Becker CPA Review 6-18
Paula has sales that qualify to be reported on the installment basis. In year 2, installment sales were $40,000 with a cost of $30,000. In year 3, installment sales were $50,000 with a cost of $25,000. Collections in year 2 were in the amount of $30,000. Collections in year 3 were $10,000 on the year 2 sales and $30,000 on the year 3 sales. How much deferred gross profit exists as of the end of year 2?

a. $2,500
b. $5,000
c. $7,500
d. $10,000
[Fill in the blank]

Question

Becker CPA Review 6-18
Paula has sales that qualify to be reported on the installment basis. In year 2, installment sales were $40,000 with a cost of $30,000. In year 3, installment sales were $50,000 with a cost of $25,000. Collections in year 2 were in the amount of $30,000. Collections in year 3 were $10,000 on the year 2 sales and $30,000 on the year 3 sales. How much deferred gross profit exists as of the end of year 2?

a. $2,500
b. $5,000
c. $7,500
d. $10,000
[Fill in the blank]

BlackTom AI · Accepted Answer

We start by identifying the key figures for Paula's year-2 installment sales: selling price (annual installment sales) = 40,000; cost of goods sold on those sales = 30,000; therefore gross profit on year-2 installment sales = 40,000 − 30,000 = 10,000.

Next, determine the gross profit percentage (GP%): GP% = gross profit / selling price = 10,000 / 40,000 = 0.25 (or 25%).

Under the installment method, deferred gross profit at year-end equals the portion of gross profit that has not yet been realized, which corresponds to the portion of the year-2 receivables not yet collected. The year-2 collections are 30,000, so the remaining receivable on year-2 sales is 40,000 − 30,000 = 10,000.

Compute the deferred gross profit by applying the GP% to the remaining receivable: Deferred gross profit = 10,000 × 0.25 = 2,500.

Now consider potential missteps:
- If someone uses total collections for both year-2 and year-3 without separating them by year or by which year the collection relates to, they might misallocate gross profit or over/understate the deferral.
- If someone assumes the entire year-2 gross profit would be recognized immediately upon collection, they would ignore the GP% that governs how much gross profit is recognized per dollar collected under the installment method.
- If one forgets to compute GP% and simply prorates using uncollected amount alone (without GP%), they would miss the percentage component and arrive at an incorrect figure.

Therefore, the correct deferred gross profit as of the end of year 2 is 2,500, corresponding to option a in the provided multiple-choice format.

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