Inventories that are high in value like real estate, car, jewelries and other big ticket items are often settled on a installment method. When there is a high risk of non-payment from buyers due to installment sales, recognizing revenue on an installment basis is allowed.
Installment Sales Method in accounting is deferring recognition of revenue until cash is received from buyer. This is also advantageous for tax purposes, as business owners will only be required to pay taxes based on cash collection from these installment sales.
Journal Entries
Using the Installment Sales Method, we will use Deferred Gross Profit general ledger account at the time of sales.
When cash is collected, create 2 journal entries. One is to record cash, and the other is to recognized gross profit on Sales
In the entry above, Sales is credited for the cash amount collected, while Cost of Sales and Gross Profit is calculated by Gross Profit Rate.
Compute for Gross Profit Rate
For example, in a real estate business where a piece of land was sold for $100,000 and the cost related to the land is $60,000. At the time of Sales a Deferred Gross Profit of $40,000 is recognized. When a collection for the amount of $5000 is made, the gross profit rate will be 40%.
When cash is collected for $5000, the journal entry will be:
