[Anonymous]

Hi all – I am new here, so please forgive (and let me know) if I unintentionally violated some rules.

Is the practice question from Wiley wrong that the balance is not net of deferred gross profit?

Practice question from Wiley:

Taft Corp., which began business on January 1, year 1, appropriately uses the installment sales method of accounting. The following data are available for December 31, year 1 and year 2.

Balance of deferred gross profit on sales account

Year 1 Year 2

Year 1 $300,000 $120,000

Year 2 – 440,000

Gross profit on sales 30% 40%

The installment accounts receivable balance at December 31, year 2, is $1,500,000

Explanation:

When using the installment sales method, the balance of the deferred gross profit account represents the gross profit not yet recognized because the related receivable has not yet been collected. The formula below expresses this relationship.

Deferred GP = GP rate × Accounts Receivable

This equation can be rearranged as follows:

Deferred GP / GP rate = Accounts Receivable

Therefore, the installment accounts receivable balance at 12/31/Y2 can be computed as follows:

From year 1 sales: $120,000 / 30% = $ 400,000

From year 2 sales: $440,000 / 40% = 1,100,000

Total $1,500,000

From Becker’s textbook, Accounts Receivable – deferred gross profit (contra asset account) = balance

So for Wiley’s question, shouldn’t the answer be 1,500,000 – 120,000 – 440,000?

Am I overthinking this problem?

Thank you so much for your help!!!

[spatel15]

I'm not totally sure where the numbers go and I haven't given the explanation a read through, but A/R – Deferred GP = COGS at Time 0. I don't know if that helps… but I don't believe A/R is ever net of Deferred GP?

EDIT: Pretty sure the only contra-account to A/R is an allowance for Bad Debt; and that requires I believe an “estimable” amount whereas installment sales are usually based on the fact that you have neither estimate nor reasonable basis that sales can/will be recognized/realized, so you record profit upon collection.

[Anonymous]

But I took this formula right from Becker's FAR study guide?

Accounts Receivable – deferred gross profit (contra asset account) = balance

[spatel15]

Hmm, you are right; deferred GP does seem to be a contra-A/R account, but I think they'll probably mention “net A/R” or something around those lines. Also, they may make the assumption that since you have balances for deferred GP, it's talking about the gross A/R as well? You are right though, but I don't think they would provide both answers,(gross and net) and expect you to choose…or at least I hope.

[Anonymous]

I would focus on the formula on page 33, not the one on page 34.

Deferred gross profit = Installment receivable X Gross profit percentage

Rearranging that formula to solve for the receivable:

Installment receivable = Deferred gross profit / Gross profit percentage — which is what they have in their answer.

I'm not sure how to interpret the formula on page 34 (AR – Def. GP = Balance). They say it's “to determine balance sheet presentation,” so I think the balance there is total assets, not AR. I don't see how deferred gross profit is contra to AR, because it doesn't reduce collectibility or value of AR.

[Author]

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