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WHAT IS FRANCHISING it is where a leading , known business entered into agreement in which for fee ONE PARTY (
FRANCHISOR) gives the other party ( FRANCHISEE) the rights to perform certain functions or sell certain products or services of the
franchisor.
A SUBSTANTIAL PERFORMANCE OF THE FRANCHISOR IS THE KEY TO RECOGNITION OF THE INITIAL FRANCHISE FEE. SUBSTANTIAL
PERFORMANCE OF THE FRANSHISOR DENOTES CONSUMMATION OFTHE TRANSACTIONS WHEN:
1. THERE IS NO REMAINING OBLIGATION BY AGREEMENT , TRADE OR PRACTICE TO REFUND THE INITIAL FEE. OR TO EXCUSE NON
PAYMENT OF UNPAID NOTES
2. SUBSTANTIALLY ALL THE INITIAL SERVICES OF THE FRANCHISOR HAVE BEEN PERFORMED
3. ALL OTHER CONDITIONS WHICH AFFECT CONSUMMATION HAVE BEEN MET.
EXAMPLE :
INITIAL FEE IS 250,000.00 , INITIAL DOWN IS 50,000, BALANCE OF 40,000 YEARLY PAY AT 12% INTEREST.
METHOD 1 ( THE SUBSTANTIAL FUTURE SERVICES ARE YET TO BE PROVIDED TO THE FRANCHISEE, THAT MEANS PERFORMANCE OF
FRANCHISOR HAS YET TO OCCUR.
CASH 50,000
NOTES RECEIVABLE 200,000
UNEARNED INITIAL FEE 250,000
TAKE NOTE IT IS CREDITED TO A SUSPENSE ACCOUNT, OR DEFERRED ACCOUNT OR A LIABILITY ACCOUNT. BECAUSE THE
PERFORMANCE HAS NOT YET SUBSTANTIALLY MET.
METHOD 2 THE PROBABILITY OF REFUNDING IS REMOTE AND THE AMOUNT OF FUTURE SERVICES OF FRANCHISOR IS MINIMAL, THAT
MEANS PERFORMANCE HAS ALMOST TAKEN PLACE.
CASH 50,000
NOTES REC 200,000
REVENUE EARNED 250,000
TAKE NOTE IT IS CREDITED TO AN DEFINITE INCOME ACCOUNT BECAUSE THE POSSIBILITY OF THE AGREEMENT TO TAKE PLACE.
METHOD 3
THE DOWN PAYMENT IS NOT REFUNDABLE , BUT A SIGNIFICANT SERVICES BY THE FRANCHISOR IS YET TO BE PERFORMED
CASH
NOTES
UNEARNED 200,000
REVENUE EARNED 50,000
SINCE THE DOWN IS NOT REFUNDABLE , IS CREDITED DIRECT TO INCOME ACCOUNT.
METHOD 4
THE DOWN IS NOT REFUNDABLE ., THE COLLECTION OF NOTES IS UNCERTAIN , SO NOTES IS NOT RECORDED
CASH 50,000
EARNED REVENUE
METHOD 5
THE DOWN IS EITHER REFUNDABLE . OR SUBSTANTIAL SERVICES MUST BE PERFORMED BEFORE THE FEE CAN BE CONSIDERED
EARNED.
CASH
UNEARNED FEE
1. THERE IS AN INITIAL FRANCHISE FEE NORMALLY FOR A NUMBER OF YEARS WITH A LOT OF CONDITIONS SUCH AS:
a. AMOUNT OF DOWN PAYMENT AT A CERTAIN TIME LIKE UPON SIGNING OF THE AGREEMENT
b. a certain amount again on a certain date say start of operation , or a certain conditions that has to be met.
c. the balance covered by a notes with interest for a certain period and the date of the start of amortization
2. THERE IS ALSO SOME COST OR EXPENSES BY THE FRANCHISOR ASSOCIATED TO THE INITIAL FEE SUCH AS TRANSFER OF FIXED
ASSETS, TRAINING AND DEVELOPMENT COST . ALL OF WHICH IS TIED UP WITH A DATE OF PERFORMANCE.
3. THERE IS ALSO A CONTINUING FEE BASED ON WHATEVER IS THE AGREEMENT, SAY A PERCENTAGE OF SALES, FOR A CERTAIN
NUMBER OF PERIODS, THEN THAT FEE IS CHANGED FOR ANOTHER AMOUNT ONWARD.
4. THERE IS ALSO A CONTINUING COST TO BE INCURRED BY FRANCHISOR . THE FAIR MARKET VALUE OF THIS CONTINUING COST IS
ALSO DETERMINED.
