Accounting principle research - Instalment sales

Accounting principle research - Instalment sales

COMMENT OF LECTURER

MARK:

in class and information from the internet were used as data for use to carry out the research successfully Most of information in this research was written by our understanding and the rest is on the Internet The general conclusion can be that installment sale is an essential activity for any business and its record is quite simple Besides that, it's still much to learn So the information above is worth reading

ACKNOWLEDGMENT

We’re all the students who are lack of academic knowledge So we couldn’t accomplish

this project without help from our lecturer – Ms Bui Phuong Uyen Although she was so

busy at her work, she guided us enthusiastically From finding and analyzing information

to writing a report, she gave us clear instructions Her assistance has been very meaningful for our research than ever before

In addition, we’re indebted Mr Ho Sy Tuy Duc for his help in advising and answering our difficult questions Though Mr Duc wasn’t in charge of instructing the project, he replied all our concerns

Last but not least, we really appreciate our members who whole-heartedly paid a high concentration as well as their zealous attitude in attempt to do this project

CONTENT

COMMENT OF LECTURER i

ABSTRACT ii

ACKNOWLEDGMENT iii

CONTENT iv

TABLE OF FIGURES vi

INTRODUCTION vii

1 General terms related to installment sales 1

1.1 Party 1

1.2 Interpretation 1

2 Installment sale in terms of IAS 18 and VAS 14 3

2.1 International Accounting Standards 18 (IAS 18 – Revenue – Installment sales) 3 2.1.1 Definition 3

2.1.2 Method of calculating and journalizing 5

2.1.2.1 For the buyers 5

2.1.2.2 For the sellers 7

2.2 Vietnamese Accounting Standards 14 (VAS 14 – Revenue and other incomes)12 2.2.1 Definition 12

2.2.2 Journalizing 13

2.2.2.1 For the buyers 13

2.2.2.2 For the sellers 14

2.3 Case 15

2.3.1 International accounting system 15

2.3.1.1 Case 1 – the buyers’ transactions 15

2.3.1.2 Case 2 – the sellers’ transactions 18

2.3.2 Vietnamese accounting system 21

3 Installment sales agreement and contract 22

4 Impacts on the financial statements 26

4.1 Balance sheet 26

4.2 Income Statement 28

4.4 Notes to the financial statements 31

5 Forms of frauds and errors related to installment sales 31

5.1 Forms of frauds and errors 31

5.2 Misleading financial accounting 33

6 Facts – Adjusted policies on installment sales 36

6.1 Vietnamese policies 36

6.2 Global policies 37

CONCLUSION – RECOMMENDATIONS 40 REFERRENCES a APPENDIX b

1 International Accounting Standards (IAS) 18 b

2 Vietnamese Accounting Standards (VAS) 14 e

3 Installment sales agreement n

4 Installment sales income r

5 COSO 1992 s

6 SAX 2002 – SAX section 404 s

7 Reasons for differences between VAS and IAS s

TABLE OF FIGURES

Figure 1: Promissory note 2

Figure 2: Amortization of Installment Notes 6

Figure 3: Tax Evasion Amount 29

Figure 4: Sarbanes-Oxley Act 37

1 General terms related to installment sales

 The purchase price: the amount of money needed to purchase

 The balance of the purchase price: the purchase price minus the first payment

 Sales price of a home $100,000

 Balance of purchase price $90,000

 Purchase price (total) $100,000

 Business day: A business day is considered every official working day of the week

Another common term isworking day Typically, these are the days between and including Monday to Friday and do not include public holidays and weekends

 The effective date: Aneffective dateoras of dateis thedateupon which something is

considered to take effect

 The final payment: That brings a balance to zero or completely satisfies an

obligation

 The final payment date: the day that that brings a balance to zero or completely

satisfies an obligation

 The first payment: the first payment in the Schedule

 The first payment date: the date that incurs the first payment

 The instalment: amount of money owed has been divided, so that can each part

happens or is paid at different times util the end or total is reached

 The instalment due date: To avoid penalties, you must pay your instalments in full before it passes to the due date

 Principal: the original amount of a debt on which interest is calculated

 Interest: money which is charged by a bank or other financial organization for

borrowing money

 The interest rate: A rate which is charged or paid for the use of money An interest

rate is often expressed as an annual percentage of the principal

 Discount: a reduction in the purchase price

 The promissory notes : A promissory note is a negotiable instrument, where in one

party (the maker or issuer) makes an unconditional promise in writing to pay a determinate sum of money to the other

