Installment Sales and Percentage of Completion

[MT327]

Can someone help me understand the difference
Particularly installment sales method. Every time I think I understand it, I come across it on a practice test and F— it up

 

[abomnia]

Installment is based on payments recieved from what I can tell. And you can’t record any gross profit until you capture all your costs first. Percent of complete lets you capture each percentage of Gross profit from what I remember

 

[BlueCollarHero]

abomnia, your explanation of installment sales is actually the cost recovery method, where you don’t recognize any profit until the cost of your widget had been recovered.
In the installment sales method, if you profit is 1%, for every $100 in installments you receive, you book $1 of profit. Hope that helps. Installment sales is not much different than the percentage of completion method conceptually. In % of completion, you can book the profit once the cost has been incurred even though you have not received payment. In installment sales, you have to have sold the product and must wait for the payments to book profit.

 

[zenji]

When do you use the installment sales method? I know we use the cost recovery when cash collectability is highly uncertain. and we use the % of completion when cost/profit estimation is reliable. but how to differentiate between installment sales and completed project method?

 

[BlueCollarHero]

installment sales is used if collectibility is uncertain…..and it is related to installment sales…
difference betwen completed contract and installment is that…in installment you know your cost…and have made the sale…just don’t know how likely is the payment….completed contract is when you don’t know the cost/profit..payment is never the issue…

 

[supersharpshooter]

here is the gist of it (copied verbatim from http://www.utdallas.edu/~sxd017210/Lecture Ch18.ppt)
Percentage-of-Completion Method recognizes revenues, costs and profit as progress is made toward completion on a long term contract.
—Appropriate when:
— Contract specifies the amount of consideration to be exchanged and the terms of settlement.
— Buyer is expected to satisfy the obligation.
— Contractor can perform according to the terms of the long term contract.
Accounting presentation:
Current period revenue = (% complete x Total revenue from contract) – Total revenue recognized in prior periods
% Complete= (total costs to date) / (Most recent estimate of total project costs)
New Accounts:
— Construction in progress inventory – asset account, costs of construction are held in inventory (for % complete method, CIP inventory is carried at cost + realized GM)
— Billings on Contract- contra-asset account (contra to CIP inventory –to avoid overstating the contractor’s interest in the project)
Balance Sheet reporting:
— Construction in process in excess of Billings is reported as a current asset.
— Billings in excess of construction costs is reported as a current liability.
————-
Completed Contract Method
For profitable contracts:
— Revenue and Expense recognition is deferred until the contract is complete.
— No adjustments are made at year end for revenue and expense recognition while the contract is ongoing.
— All contract revenues and expenses are recognized in the year the contract is completed.
In the case of an unprofitable contract:
— Recognize the expected contract loss in the period in which the loss becomes known.
— Debit loss on contract for the amount of the expected loss with a credit to CIP inventory.
———-
Installment Sales Method
— Sale and cost of sale recorded as usual.
— Compute gross margin rate on the installment sales.
— Recognize gross margin as cash is received.
— Gross margin not realized is deferred until a future period.
Accounting presentation:
— Deferred Gross Margin (DGM) – a contra account to installment sales A/R. This reduces the A/R to a net amount that represents the cost of inventory yet to be recovered
— Realized Gross Margin – an income statement account (temporary account).
———
Cost Recovery Method
— Like the installment sales method, cost recovery is used when we are highly uncertain about the collectibility of the sales revenue.
— The cost recovery method is more conservative than the installment sales method
— No profit is recognized until cost of item sold is fully recovered.