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Q. Instalments basis of revenue recognition?
When accumulating the selling price of goods sold in monthly or annual instalments and considerable doubt exists as to collectability the company may use the instalment basis of accounting. Companies compose these sales in spite of the doubtful collectability of the account because their margin of profit is high and the goods can be repossessed if the payments are not received. Under the instalment basis the percentage of total gross margin selling price of a good minus its cost recognized in a period is equal to the percentage of total cash from a sale that is received in that period. Therefore the gross margin recognized in a period is equal to the cash received times the gross margin percentage gross margin divided by selling price. The formula to recognize gross profit on cash collections made on instalment sales of a certain year is
To exemplify assume a company sold a stereo set. The actualities of the sale are
The buyer makes 10 equivalent monthly instalment payments of USD 50 to pay for the set (10 X USD 50 = USD 500). If the company collects three monthly payments in 2010 the total amount of cash received in 2010 is USD 150 (3 X USD 50). The gross margin to make out in 2010 is
The company collects the other instalments when due thus it receives a total of USD 350 in 2011 from 2010 instalment sales. The gross margin to identify in 2011 on these cash collections is as follows
For the reason that the instalment basis delays some revenue recognition beyond the time of sale it is acceptable for accounting purposes only when considerable doubt exists as to collectability of the instalments.
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