ILLUSTRATIVE PROBLEM
A CONTRACT HAS BEEN SIGNED ON MAY 1, 2011, WITH THE FF; PROVISIONS
2. DIRECT COST ASSOCIATED WITH THE INITIAL FEE THIS IS NOT A CONTINUING COST, THIS IS RELATIVE TO THE INITIAL FEE.
a 80,000 COST OF EQUIPMENT DELIVERY ON MAY1 2011, THE FAIR MARKET IS 120,000.
b. initial services of 140,000 , 50,000 prior to signing, 90,000 to be incurred in oct 1 2011.
3. CONTINUING FEE of 10% of gross sales , which is estimated to be 90,000 per month , for 3 years , then 150,000 a month
thereafter.
4. CONTINUING COST starting the commencemnent of operation, to be incurred by franchisor 10,000 a month., these cost have a
fair market value of 11,000.
JOURNAL ENTRIES:
MAY 1
1. CASH 100,000
NOTES REC. 350,000
REVENUE 120,000
UNEARNED REVENUE 330,000
THE REVENUE OF 120,000 IS ARRIVED AT BECAUSE THE EQUIPMENT WAS PERFORMED BY THE FRANCHISOR ON TIME, OF COURSE THE
330,000 IS ASSUMED TO BE UNEARNED DEPENDING ON THE DATE OF THE PERFORMANCE OF ANY AGREEMENT.
OCT 1
1. CASH 50,000
REVENUE FROM INITIAL FEE 50,000
THIS IS AS PER AGREEMENT TO BE RECEIVED OCT.
explanation : since all the agreement by oct has already been met, a need to recognized the actual revenue must be
computed.
supposed to be the 330,000 is credited to revenue on entry no. 2 in OCT. but the 72,000 has not incurred yet by the franchisor
because it will be incurred monthly, hence cannot credit to revenue in total now. THAT IS WHY 330,000 LESS 72,000
IS 258,000.00 this 72,000 will be amortized for 36 months.
4. CASH 9,000
UNEARNED INITIAL 2,000
REVENUE CONTINUING FEE 11,000
THE 2,000 IS DEBITED TO UNEARNED FOR THE NEXT 36 MONTHS TO CLOSE THE UNEARNED INITIAL REVENUE
NOVEMBER
CASH 9,000
UNEARNED INITIAL REVENUE 2,000
REVENUE EARNED CONTINUING 11,000
DECEMBER
CASH 9,000
UNEARNED 2,000
REVENUE 11,000
JAN 2012
CASH 9,000
UNEARNED 2,000
REVENUE 11,000
this will be the repetitive entry onward , except the amortization f the 2,000.00 and of course the additional entry on the
collection of notes receivable
THAT ARE TWO METHODS THAT WAS DEVELOP TO ANSWER FOR THIS ISSUE.
UNDER THE PERCENTAGE OF COMPLETION METHOD, THE PERCENTAGE OF THE ACTUAL AMOUNT SPENT AT THE END OF THE INTERIM
PERIOD IS OBTAINED AGAINST THE TOTAL ESTIMATED COST THAT IS STILL NEEDED TO COMPLETE THE PROJECT AT THE END OF THE
INTERIM PERIOD.
1. CONSTRUCTION IN PROGRESS -
A. CREDITED TO NEGATIVE NET REVENUE( EXCEPT WHEN A TOTAL LOSS WILL BE INCURRED.
B. CREDITED AT THE END OF THE CONTRACT FOR THE CONTRACT PRICE BY DEBIT TO ADVANCE BILLING.
THAT MEANS THERE ARE TWO TYPES OF TRANSACTION THAT ENTERS TO THIS ACCOUNT, THE COST AND THE PROFIT , WHICH
TOTALS THE CONTRACT PRICE.
AT THE END OF THE CONTRACT THE BALANCE OF THIS ACCOUNT SHALL BE CLOSED TO THE ADVANCE BILLING ACCOUNT WHICH
ACCUMULATES THE REGULAR BILLING OF THE CONTRACT PRICE WHICH IS DEBITED TO ACCOUNTS RECEIVABLE AND CREDITED TO
ADVANCE BILLING. NATURALLY , THE ADVANCE BILLING WILL DEFINITELY HAVE A BALANCE REPRESENTING THE CONTRACT PRICE.
