Chapter 5, Problem 5.26E

Journal entries; point of delivery, installment sales, and cost recovery methods

[This is a variation of E 5–25 focusing on journal entries.]

On July 1, 2018, the Foster Company sold inventory to the Slate Corporation for $300,000. Terms of the sale called for a down payment of $75,000 and three annual installments of $75,000 due on each July 1, beginning July 1, 2019. Each installment also will include interest on the unpaid balance applying an appropriate interest rate. The inventory cost Foster $120,000. The company uses the perpetual inventory system.

Required:

1. Prepare the necessary journal entries for 2018 and 2019 assuming revenue recognition upon delivery. Ignore interest charges.

2. Repeat requirement 1 applying the installment sales method.

3. Repeat requirement 1 applying the cost recovery method.

To determine

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.

Cost recovery method:

Under the cost recovery method, gross profit is recognized when the cost of the sales is recovered. Where there is an extremely high degree of uncertainty in the installment sales, this method can be used.

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 prepare: The journal entries for 2018 and 2019 assuming revenue recognition upon delivery.

Explanation of Solution

In the year 2018 (Revenue recognition upon delivery)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Installment receivables		$300,000
	Sales revenue			$300,000
	(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
	Cost of goods sold		$120,000
	Inventory			$120,000
	(To record cost of installment sales)

Table (2)

• Cost of goods sold is an expense. There is a decrease in liability value. Therefore, it is debited.
• Inventory is an asset. There is a decrease in assets value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$75,000
	Installment receivables			$75,000
	(To record cash collections from installment sales)

Table (3)

• 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 (Revenue recognition upon delivery)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$75,000
	Installment receivables			$75,000
	(To record cash collections from installment sales)

Table (4)

• 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.

To determine

To prepare: The journal entries for 2018 and 2019 assuming revenue recognized under installment sales method.

Explanation of Solution

In the year 2018 (Installment sales method)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Installment receivables		$300,000
	Inventory			$120,000
	Deferred gross profit			$180,000
	(To record installment sales)

Table (5)

• 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		$75,000
	Installment receivables			$75,000
	(To record cash collections from installment sales)

Table (6)

• 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		$45,000
	Realized gross profit			$45,000
	(To record gross profit recognize from installment sales)

Table (7)

• 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 (Installment sales method)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$75,000
	Installment receivables			$75,000
	(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.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Deferred gross profit		$45,000
	Realized gross profit			$45,000
	(To record gross profit recognize from installment sales)

Table (9)

• 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.

To determine

To prepare: The journal entries for 2018 and 2019 assuming revenue recognized under cost recovery method.

Explanation of Solution

In the year 2018 (Cost recovery method)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Installment receivables		$300,000
	Inventory			$120,000
	Deferred gross profit			$180,000
	(To record installment sales)

Table (10)

• 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		$75,000
	Installment receivables			$75,000
	(To record cash collections from installment sales)

Table (11)

• 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 (Cost recovery method)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$75,000
	Installment receivables			$75,000
	(To record cash collections from installment sales)

Table (12)

• 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		$30,000
	Realized gross profit			$30,000
	(To record gross profit recognize from installment sales)

Table (13)

• 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.