1 The marker is the party making the promise to pay

2 The payee is the party to whom the note is payable

3 The face amount is the amount for which the note is written on its face

4 The issuance date is the date a note is issued

5 The due date or maturity date is the date the note is to be paid

6 The term of a note is the amount of time between the issuance and due dates

 Mortgage note: a note is secured by an asset

 The signature date: the date upon which this agreement is signed by the party

signing last in time

 VAT: Value Added Tax and is a sales tax charged And it also depends on policy

relating to VAT of each nation In Vietnam, VAT is always stable at 10% for almost products and services, but in US or EURO countries, it is adjusted every year by the government

Figure 1: Promissory note

Source: Financial Accounting 12e by Warren, Reeve, Duchac

2 Installment sale in terms of IAS 18 and VAS 14

2.1 International Accounting Standards 18 (IAS 18 – Revenue – Installment sales)

2.1.1 Definition

In United States income tax law, an installment sale is generally a "disposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occurs." The term "installment sale" does not include, however, a

"dealer disposition" (as defined in the statute) or, generally, a sale of inventory The installment method of accounting provides an exception to the general principles of income recognition by allowing a taxpayer to defer the inclusion of income of amounts that are to be received from the disposition of certain types of property until payment in cash or cash equivalents is received The installment method defers the recognition of income when compared with both the cash and accrual methods of accounting Under the cash method, the taxpayer would recognize the income when it is received, including the entire sum paid in the form of a negotiable note The deferral advantages of the installment method are the most pronounced when comparing to the accrual method, under which a taxpayer must recognize income as soon as he or she has a right to the income.1

You cannot use the installment method to report a loss You can choose to report all your gain in the year of sale

The installment sales method cannot be used for the following2:

 Sale of inventory The regular sale of inventory of personal property does not

qualify as an installment sale even if you receive a payment after the year of sale

 Dealer sales Sales of personal property by a person who regularly sells or

othersise disposes of the same type of personal property on the installment plan are not installment sales

This rule also applies to real property held for sale to customers in the ordinary course of

a trade or business However, the rule does not apply to an installment sale of property used or produced in farming

 Special rule Dealers of time-shares and residential lots can treat certain sales as

installment sales and report them under the installment method if they elect to pay a special interest charge

 Stock or securities You cannot use the installment method to report gain from the

sale of stock or securities traded on an established securities market You must report the entire gain on the sale in the year in which the trade date falls

 Installment obligation The buyer’s obligation to make future payments to you

can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer’s debt to you

 General rules If a sale qualifies as an installment sale, the gain must be reported

under the installment method unless you elect out of using the installment method

 Sale at a loss If your sales results in a loss, you cannot use the installment

method If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale

 Unstated interest If your sale calls for payments I a later year and the sales

contract provides for little or no interest, you may have to firgue unstated interest, even if you have a loss

The sellers may issue installment note which is a debt that requires the borrower to make equal periodic payments to the lender for the term of the note At the end of the note’s term, the principal will have been repaid in full Each note payment includes the following3:

 Payment off a portion of the amount intially borrowed, called the principal

 Payment of interest on the outstanding balance

When it comes to purchasing transactions, for buyers, installment notes are often used to

purchase specific assets such as equipment, and are often secured by the purchased asset

When a note is secured by an asset, it is called a mortgage note If the borrower fails to

pay a mortgage note, the lender has the right to take possession of the pledged asset and sell it to pay off the debt Mortgage notes are typically issued by an individual bank Individuals typically use mortgage notes when buying a house or car

3

Based on Chapter 14 – Long-term liabilities – Bonds and Notes - page 636 - Financial Accounting 12e –

Warren – Reeve - Duchac

2.1.2 Method of calculating and journalizing

2.1.2.1 For the buyers

 Issuing an installment note (Based on Financial Accounting 12e – by Warren – Reeve – Duchac)

When an installment note is issued, an entry is recorded debiting Cash and crediting Notes Payable

To illustrate, assume that Lewis Company issue a $24,000, 6%, five-year installment note that has annual payments of $5,689 The first note payment consists of $1,440 of interest and $4,258 of principal repayment

To record the issuance of the installment note, we have an entry is as follows:

