Requirement – 1
The revenue recognition principle
The revenue recognition principle refers to the revenue that should be recognized in the time period, when the performance obligation (sales or services) of the company is completed.
Installment sales method:
Under the installment sales, the revenue and costs are recognized only when the payment of cash is received from customer. Two composed components are involved in the each payment of cash, and components of sales are as follows:
- Partial recovery of the cost from sales
- Component of gross profit
These components are determined by the percentage of gross profit.
Rules of Debit and Credit:
Following rules are followed for debiting and crediting different accounts while they occur in business transactions:
- Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and
stockholders’ equities . - Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.
To calculate: The amount of gross profit that would be recognized in each year from installment sales.
Explanation of Solution
Gross profit in the year 2018:
Here,
Cash collection in 2018 is $120,000
Gross profit is 40% (Refer to equation (1)).
Now, calculate the gross profit:
Hence, the calculated gross profit is $48,000.
Working note:
Calculate the cost of recovery in 2018:
Given,
The cost of sales is $180,000
Sales are $300,000
Now, calculate the cost recovery:
Hence, the calculated cost recovery is 60%, than gross profit ratio is 40%
Gross profit in the year 2019:
Here,
The cash collection form 2018 sales is $100,000,
Cash collection form 2019 sales is $150,000,
Calculated 2018 gross profit is 40% (Refer to equation (1)),
Gross profit is $30% (Refer to equation (2)).
Now, calculate the gross profit:
Hence, the calculated gross profit is $85,000.
Working note:
Calculate the cost of recovery in 2019:
Given,
The cost of sales is $280,000
Sales are $400,000
Now, calculate the cost recovery:
Hence, the calculated cost recovery is 70%, than gross profit ratio is 30%
Requirement – 2
To prepare: All necessary
Requirement – 2
Explanation of Solution
In the year 2018
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Installment receivables | $300,000 | |||
Inventory | $180,000 | |||
Deferred gross profit | $120,000 | |||
(To record installment sales) |
Table (1)
- Installment receivable is a liability. There is a decrease in asset value. Therefore, it is debited.
- Inventory and deferred gross profits are assets. There is a decrease in assets value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Cash | $120,000 | |||
Installment receivables | $120,000 | |||
(To record cash collections from installment sales) |
Table (2)
- Cash is an asset. There is an increase in asset value. Therefore, it is debited.
- Installment receivable is a liability. There is an increase in liability value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Deferred gross profit | $48,000 | |||
Realized gross profit | $48,000 | |||
(To record gross profit recognize from installment sales) |
Table (3)
- Deferred gross profits are assets. There is an increase in assets value. Therefore, it is debited.
- Realized gross profit is a liability. There is an increase in liability value. Therefore, it is credited.
In the year 2019
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Installment receivables | $400,000 | |||
Inventory | $280,000 | |||
Deferred gross profit | $120,000 | |||
(To record installment sales) |
Table (4)
- Installment receivable is a liability. There is a decrease in asset value. Therefore, it is debited.
- Inventory and deferred gross profits are assets. There is a decrease in assets value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Cash | $250,000 | |||
Installment receivables | $250,000 | |||
(To record cash collections from installment sales) |
Table (5)
- Cash is an asset. There is an increase in asset value. Therefore, it is debited.
- Installment receivable is a liability. There is an increase in liability value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Deferred gross profit | $85,000 | |||
Realized gross profit | $85,000 | |||
(To record gross profit recognize from installment sales) |
Table (6)
- Deferred gross profits are assets. There is an increase in assets value. Therefore, it is debited.
- Realized gross profit is a liability. There is an increase in liability value. Therefore, it is credited.
Requirement – 3
To prepare: All necessary journal entries for each year in cost recovery method.
Requirement – 3
Explanation of Solution
In the year 2018
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Installment receivables | $300,000 | |||
Inventory | $180,000 | |||
Deferred gross profit | $120,000 | |||
(To record installment sales) |
Table (7)
- Installment receivable is a liability. There is a decrease in asset value. Therefore, it is debited.
- Inventory and deferred gross profits are assets. There is a decrease in assets value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Cash | $120,000 | |||
Installment receivables | $120,000 | |||
(To record cash collections from installment sales) |
Table (8)
- Cash is an asset. There is an increase in asset value. Therefore, it is debited.
- Installment receivable is a liability. There is an increase in liability value. Therefore, it is credited.
In the year 2019
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Installment receivables | $400,000 | |||
Inventory | $280,000 | |||
Deferred gross profit | $120,000 | |||
(To record installment sales) |
Table (9)
- Installment receivable is a liability. There is a decrease in asset value. Therefore, it is debited.
- Inventory and deferred gross profits are assets. There is a decrease in assets value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Cash | $250,000 | |||
Installment receivables | $250,000 | |||
(To record cash collections from installment sales) |
Table (10)
- Cash is an asset. There is an increase in asset value. Therefore, it is debited.
- Installment receivable is a liability. There is an increase in liability value. Therefore, it is credited.
Date | Account Title and Explanation | Post Ref. | Debit | Credit |
Deferred gross profit (2) | $40,000 | |||
Realized gross profit | $40,000 | |||
(To record gross profit recognize from installment sales) |
Table (11)
- Deferred gross profits are assets. There is an increase in assets value. Therefore, it is debited.
- Realized gross profit is a liability. There is an increase in liability value. Therefore, it is credited.
Working note:
1. Calculate the value of gross profit in 2018:
Given,
Cash collected is $120,000
Cost recovery is $120,000.
Now, calculate the gross profit:
2. Calculate the value of gross profit in 2019:
Given,
Cash collected form 2018 sales is $100,000
Cash collected form 2019 sales is $150,000
Cost recovery form 2018 is $120,000
Cost recovery form 2019 is $120,000
Now, calculate the gross profit:
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Chapter 5 Solutions
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