CREDITED EVERY TIME A BILLING STATEMENT IS MADE AND WOULD END UP WITH THE TOTAL CONTRACT PRICE AND
DEBITED AT THE END OF THE CONTRACT FOR THE CONTRACT PRICE. WITH THE CREDIT TO CONSTRUCTION IN PROGRESS
DEBITED TO THE AMOUNT ARRIVED AT BY MULTIPLYING THE COMPLETION PERCENTAGE OF THE PROJECT AS AGAINST
THE PARTIAL AND ESTIMATED COST TO FINISH THE PROJECT. RATIO X TOTAL ESTIMATED COST OF THE PROJECT
4. CONSTRUCTION REVENUE = CREDITED TO THE AMOUNT ARRIVED AT BY MULTIPLYING THE COMPLETION RATIO AS AGAINST
THE TOTAL PROJECT PRICE
:
SAMPLE:
THIS PERCENTAGE 23.1% WILL NOW BE APPLIED TO THE TOTAL CONTRACT PRICE OF THE PROJECT TO GET THE GROSS REVENUE.(
JUST LIKE GROSS SALES )
THE SAME PERCENTAGE SHALL BE APPLIED TO THE ACCUMULATED ACTUAL COST PLUS THE ESTIMATED COST STILL NEEDED TO
COMPLETE THE PROJECT TO BE ABLE TO GET THE EQUIVALENT COST INCURRED AS OF THAT DATE ( JUST LIKE COST OF SALES)
EXAMPLE:
IN EFFECT THIS 854.70 IS 23.!% OF THE NET REVENUE, JUST LIKE THE GROSS PROFIT IN CASE OF NON CONSTRUCTION BUSINESS.
1. THE PURCHASE OR USE OF MATERIALS , LABOR , OVERHEAD ETC. THE RECORDING SYSTEM WOULD DEPEND ON THE ACCOUNTING
SYSTEM THAT THE COMPANY WOULD LIKE TO ADOPT, SAYING THEY WANT TO REFLECT THE COST OF MATERIALS, LABOR , OVERHEAD
AND OTHER COST.
2. THE BILLING
ACCTS. RECEIVABLE 20
ADVANCE BILLING 20
3, COLLECTION
CASH 20
ACCTS. REC 20
AT THE END OF YEAR OF CONTRACT , THE TOTAL BALANCE OF THE CONSTRUCTION IN PROGRESS ACCOUNT WOULD BE THE TOTAL
COST , PLUS THE NET REVENUE ( MARK UP X COMPLETION RATIO 100%.( what isbeing debited to construction in process acct is the
whole cost of building that project and the profit or mark up ..
THIS CONSTRUCTION IN PROGRESS ACCOUNT WILL BE CLOSED TO ADVANCE BILLING ACCOUNT.SINCE THIS IS AN OFFSET TO ACCTS.
RECEIVABLE WHICH THE TOTAL CONTRACT PRICE WILL PASSED THRU THIS ACCTS. REC. ACCT.
THE CONSTRUCTION REVENUE ACCOUNT WOULD BE THE MARK UP ITSELF.
IN EFFECT THE NET BALANCE OF THE CONSTRUCTION IN PROGRESS IN THE ENTRY IN NO. 4, 5 REPRESENTS THE REVENUE FOR THE
PERIOD HANGED IN THE ASSET ACCOUNT CONSTRUCTION IN PROGRESS AS A TEMPORARY ACCOUNT UNTIL IT WILL BE CLOSED AT THE
END OF THE CONTRACT.
=======================================================================
TO ILLUSTRATE ;
A CONSTRUCTION CO. IS CONTRACTED TO CONSTRUCT A BUILDING ESTIMATED TO COST 800,000 AT A PRICE OF 1,000,000 TO
FINISHED IN 3 YEARS
2011 2012 2013 total
CUMULATIVE COST INCURRED 136,500 386,100 413,900 800,000
ESTIMATED COST TO FINISHED TO PROJECT 513,500 328,900
TOTAL PARTIAL AND ESTIMATED COST 650,000 715,000
=======================================================================
JOURNAL ENTRY
ADJUSTING ENTRY:
THE 249,600 IN THE SECOND YEAR IS THE ACTUAL EXPENSES FOR THAT YEAR , SO THAT ADDING 136,500 PLUS 249,600 IS THE
ACCUMULATED ACTUAL EXP. UP TO YEAR 2012 IS 386,100
=======================================================================
HOW THE CONSTRUCTION REVENUE ARRIVE AT:
TAKE NOTE THAT YOU CANNOT COMPUTE THE NET REVENUE FOR SUCCEEDING YEAR UNLESS YOU COMPUTE THE CUMULATIVE NET
REVENUE AS OF THE PRESENT YEAR , SAY THE 153,900 THEN DEDUCT THE REVENUE LAST YEAR , 73,500 TO GET 80,400
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
=======================================================================
DONT BE CONFUSED ON THE JOURNAL ENTRY ON REVENUE, WHAT WAS ADOPTED IS JUST LIKE AN ORDINARY RECORDING OF GROSS
SALES AND THE RECORDING OF COST OF SALES, HERE , THE COMPLETION RATIO IS FIRST APPLIED TO THE CONTRACT PRICE BUT ARE
REDUCED BY THE COMPLETION RATIO APPLIED TO THE ESTIMATED COST OR EXPENSES AS OF THAT YEAR , THE NET EFFECT IS ALSO
NET REVENUE ( CONTRUCTION REVENUE LESS CONSTRUCTION COST )
=========================================================================
IF YOU WE ARE GOING TO PUT THESE ENTRIES INTO T ACCOUNTS :
BALANCE SHEET
ASSETS
CASH 65,000 494,000 910,000
ACCTS. REC. 39,000 65,000 90,000
CONS.PROGRESS 210,000 -
LESS: ADV. BILL 104,000) 106,000
TOTAL 210,000 559,000 1,000,000
LIABILITIES
===========================================================
THE ADVANCE BILLING AS A RULE MUST BE OFFSET OR CONTRA ACCOUNTS TO CONSTRUCTION IN PROGRESS, IF CONSTRUCTION IN
PROGRESS ACCOUNT IS BIGGER THAT MEANS THE EXPENSES IS IN EXCESS OF THE BILLING ( put to asset side )
if the advance bill is more than the construction in progress , it means, the billing is excess of the cost. reflect to liabilities side .