Cash 24,000

Notes Payable 24,000

Issued $24,000 of installment note for cash

 Annual payment (Based on Financial Accounting 12e – by Warren – Reeve – Duchac)

The preceding note payable requires Lewis Company to repay the principle and interest

in equal payments of $5,689 beginning December 3, 2010 for each of the next five year Unlike bonds, however, each installment note payment includes an interest and principal component

The interest portion of an installment note payment is computed by multiplying the interest rate by the carrying amount (book value) of the note at the beginning of the period The principal portion of the payment is then computed as the difference between the total installment note payment (case paid) and the interest component These computations are illustrated in the figure as follows:

1 The January 1, 2010, carrying value (column A) equals the amount borrowed from the bank The January 1 balance in the following years equals the December

31 balance from the prior year

2 The note payment (column B) remains constant at $5,698, the annual cash payments required by the bank

3 The interest expense (column C) is computed at 6% of the installment not carrying amount at the beginning of each year As a result, the interest expense decreases each year

4 Notes payable decreases each year by the amount of the principal repayment (column D) The principal repayment is computed by subtracting the interest expense (column C) from the total payment (column B) The principal repayment (column D) increases each year as the interest expense decreases (column C)

5 The carrying amount on December 31 (column E) of the note decreases from

$24,000, the initial amount borrowed, too $0 at the end of the five years

The entry to record the first payment on December 31, 2010, is as follows:

Figure 2: Amortization of Installment Notes

Source: Financial Accounting 12e by Warren, Reeve, Duchac

The entry to record the second payment on December 31, 2011, is as follows:

The entry to record the final payment on December 31, 2014, is as follows:

2.1.2.2 For the sellers

―The installment sales and cost recovery methods are only used in unusual circumstances.‖ 4

When it comes to the sellers’ view, one of the most important transactions is how to calculate and record revenue According to installment regulation, there are two way of calculate and journalize revenue for the sellers These are installment sales method and cost recovery method, which is presented respectively in this part

 Installment sales method

o Calculating

The installment sales method is used to recognize revenue after the sale has occurred and when sales are stipulated under much extended cash collection terms In general, when the risk of not being able to collect is reasonably high and when there is no reasonable basis for estimating the proportion of installment accounts, revenue recognition is deferred, and the installment sales method is used The installment sales method is typically used to account for sales of consumer durables, retail land sales, and retirement property Under the cost, another method to recognize income after the sale is made, no profit is recognized until all the costs are recovered

Due to the fact that installment transactions related to revenue significantly regard the sellers, this method will focus on the installment sale method under the sellers’ view The installment sales method recognizes revenue and income proportionately as cash is collected The amount recognized in any period is thus based on two factors:

1 The gross profit percentage:

2 The amount of cash collected on installment accounts receivable

Below is an example of calculation of installment sales for years 2009 and 2010

 2009 income from installment sales calculation:

The income recognized in 2009 equals cash collections in 2009 multiplied by the gross profit percentage in 2009 and is calculated as follows:

$300,000×30% = $90,000

Such income is shown on the 2009 income statement as 2009 income from installment sales

 2009 Deferred Gross Profit calculation:

The deferred gross profit is an A/R contra-account and is the difference between gross profit and recognized income and is calculated as follows:

$360,000 − $90,000 = $270,000

The deferred gross profit is thus deferred and recognized in income in subsequent periods, i.e when the installment receivables are collected in cash

 2010 income from installment sales is $288,800 and calculated as follows:

Total 2010 installment sales income

Gross profit recognized Component relating to 2009 Sales

Cash collections in 2010 from 2009 sales $600,000

Multiplied by year 2009 gross profit percentage 30%

Component relating to 2010 sales

Cash collections in 2010 from 2010 sales $340,000

Multiplied by year 2010 gross profit percentage 32%

$108,800

Total installment sales income recognized in 2010 $288,800

A more comprehensive table would clearly show gross profit and deferred income recognized for each year: 2009 and 2010

Gross profit recognized on current year's sales 90,000 108,800

Plus: Gross profit recognized on installment sales of prior 180,000

years

Total gross profit recognized in the year $90,000 $288,800 Installment sales and the related costs of goods sold must be tracked by individual year in order to compute the gross profit percentage that applies to each year Furthermore, the accounting system must correctly match the cash collections with the specific sales year

so that the correct gross profit percentage is applied

On the balance sheet, "the accounts receivable - installment sales" is classified as current assets if it is due within 12 months of the balance sheet Otherwise, it is classified as long term assets

