Chapter 5, Problem 5.17P

Installment sales and cost recovery methods

Mulcahey Builders (MB) remodels office buildings in low-income urban areas that are undergoing economic revitalization. MB typically accepts a 25% down payment when they complete a job and a note that requires that the remainder be paid in three equal installments over the next three years, plus interest. Because of the inherent uncertainty associated with receiving these payments, MB has historically used the cost recovery method to recognize revenue.

As of January 1, 2018, MB’s outstanding gross installment accounts receivable (not net of deferred gross profit) consist of the following:

1. $400,000 due from the Bluebird Motel. MB completed the Bluebird job in 2016, and estimated gross profit on that job is 25%.

2. $150,000 due from the PitStop Gas and MiniMart. MB completed the PitStop job in 2015, and estimated gross profit on that job is 35%.

Dan Mulcahey has been considering switching from the cost recovery method to the installment sales method, because he wants to show the highest possible gross profit in 2018 and he understands that the installment sales method recognizes gross profit sooner than does the cost recovery method.

Required:

1. Calculate how much gross profit is expected to be earned on these jobs in 2018 under the cost recovery method, and how much would be earned if MB instead used the installment sales method. Ignore interest.

2. If Dan is primarily concerned about 2018, do you think he would be happy with a switch to the installment sales method? Explain.