=======================================================================
there is a possibility that while the construction is going on, it is estimated that it will incur a loss.
1. the estimated future cost may indicate a loss on the current period, but there will be a profit on the total contract.
2. the estimated cost may indicate that totally a loss will be incurred.
EXAMPLE of a contract that the result will be a net loss as whole, that means it may have profit on some years but in total for the
whole contract it will be a net loss.
THERE IS A PROFIT OF 54,600 IN YEAR 1, BUT IN YEAR TWO , THERE IS A LOSS OF 85,800.
TAKE NOTE THAT BY THE END OF YEAR 2 , IT IS ESTIMATED THE YEAR 3 WILL ALSO BE A LOSS JUST LIKE THE 2ND YEAR.
IF A LOSS IS EXPECTED FOR THE WHOLE CONTRACT , THE ENTIRE LOSS OF THE WHOLE CONTRACT SHOULD ALREADY BE RECOGNIZED
IN THE YEAR WHERE IT IS DISCOVERED. THAT MEANS THE CUMULATIVE PROFIT AS THAT DATE MUST BE THE AMOUNT OF THE TOTAL
LOSS
THE REGULAR ENTRY DEBITING CONSTRUCTION COST OR EXPENSE FOR YEAR 2 IS STILL NEEDED AND THE CREDIT TO CONSTRUCTION
REVENUE , AND A CREDIT TO CONST. IN PROGRESS FOR THE GROSS LOSS..
IF THIS THE CASE THE COMPUTATION OF NET REVENUE IN yr. 3 Need TO BE IGNORED.. EVEN THE SUPPOSED CREDIT TO
CONSTRUCTION IN PROGRESS ACCOUNT IN RECOGNIZING THE NET LOSS IN YEAR 2 NEED TO BE REVERSED BECAUSE IF THE WHOLE
CONTRACT WILL BE A LOSS THERE IS NO USE to have A BALANCE FOR THE CONSTRUCTION IN PROGRESS ACCOUNT REPRESENTING A
LOSS ( note that construction in progress includes the net revenue ), that is why even the profit of year 1 , debited to construction
in process has to be reversed , in year 2. SO WHAT IS LEFT ON THE BALANCE OF CONSTRUCTION IN PROGRESS ACCOUNT IS THE
CUMULATIVE COST OR EXPENSE IN CONSTRUCTING THE PROJECT.
NOW SINCE THE LOSS IN YEAR 3 HAS TO BE RECOGNIZED IN YEAR TWO AN ENTRY DEBITING CONST. COST OR EXPENSE AND
CREDITING RESERVE FOR LOSS IS NEEDED SO THAT THE CUMULATIVE PROFIT FOR YEAR WILL APPEAR TO BE THE WHOLE TOTAL LOSS
OF THE PROJECT.
THE NET LOSS IN YEAR 3, OF 48,800 WILL BE RECORDED THIS YEAR 2 AND CHARGD TO RESERVE FOR CONTRACT LOSS.
IF THE RULE IS, IF THE WHOLE CONTRACT WILL BA LOSS, THEYEAR WHERE THE LOSS IS KNOWN SHOULD RECOGNIZED THE TOTAL
LOSS of the whole contract THAT MEANS THE LOSS IN THE SUCCEEDING YEARS SHOULD ALSO BE CHARGED TO THE YEAR WHERE THE
TOTAL LOSS WAS KNOWN. IN THIS CASE IN YEAR 2
IF THIS IS CASE THE RETAINED EARNINGS AS OF THE YEAR WHERE THE LOSS IS ANTICIPATED MUST TURNED OUT TOBE EQUAL TO THE
TOTAL LOSS OF THE CONTRACT. EVEN THE CONTRACT HAS NOT YET ENDED.