Under the GAAP, the interest component of the periodic cash proceeds is computed separately In fact, interest payments are not considered when the recognized gross profit

is computed on installment sales Certain procedures differentiate between principal and interest payments on customer receivables

o Journalizing

Back to the example above, the entries are mentioned as follows

Deferred gross profit is the difference between the selling price and the cost of inventory

Installment sales receivable 2009 1,200,000

Inventory 840,000 Deferred gross profit 360,000 During 2009, a company collected $300,000 on its installment sales

Cash 300,000

Installment sales receivable 2009 300,000 This entry below records the Realized Gross Profit by adjusting the Deferred Gross Profit account in 2009

Deferred gross profit 2009 90,000 ($300,000 x 30%) Realized gross profit 90,000 During 2010, Company sold $1,300,000 on installment and collected $600,000 on its

2009 installment sales and $340,000 on its 2010 installment sales

Installment sales receivable 2010 1,300,000

Inventory 884,000 Deferred gross profit 416,000

Cash 940,000

Installment sales receivable 2009 600,000 Installment sales receivable 2010 340,000 This entry below records the Realized Gross Profit by adjusting the Deferred Gross Profit account in 2010

Deferred gross profit 2009 180,000 ($640,000 x 30%) Deferred gross profit 2010 108,880 ($340,000 x 32%) Realized gross profit 288,880

Balance sheet in 2009

Installment sales receivable 2009: 900,000

Installment sales receivable 2010: 340,000

 Cost recovery method

o Calculating

The cost recovery method does not recognize any income on a sale until the cost of the

item sold has been fully recovered through cash receipts Once the seller has recovered all costs, any subsequent cash receipts are included in income The cost recovery method

is used when the uncertainty of collection of the sales price is so great that even use of the installment method cannot be justified The cost recovery method is the most conservative of all revenue recognition methods

Under the cost recovery method, both revenues and cost of sales are recognized at the point of sale, but the related gross profit is deferred until all costs of sales have been recovered Each installment must also be divided between principal and interest, but unlike the installment method where a portion of the principal recovers the cost of sales and the remainder is recognized as gross profit, all of the principal is first applied to

recover the cost of the asset sold After all costs of sales have been recovered, any subsequent cash receipts are realized as gross profit

o Journalizing

With the example as we analyzed above, however, there are also a few differences

Deferred gross profit is the difference between the selling price and the cost of inventory Installment sales receivable 2009 1,200,000

Inventory 840,000 Deferred gross profit 360,000 During 2009, a company collected $300,000 on its installment sales

Cash 300,000

Installment sales receivable 2009 300,000 The entries are exactly the same as under the Installment Method as mentioned before, however, there is no entry to realize gross profit Because we have not collected cash in excess of COGS yet, therefore no gross profit is recognized in 2009

Here are the entries we would make in 2010 relating to 2009 sales

Cash 600,000

Installment sales receivable 2009 600,000 Now, we have fully recovered the $840,000 cost during 2009, so the entire deferred gross profit will be recognized

Deferred gross profit 360,000

Realized gross profit 360,000

2.2 Vietnamese Accounting Standards 14 (VAS 14 – Revenue and other incomes)

2.2.1 Definition

Installment is lending method that the term for paying principal and interest is all the same The amount of money for paying debt is also the same as agreement in the contract and the interest need to pay in each term is based on the balance of outstanding principal and the actual duration of the repayment period Normally, a term debt can lengthen 1 month, 3 months, 6 months, even a year or more It depends on a demand, financial ability for paying a down payment or financial ability to pay periodically Installment

sales are also applied in consumer lending, purchasing assets with high value The interest rate is agreed detailed in the contract between the buyers and sellers.5

 Borrowing without installment payment

The term of borrowing without installment payment consist of maturity value (included both principal and interest value) is paid to the banks only one time when due date comes This kind is applied to credits which are small values and short—term payments

 Borrowing with installment payment

Borrowers will pay maturity value (included both principal and interest value) to the banks many times during the period This kind is applied to credits which are high values

2.2.2 Journalizing

2.2.2.1 For the buyers

When purchasing fixed assets under installment contract, journalizing transactions has to follow:

 For purchasing tangible or intangible assets which are used immediately for operating activities, speculation, operating lease:

