Installment sales method is used and allowed by General Accepted Accounting Principles (GAAP) when receivables are collected over an extended period of time, and when there is no reasonable basis for estimating the degree of collectibility. Revenue shall be recognized at the time of collection and installment sales method allows revenue to deferred and recognized each year in proportion to the receivables collected during that year.
We can determine gross profit rates for prior years and current year, recognition of gross profit, and determining deferred gross profit using the T-Account.
Determining gross profit rates:
Prior year sales: Deferred Gross Profit, beginning of current year / Installment Accounts Receivable, beginning of current year
Current year: Gross Profit / Installment Sales
Realized Gross Profit on installment sales = Collections X Gross Profit Rate or Installment Accounts Receivable (IAR), beginning of the current year less IAR, end of the current year equals Decrease in IAR less Defaults, unpaid balance (if any) equals Collections in current year multiply by Gross Profit Rate.
Deferred Gross Profit, end of the current year = Installment Accounts Receivable, end of the current year X Gross Profit Rate or Deferred Gross Profit before adjustment for RGP Less Realized Gross Profit on Installment Sales
Moreover, you can use the T-Account form in analyzing and solving problems related to Installment Sales in general.