==============================================================
PROBLEM :
TAKE NOTE THE CONSTRUCTION COST IS NOT TO DATE , IT IS FOR THE CURRENT YEAR. IN COMPUTING FOR THE COMPLETION RATIO
, IT MUST BE BASED ON CUMULATIVE COST SPENT.
THERE IS A LOSS IN THE 2ND YEAR , BUT THE TOTAL CONTRACT IS A PROFIT.
COMPUTE FOR THE ESTIMATED INCOME OR LOSS FOR EACH YEAR. AND THE INCOME REALIZED EACH YEAR.
IN SOME CASES , THERE ARE CIRCUMSTANCES SURROUNDING A REVENUE TRANSACTIONS SUCH THAT CONSIDERABLE UNCERTAINTY OF
FULL COLLECTION WOULD EXISTS SIMPLY BECAUSE OF THE INSTALLMENT SALES WHICH NORMALLY HAS A VERY LONG COLLECTION
TERMS . THIS SITUATION CAN OCCUR IF THE SALES IS UNUSUAL IN NATURE OR SALES TO CUSTOMERS WHERE IN CASE OF DEFAULT OF
THIS CUSTOMER , A LITTLE COST OR PENALTY IS CHARGED.
UNDER THIS CIRCUMSTANCES, WHERE UNCERTAINTY OF COLLECTION SUGGEST THAT REVENUE RECOGNITION SHOULD BE BASED
ON THE ACTUAL COLLECTION RATHER THAN THE TIME OF SALE.
1. INSTALLMENT SALES
2. COST RECOVERY METHOD
3. CASH METHOD.
ACCOUNTING FOR INSTALLMENT SALES METHOD IS WHERE AT THE TIME OF SALE the following entry is made. ( IF USING PERPETUAL
INVENTORY METHOD)
THIS IS THE REGULAR ENTRY:
CASH 10,000
INSTALLMENT ACCTS. RECEIVABLE 10,000
to record collection
NOW CONSIDERING THAT IN INSTALLMENT SALES METHOD , THE INSTALLMENT SALES ACCOUNT IS NOT CONSIDERED A REVENUE
YET, AND EVEN THE COST OF SALES FOR INSTALLMENT SALES this two accounts are REVERSED.at the end of the
period. THEREFORE THE CREDIT ENTRY ON THE SALES AND THE DEBIT ENTRY ON COST OF INSTALLMENT SALES NEED TO BE
REVERSED . OF COURSE IF ONLY THESE ACCOUNT WILL BE THE ONE TO BE REVERSED , THERE IS A DIFFERENCE IN AMOUNT
BECAUSE THE DEBIT IS BIGGER THAN THE COST OF SALES WHICH IS CREDITED, THAT DIFFERENCE IS ACTUALLY THE GROSS PROFIT ,
HENCE , AN ACCOUNT NAME "" deferred gross profit " is to be credited. and will not be a nominal accounts but a REAL ACCOUNTS OR
BALANCE SHEET account .
NOW YOU MAY ASK, HOW TO COMPUTE FOR THE ACTUAL REVENUE OR ACTUAL GROSS PROFIT THAT WILL BE REFLECTED ON THE
PROFIT AND LOSS. BECAUSE THE FACT IS THE GROSS PROFIT WAS TRANSFERRED TO THE BALANCE SHEET.
IN INSTALLMENT ACCOUNTING , THE RECOGNITION OF THE REVENUE IS BASED ON THE AMOUNT OF COLLECTION OF THAT SALES
MADE MULTIPLY BY THE GROSS PROFIT RATIO OF THAT SALES MADE . BUT SINCE THE GROSS PROFIT WAS CLASSIFIED AS BALANCE
SHEET ACCOUNT, IT IS NECESSARY THAT WHEN A COLLECTION IS MADE, THE EQUIVALENT GROSS PROFIT OF THAT COLLECTION
USING THE GROSS PROFIT RATIO WILL BE TRANSFERRED BACK TO THE PROFIT AND LOSS UNDER THE ACCOUNT NAME " realized
gross profit. , that means if the SALES was totally collected the deferred or the unrealized gross profit will become zero.