Debit 211, 213, 217 (historical cost) Debit 133 (VAT refund – if any) Debit 242 – long-term prepaid expense (interest expense is the difference between total payment and sum of the paid cash and VAT (if any)

Credit 331 – Notes payable (total payment)

 Period payment

Debit 331 – Notes payable

Credit 111, 112 (maturity amount including principal and interest)

 Recording periodically as an expense

Debit 635 – financial expenses

Credit 242 – long-term prepaid expenses

2.2.2.2 For the sellers

VAT included

When purchasing merchandise under installment contract for the merchandise which are VAT objectives and VAT deduction method, accountants will record the transactions as follows:

Debit 131 – Notes Receivable

Credit 511 – Revenue (5111, 5112, 5117) (the sums of cash payment immediately not VAT included)

Credit 333 – Taxes payable (3331) Credit 3387 – Unearned revenue (the difference between the usual price and total payment under installment sales)

When receiving cash payment:

Debit 111, 112

Credit 131 – Notes Receivable Recording interest revenue periodically:

Debit 3387 – Unearned revenue

Credit 515 – Interest revenue

- Recording cash payment

2.3.1 International accounting system

2.3.1.1 Case 1 – the buyers’ transactions 6

The following transactions were completed by Simmons Inc., whose fiscal year is the calendar year:

In 2012:

July 1 Issued $64,000,000 of 10-year, 12% callable bonds dated July 1, 2012, at

a market (effective) rate of 14%, receiving cash of $57,219,878 Interest is payable semiannually on December 31 and June 30

October 1 Borrowed $320,000 as a five-year, 6% installment note from Ibis Bank

The note requires annual payments of $75,967, with the first payment occurring on September 30, 2013

December 31 Accrued $4,800 of interest on the installment note The interest is payable

on the date of the next installment note payment

31 Paid the semiannual interest on the bonds The bond discount is amortized

annually in a separate journal entry

31 Recorded bond discount amortization of $339,006, which was determined

using the straight-line method

31 Closed the interest expense account

In 2013:

June 30 Paid the semiannual interest on the bonds

September 30 Paid the annual payment on the note, which consisted of interest of

$19,200 and principal of $ 56,767

December 31 Accrued $3,948 of interest on the installment note The interest is

payable on the date of the next installment note payment

31 Paid the semiannual interest on the bonds The bond discount is

amortized annually in a separate journal entry

31 Recorded bond discount amortization of $ 678,012, which was

determined using the straight-line-method

31 Closed the interest expense account

In 2014:

June 30 Recorded the redemption of the bonds, which were called at 98 The

balance in the bond discount is $ 5,424,098 after payment of interest and amortization of discount has been recorded (Record the redemption only)

September 30 Paid the second annual payment on the note, which consisted of

interest of $ 15,794 and principal of $ 60,173

Instructions

1 Journalize the entries to record the foregoing transactions

2 Indicate the amount of the interest expense in (a) 2012 and (b) 2013

3 Determine the carrying amount of the bonds as of December 31, 2013

Discount on Bonds Payable 5,424,098 Cash 62,720,000*

*$64,000,000 × 0.98

2014

Sept 30 Interest Expense 11,846

Interest Payable 3,948 Notes Payable 60,173 Cash 75,967

2.3.1.2 Case 2 – the sellers’ transactions 7

Lecole Company of France appropriately accounts for certain sales using the

installment sales method The perpetual inventory system is used Information related

to installment sales for 2006 and 2007 is as follows:

2 Prepare all necessary journal entries for each year

3 Repeat requirements 1 and 2 assuming that Lecole uses the cost recovery method

to account for its installment sales

The gross profit percentage:

x100= 40%

2007 Deferred gross profit: 400,000 – 280,000 = 120,000

The gross profit percentage:

Deferred gross profit 120,000

2006 To record cash collections from installment sales

Cash 100,000

Installment receivables 100,000

2006 To recognize gross profit from installment sales

Deferred gross profit 40,000

Realized gross profit 40,000

2007 To record installment sales

Installment receivables 400,000

Inventory 280,000

Deferred gross profit 120,000

2007 To record cash collections from installment sales

Cash 250,000

Installment receivables 250,000

2007 To recognize gross profit from installment sales

Deferred gross profit 85,000

Realized gross profit 85,000

Deferred gross profit 120,000

2006 To record cash collection from installment sales

Cash 100,000

Installment receivables 100,000

2007 To record installment sales

Installment receivables 400,000

Inventory 280,000

Deferred gross profit 120,000

2007 To record cash collection from installment sales

Cash 250,000

Installment receivables 250,000

2007 To recognize gross profit from installment sales

Deferred gross profit 20,000

Realized gross profit 20,000

2.3.2 Vietnamese accounting system

Fixed asset installment 8

Company ABC uses VAT deduction method In 2005, this company has these transactions

