EXERCISE 18-15 (10-15 minutes)

(a)   Realized gross profit recognized in 2005 under the installment method of accounting is $87,375. When gross profit is expressed as a percentage of cost, it must be converted to percentage of sales to compute the realized gross profit under the installment method of accounting. Thus, 2004 and 2005 gross profits as a percentage of sales are 20% and 21.875% respectively.

Sale Year	Gross Profit Percentage	2005                Collections	2002                   Realized Profit
2004	.25/(1.00 + .25) = 20%	$240,000	$48,000
2005	.28/(1.00 + .28) = 21.875%	180,000	39,375
		TOTAL	$87,375

(b)   The balance of “Deferred Gross Profit” could be reported on the balance sheet for 2005:

        (1)   As a current liability on the theory that it is related to Installment Accounts Receivables that are normally treated as current assets;

        (2)   As a deferred credit between liabilities and stockholders’ equity. This treatment is criticized because there is no obligation to out­siders; or

        (3)   As an adjustment or offset to the related Installment Accounts Receivable. This is because the deferred gross profit is a part of revenue from installment sales not yet realized. The related receivable will be overstated unless the deferred gross profit is deducted. On the other hand, the amount of deferred gross profit has no direct relationship with the estimated collectibility of the accounts receivable.

        It is not a settled matter as to the proper classification of “deferred gross profit” on the balance sheet when the installment method of accounting is used to measure income.

(c)   Gross profit as a percent of sales in 2004 is 20% (as computed in (a) above); gross profit therefore is $96,000 ($480,000 X .20) and the cost of 2004 sales is $384,000 ($480,000 – $96,000). Because the amounts collected in 2004 ($140,000) and 2005 ($240,000) do not exceed the total cost of $384,000, no profit is recognized in 2004 or 2005 on 2004 sales. Also, no profit is recognized on 2005 sales since the collections of $180,000 do not exceed the total cost of $484,375.