that means revenue is recognized in the profit and loss depending on the amount of collection multiplied by the gross profit ratio. (
COLLECTIONS X GROSS PROFIT = realized gross profit)
if that is the case. the balance of the unrealized or deferred gross profit if divided by the gross profit ratio will be equal to the
INSTALLMENT SALES RECEIVABLE BALANCE ( deferred gross profit divide gross profit ratio = RECEIVABLE ) or installment
receivable multiplied by the gross profit is the deferred gross profit appearing on the balance sheet.( RECEIVABLE X GROSS PROFIT
RATIO = DEFERRED GROSS PROFIT )
or the realized gross profit for a particular period divide by the gross profit ratio is equal to the amount of collections made on the
sales. ( REALIZED GROSS PROFIT DIVIDE BY gross profit ratio = COLLECTIONS )
WHEN YOU ARE ENGAGING IN SELLING A PRODUCT , YOU PURCHASE THAT PRODUCT FROM OTHER SOURCES FOR RESALE . WHEN YOU
ARE TO SELL THAT PRODUCT , YOU MUST ADD A CERTAIN AMOUNT FROM THE COST OF THE PRODUCT TO ARRIVE AT THE SELLING
PRICE.
THE AMOUNT THAT YOU WILL ADD ON THAT COST OF THE PRODUCT IS DEPENDING ON HOW MUCH YOU WANT TO HAVE A GROSS
PROFIT AND THAT GROSS PROFIT WILL ANSWER FOR THE OPERATING COST AND YOUR NEEDED NET PROFIT.
THE AMOUNT YOU ADD IS THE GROSS PROFIT OF THAT PRODUCT. DIVIDING THAT AMOUNT YOU ADDED OR THE GROSS PROFIT
AGAINST THE SELLING PRICE IS THE GROSS PROFIT RATIO. DIVIDING THE COST OF THE PRODUCT AGAINST THE SELLING PRICE IS THE
COST OF SALES RATIO.
NOW, IT WOULD BE IMPRACTICAL THAT EVERYTIME YOU PURCHASE A PRODUCT , YOU WILL THINK OF HOW MUCH YOU HAVE TO ADD
TO ARRIVE AT SELLING PRICE. THEREFORE YOU HAVE SET A COST OF SALES RATIO AGAINST THE SELLING PRICE SO THAT EVERYTIME
YOU PURCHASED A PRODUCT YOU JUST DIVIDE YOU COST TO THIS COST RATIO TO ARRIVE AT SELLING PRICE., IT'S AUTOMATIC NOW
THAT THE COST LESS THE SELLING PRICE IS YOUR GROSS PROFIT , SO GROSS PROFIT DIVIDE SALES PRICE IS YOUR GROSS PROFIT
RATIO.
EXAMPLE
PURCHASED COST 3,300.00 AND YOU KNOW THAT YOUR COST RATIO IS 80%, SO DIVIDE 3,300.00 BY 80%, YOU
GET 4,125.00 AS SELLING PRICE.
This deferred gross profit account though a non assets accounts , can be presented as a contra accounts of INSTALLMENT
ACCOUNTS RECEIVABLE or can be presented as a DEFERRED ACOUNT ON THE LIABILITIES SIDE . The following are pro forma journal
entries and adjusting entry:
1. SALES ON INSTALLMENT
CASH 20,000
INSTALLMENT REC. 2011 5,000
INST. RECE 2012 10,000
INST RECE 2013 5,000
5. CLOSING OF INSTALLMENT SALE ACCOUNT AND COST OF SALES AND SET UP OF DEFERRED GROSS PROFIT. FOR SALES THIS PERIOD.
TAKE NOTE THAT THE PRE TRIAL BALANCE WOULD SHOW YOU THE INSTALLMENT SALES ACCOUNT AND THE COST OF INSTALLMENT
SALES ACCOUNT OF THE CURRENT PERIOD BECAUSE THE CLOSING OF THAT ACCOUNTS ARE MADE AS PART OF THE ADJUSTING
JOURNAL ENTRIES
THE DEFERRED GROSS PROFIT AND THE INSTALLMENT ACCTS. RECEIVABLE OF PREVIOUS SHALL BE INDICATED IN THE BALANCE SHEET
WITH INDICATION OF WHAT YEAR IT WAS JOURNALIZED
ILLUSTRATIVE EXAMPLE..
CASH 70,000
INSTALLMENT REC 2013 137,500
INST. REC 2012 30,000
INST. REC 2011 7,500
ACCOUNTS RECEIVBLE 42,500
MDSE INV. BEG 130,000
OTHER ASSETS 120,000
ACCTS PAYABLE 80,000
DEFERRED GROSS PROFIT 2012 112,500
DEF. GROSS PROFIT 2011 24,000
CAPITAL STOCK 212,500
RETAINED EARNINGS 171,000
SALES REGULAR 312,500
INSTALLMENT SALES 800,000
PURCHASES 875,000
COST OF INST. SALES 580,000
COST OF SHIPPED INSTALLMENT GOODS 580,000
EXPENSES 300,000
AS I HAVE EXPLAINED EARLIER ABOVE , BEFORE YOU CAN COMPUTE THE REALIZED GROSS PROFIT ,SO THAT AN ADJUSTING ENTRY CAN
BE MADE , YOU MUST KNOW THE GROSS PROFIT RATIO OF THE PRODUCT SOLD, IN THE ABOVE EXAMPLE IT WOULD APPEAR THAT
EVERY YEAR THERE IS DIFFERENT GROSS PROFIT RATIO.
