[Jasminekoko]

Hello,

I am working on Kieso on CPAExcel and came across this question which I have no idea why 28% is the correct answer. Please share some ideas. Thank you.

Asp Co. appropriately uses the installment method of revenue recognition to account for its credit sales. The following information was abstracted from Asp’s December 31, year 2, financial statement:

Sales Yr 2: $1,500,000 Yr 1: $1,000,000

Accounts receivable:

Year 2 sales 900,000: yr 2

Year 1 sales 540,000: yr 2 600,000: yr 1

Deferred gross profit:

Year 2 sales 252,000: yr 2

Year 1 sales 108,000: yr 2 120,000: yr 1

What was Asp’s gross profit percentage for year 2 sales?

20%

25%

28%

40%

This answer is correct. The installment method recognizes revenue as cash is collected. In year 2, accrual basis sales were $1,500,000. The balance in accounts receivable attributable to the year 2 sales was $900,000, which indicates that revenue recognized under the installment method would be $600,000 ($1,500,000 – $900,000). The gross profit percentage can be calculated by examining the relationship between the deferred gross profit of $252,000 for the year 2 sales, and the year 2 sales, which have not yet been collected. Therefore, this answer is correct because the gross profit percentage for year 2 sales is calculated as $252,000/$900,000 = 28%.

[Determined CPA]

I think you need to start with learning the formulas that go with installment sales, which is do-able bc there are only 4!!

1. Gross profit = Sales – Cost of goods sold

2. Gross profit % = gross profit (calc in #1) divided by sales

3. Earned gross profit = gross profit % (calc in #2) times collections (which isn't always obvious, sometimes you will need to take sales and back out accounts receivable and write offs to determine what has already been collected)

4. Deferred gross profit = gross profit % times accounts receivable

If you can remember those 4 formulas, you can answer any variation of an installment sale question.

In this particular question, it's asking for gross profit percentage on year 2 sales. I immediately know to ignore year 1!

This question also gives you accounts receivable.

So,

gross profit % times A/R = deferred gross profit

X times 900,000 – 252,000 (these are the year 2 amounts!)

Solve for X

252,000/900,000=.28

A - 75
B - 78 God is good.
F - 77 Answered prayers.
R - 84! Done!!

Paperwork sent - waiting for license!!
Still on a cloud and in shock. Through God, all things will happen.

[Jasminekoko]

But there are 2 receivables in yr 2, 1 is 900,000 and 1 is 540,000, and 2 deferred GP in yr 2 as well. What got me are those. Please explain. Thank you.

[Jasminekoko]

Thank you for your formulas. Appreciate it.

[Author]

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