as royalty income for year 1?
A. $54,000
B. $59,400
C. $60,000
D. $75,000

B. $59,400

Net Sales Rev= 59,400


Asp Co. appropriately uses the installment method of revenue recognition to account for its credit sales. The following information was abstracted from Asp's December 31, year 2, financial statements:

Year 2 Year 1
Sales $1,500,000 $1,000,000
Accounts receivable:
Year 2 sales 900,000
Year 1 sales 540,000 600,000
Deferred gross profit:
Year 2 sales 252,000
Year 1 sales 108,000 120,000
What was Asp's gross profit percentage for Year 2 sales?

A. 20%
B. 25%
C. 28%
D. 40%

The installment method of revenue recognition recognizes deferred gross profit equal to the gross profit percentage multiplied by the related amount of gross accounts receivable. Deferred gross profit is a contra account to accounts receivable which reduces net accounts receivable to its cost equivalent.

With $900,000 of Accounts Receivable remaining on year 2 sales and the related $252,000 Deferred Gross Profit balance, the gross profit percentage is 28% ($252,000/$900,000). Multiplying $900,000 by 28% yields $252,000.

This is the amount of unrecognized (deferred) gross profit in accounts receivable.


Drew Co. produces expensive equipment for sale on installment contracts. When there is doubt about eventual collectibility, the income-recognition method least likely to overstate income is
A. At the time the equipment is completed.
B. The installment method.
C. The cost-recovery method.
D. At the time of delivery.

C. The cost-recovery method.

The cost recovery is the most conservative of the methods listed in the answer alternatives. It recognizes income slower than any other method listed.

This method recognizes no income until the cash collections exceed the cost of the equipment and would tend to overstate income the least. The cost recovery method is more conservative that the installment method, which recognizes profit on each dollar of cash collected.


Bear Co., which began operations on January 2, 20x5, appropriately uses the installment-sales method of accounting. The following information is available for 20x5:
Installment sales $1.4mn

Realized gross profit on installment sales $240,000

Gross profit percentage on sales 40%

For the year ended December 31, 20x5, what amounts should Bear report as accounts receivable and deferred gross profit?

Accounts receivable Deferred gross profit
$600,000 $320,000
$600,000 $360,000
$800,000 $320,000
$800,000 $560,000

$800,000 $320,000

Think about it this way:
What we know:
Sales 1,400,000
GP 560,000 (1.4*.4)

Realized GP $240,000

Need to find out:
Deferred GP: 560,000 GP- RGP 240,000= 320,000 DGP

Now, we know that GP is .4 of sales ( collected or uncollected)
We want to know, now, what is the A.R balance. aka the amount uncollected!

DGP is the GP of the amount uncollected.
SO : 320,000/.4= 800,000


On January 1, 20x5, Rex Co. sold a used machine to Lake, Inc. for $525,000. On this date, the machine had a depreciated cost of $367,500
Lake paid $75,000 cash on January 1, 20x5 and signed a $450,000 note, bearing interest at 10%.
The note was payable in three annual installments of $150,000 beginning January 1, 20x6. Rex appropriately accounted for the sale under the installment method. Lake made a timely payment of the first installment on January 1, 2006 of $195,000, which included interest of $45,000 to date of payment.
At December 31, 20x6, Rex has deferred gross profit of

A. $105,000
B. $99,000
C. $90,000
D. $76,500

The gross profit percentage on the machine is 30% [($525,000 - $367,500)/$525,000]. Total gross profit is $157,500 ($525,000 - $367,500). This amount is deferred until cash is collected.

Under the installment method, 30% of each cash receipt is recognized gross profit. The $150,000 installments must be principal amounts, because they sum to the face value of the note. Interest is paid in addition to the installment amounts. As of December 31, 20x6, only one $150,000 installment was collected.

Total gross profit on sale
Less gross profit recognized on cash collections:
($75,000 + $150,000).30
Equals deferred gross profit at 31 December 20x6


Entor Co. sold equipment to Pane Co. for $50,000. The equipment had a net book amount of $30,000. The collections were $20,000 in the first year, $15,000 in the next year, and $15,000 in the last year. What is the amount of gross profit for the third year if Entor used the installment-sales accounting method for the transaction?
A. $0
B. $5,000
C. $6,000
D. $15,000

C. $6,000
The total gross profit to be recognized is $20,000 ($50,000-$30,000). This is recognized over the length of the transaction at a rate of $20,000/$50,000 = 40%.

The amount collected in year three multiplied by the gross profit rate is $15,000 X 40% = $6,000


UVW Broadcast Co. entered into a contract to exchange unsold advertising time for travel and lodging services with Hotel Co. As of June 30, advertising commercials of $10,000 were used. However, travel and lodging services were not provided.
How should UVW account for advertising in its June 30 financial statements?

A. Revenue and expense are recognized when the agreement is completed.
B. An asset and revenue for $10,000 is recognized.
C. Both the revenue and expense of $10,000 are recognized.
D. Not reported.

B. An asset and revenue for $10,000 is recognized.

UVW has a receivable and revenue for the $10,000 of advertising services provided to date. Without receipt of any travel and lodging services, the firm reports a receivable for the unpaid advertising services. These services will be "paid" in the form of travel and lodging.


On December 31, 20x4, Mill Co. sold construction equipment to Drew, Inc. for $1.8mn.
The equipment had a carrying amount of $1.2mn. Drew paid $300,000 cash on December 31, 20x4 and signed a $1.5mn note bearing interest at 10%, payable in five annual installments of $300,000. Mill appropriately accounts for the sale under the installment method.
On December 31, 20x5, Drew paid $300,000 principal and $150,000 interest.
For the year ended December 31, 20x5, what total amount of revenue should Mill recognize from the construction equipment sale and financing?

A. $250,000
B. $150,000
C. $120,000
D. $100,000

A. $250,000

1. Get G.P Margin


2. Installment payment * GPM % + Interest = Amount of revenue


When would a company use the installment sales method of revenue recognition?

When collectibility of installment accounts receivable is reasonably predictable.

When repossessions of merchandise sold on the installment plan may result in a future gain or loss.

When installment sales are material, and there is no reasonable basis for estimating collectibility.

When collection expenses and bad debts on installment accounts receivable are deemed to be immaterial.

When installment sales are material, and there is no reasonable basis for estimating collectibility.

The installment method of revenue recognition is used when the realizability criterion of revenue recognition is not met. In other words, there is significant uncertainty that the receivable will be collected. Until cash is collected (realizability is therefore assured for the amount collected), no gross profit is recognized. The cost-recovery method, which is even more conservative, may also be used in this situation.


When looking at an installment method problem, what should be your first question. And what are the steps to follow to find the revenue recognition for the period?

1. What is the cost?

Usually, the cost at the moment is the Carrying Value of the asset.

2. Take the revenue-cost/revenue to get the GP percentage.

3. Take the payment made for the equipment (Not interest) and multiply that to the GP%

4. Take the total revenue (included interest) and that is the revenue recognized in the period