ALSO AS EXPLAINED THE BEGINNING BALANCE OF RECEIVABLE AND THE DEFERRED GROSS PROFIT ( even those end of the year before
adjustment is also a beginning balance ) IS DIRECTLY RELATED TO EACH OTHER BECAUSE THE RECEIVABLE DECREASES THE SAME
AMOUNT OF THE DEFERRED GROSS PROFIT AS A RESULT OF THE COLLECTION MADE AND BEING MULTIPLIED TO THE GROSS PROFIT
RATIO TO REDUCE THE DEFERRED GROSS PROFIT. THAT MEANS , IF YOU DIVIDE THE DEFERRED GROSS PROFIT WITH THE COST
PROFIT RATIO , THE ANSWER IS THE BEGINNING LAST YEAR OF THE RECEIVABLE AMOUNT.
NOW CONSIDERING THAT THE ABOVE EXAMPLE DID NOT SPECIFY HOW MUCH COLLECTION WAS MADE FOR 2011, 2012, A
RECONSTRUCTION OF THE installment receivable account must be made to determine how much collection was made on a particular
year..
IT IS ASSUMED THAT THE ENDING DEFERRED GROSS PROFIT THIS YEAR IS THE LAST YEAR ENDING BALANCE ALSO BECAUSE THAT
BALANCE IS BEFORE ADJUSTING ENTRIES.
FOR 2013
INSTALLMENT SALES AMOUNT 800,000
COST OF INSTALLMENT SALES 580,000
GROSS PROFIT 220,000
220,000 DIVIDE 800,000 EQUALS 27.5%
DIVIDE INSTALLMENT SALES AMOUNT 800,000
1. IS TO ADJUST THE DEFERRED GROSS PROFIT FOR 2011, 2012 BY KNOWING THE COLLECTION MADE FOR 2011, 2012 THIS YEAR..
THIS IS HOW TO RECONSTRUCT THE RECEIVABLE TRANSACTIONS SINCE THERE IS NO DATA ON HOW MUCH WAS COLLECTED FOR 2011,
12 .
SINCE THE ENDING RECEIVABLE AND THE BEGINNING RECEIVABLE IS GIVEN , AND THE ENDING BALANCE IS SMALLER THEREFORE THERE
IS A CREDIT MADE ON THE RECEIVABLE ACCOUNT WHICH REPRESENT COLLECTION., HENCE THAT REDUCTION IS THE COLLECTION
ITSELF.
2011 2012
FOR 2013
to recognize the realized gross profit and reducing the deferred gross profit.
5. INVENTORY 150,000
COST OF SALES 150,000
to set up ending inventory
CLOSING ENTRIES.
EXERCISES:
required: compute gross profit, cost of sales, realized gross profit, collections.
the collection history confirms that the sales was collected at 10% first year , 40% 2nd year , 30% 3rd year
=====================================================================
.EXERCISE 3
IN JAN 1, 1997 A COMPANY SOLD A PARCEL OF LAND COSTING 85,000 FOR 140,000, 10% DOWNPAYMENT, BALANCE TO PAY
ANNUALLY FOR 10 YRS AT 12% INTEREST PAYABLE EVERY END OF DEC.
IN THE BALANCE SHEET , THERE EXIST A RECEIVABLE FOR THAT CUSTOMER AND A DEFERRED GROSS PROFIT FOR THAT PRODUCT.
SINCE THE PRODUCT WILL BE REPOSSESSED , THE BALANCE OF THE RECEIVABLE AND THE DEFERRED GROSS PROFIT HAS TO BE
CLOSED.
THE DIFFERENCE BETWEEN THE RECEIVABLE AND THE DEFERRED GROSS PROFIT IS ACTUALLY THE COST OF THE PRODUCT ITSELF
BECAUSE ANY REDUCTION ON THAT RECEIVABLE DUE TO COLLECTION , THE DEFERRED GROSS PROFIT IS ALSO CORRESPONDING
REDUCED BY APPLYING THE PROFIT RATIO ON THAT COLLECTION.
THAT MEANS , IF THAT PRODUCT IS REPOSSESSED , THE RECEIVABLE IS CLOSED AND THE DEFERRED GROSS PROFIT IS CLOSED , THE
DIFFERENCE IS THE ORIGINAL COST OF THAT PRODUCT. NOW , CONSIDERING THAT THE PRODUCT UNDERGO DEPRECIATION DUE TO
WEAR AND TEAR THAT INVENTORY MAY NOT BE ANYMORE REALISTIC, HENCE A PROPER VALUATION IS NECESSARY, WHERE IS EITHER
GAIN OR LOSS MAY OCCUR DUE TO REPOSSESSIONS.
EXAMPLE:
INVENTORY 5,000
DEFERRED GROSS PROFIT 10,,000
INST. RECEIVABLE 15,000
THEREFORE , A PROPER VALUATION ON THE RETURNED PRODUCT IS NEEDED. THE FOLLOWING MAY BE THE BASIS.
1. THE FAIR MARKET VALUE., IF MORE THAN THE COST , HENCE A GAIN, IF LESS, THEN A LOSS ON REPOSSESSIONS
2. THE BOOK VALUE OR THE COST, NO GAIN NOR LOSS
3. RESALE VALUE LESS RECONDITIONING COST PLUS NORMAL PROFIT
4. NO MORE VALUE, A TOTAL LOSS.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
TRADE INS
PRODUCTS BEING TRADED IN AS PART OF PAYMENT FOR THE NEW PRODUCT PURCHASED SHOULD BE RECORDED AT VALUES AFTER
RECONDITIONING COST , WILL MAKE THE PRODUCT REALIZE A NORMAL GROSS PROFIT ON IT SSALE.
AS TO INDUCE A SALES , AN OVERALLOWANCE IS GIVEN ON THE PRODUCT BEING TRADE IN. THIS OVERALLOWANCE AMOUNT MAY BE
RECORDED AS A SEPARATE ACCOUNT AND DEDUCT ON THE SALES FIGURE ON TEH PROFIT AND LOSS OR MAYBE APPLIED ON THE SALES
FIGURE .
EXAMPLE:
A PRODUCT COSTING 5,000.00 IS SOLD AT 8,000. A USED SIMILAR PRODUCT IS ACCEPTED AS PARTIAL PAYMENT FOR 1,000. THE
USED PRODUCT CAN BE RESOLD AT 1,500.00 AFTER REPAIR COST OF 400.00 THE COMPANY WANTS A 20% GROSS PROFIT ON TEH
RESALE OF THE USED CAMERA.
======================================================================
when interest is calculated , the interest revenue should be accounted for separately, that is, each payment received is separated
into interest revenue. the interest revenue should be recorded on accrual basis.
EXAMPLE :
On Oct end , a lot is sold costing 200,000.00 for 300,000.00 . a 75,000 down was made and the balance payable in monthly
installment with first payment due end nov. payable in 75 months. the monthly installment is 3,000 a month plus 12% interest on
the unpaid balance
ENTRIES
CASH 75,000
Notes receivable 225,000
REAL ESTATE 200,000
DEFERRED GROSS PROFIT 100,000
November
Cash 5,250.00
notes rece 3,000
interest income 2,250
dec. 31
cash 5,220.00
notes rec 3,000.00
interest 2,220.00
to record collection in dec. with a principal balance of 222,000 x 1% =2220.00
CASH 62,500
INS. REC. 2013 200,000
INST. REC 2012 50,000
INST REC 2011 12,500
ACCTS REC 100,000
INVENTORY 75,000
OTHER ASSETS 130,000
ACCTS PAYABLE 187,500
DEF. GROSS PROFIT 2012 240,000
DEF GROSS PROFIT 2011 56,250
CAPITAL STOCK 250,000
RETAINED EARNINGS 111,250
SALES 480,000
INSTALLMENT SALES 1,250,000
PURCHASES 1,137,500
REPOSSESS INV 25,000
COST OF INSTALLMENT 775,000
SHIPMENTS ON INST. SALES 775,000
LOSS ON REPOSSESS 32,500
EXPENSES 750,000
TOTAL 3,350,000 3,350,000
THE FOLLOWING BEGININNING BALANCES OF SOME ACCOUNTS AS OF DEC 31, 2012 LAST YEAR.
DURING THE YEAR THERE WAS AN ENTRY WHICH IS INCOMPLETE FOR A REPOSSESSED UNITS.
REQUIRED:
1. compute the gross profit for the three years.
2. correct the wrong entry.
3 make adjusting and closing entries.
4. make PROFIT AND LOSS AND BALANCE SHEET.
NOTE:
When a repossession is made , the corresponding deferred gross profit of the product should also be reversed . Since there is no
debit to this account, the balancing account used was loss on repossesion
it would appear that the repossessed units below to 2013, 2012,2011 sales. because all the 3 yrs receivable were credited.
IN determining the the amount of collection , make sure you adjust first the ending balance of the installment receivable because
that was reduced because of the entry made out of the repossessions.