Transaction 1: In January 1st, 2005, purchased tangible fixed asset 940 million VND, 2 years installment, its actual price without VAT was 700 million, VAT 10%, not pay yet You have to pay principal and interest semiannually by cash This tangible fixed asset was funded by bank’s long-term loan

July 1: Pay principal and interest

Transaction 2: In January 1st, purchased intangible fixed asset 900 million VND, 3 years installment, its actual price without VAT was 600 million, VAT 10%, paid one tenth of principal, the remaining principal and interest will be paid quarterly by cash This intangible fixed asset was funded by development investment fund

= 20 Credit 242 20

3 Installment sales agreement and contract

For a start, it is necessary to understand some of general terms in relation to agreement

 Agreement: The buyer and seller may enter into a written agreement as to the

allocation of any consideration or the fair market value of any of the assets This

agreement is binding on both parties unless the IRS determines the amounts are not appropriate

 Reporting requirement Both the buyer and seller involved in the sale of

business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred

 Sale of Partnership Interest: A partner who sells a partnership interest at a gain

may be able to report the sale on the installment method The sale of a partnership interest is treated as the sale of a single capital asset The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income (The term ―unrealized receivables‖ includes depreciation recapture income, discussed earlier).The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method The gain allocated to the other assets can be reported under the installment method

In order to make it clearer, the below example will put in research.9

Example — Sale of a Business

On June 4, 2011, you sold the machine shop you had operated since 2003 You received a

$100,000 down payment and the buyer’s note for $120,000 The note payments are

$15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2012 The total selling price is $220,000 Your selling expenses are $11,000

The selling expenses are divided among all the assets sold, including inventory Your selling expense for each asset is 5% of the asset’s selling price ($11,000 selling expense

$220,000 total selling price)

The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:

Inventory $ 10,000 0 $ 8,000 Land 42,000 0 15,000

Building 48,000 9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376

Under the residual method, you allocate the selling price to each of the assets based

on their FMV ($201,500) The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill

The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown

in the following chart

Sale Price Sale Expense Adj Basis Gain

Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Machine A 71,000 3,550 63,800 3,650 Machine B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill .18,500 925 0 17,575

$ 220,000 $ 11,000 $ 150,216 $ 58,784 The building was acquired in 2003, the year the business began, and it is section 1250 property There is no depreciation recapture income because the building was depreciated using the straight line method

All gain on the truck, machine A, and machine B is depreciation recapture income since

it is the lesser of the depreciation claimed or the gain on the sale Figure depreciation recapture in Part III of Form 4797

The total depreciation recapture income reported in Part II of Form 4797 is $5,209 This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed) These gains are reported in full in the year of sale and are not included in the installment sale computation

Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale

The selling price equals the contract price for the installment sale ($108,500) The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart

Selling Price Installment sale basis Gross Profit

Land $ 42,000 $ 17,100 $ 24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $ 108,500 $ 56,425 $ 52,075

The gross profit percentage (gross profit + contract price) for the installment sale is 48% ($52,075 + $108,500) The gross profit percentage for each asset is figured as follows:

is $111,500 This is 50.7% ($111,500 + $220,000) of the total selling price

Multiply principal payments by 49.3% to determine the part of the payment for the installment sale The balance, 50.7%, is for the part reported in the year of the sale

The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale When you receive principal payments in later years, no part of the payment for the

sale of these assets is included in gross income Only the part for the installment sale (49.3%) is used in the installment sale computation

The only payment received in 2011 is the down payment of $100,000 The part of the payment for the installment sale is $49,300 ($100,000 x 49.3%) This amount is used in the installment sale computation

Installment income for 2011 Your installment income for each asset is the gross profit

percentage for that asset times $49,300, the installment income received in 2011

Income

Land—22.95% of $49,300 $11,314 Building—8.85% of $49,300 4,363 Goodwill—16.2% of $49,300 7,987 Total installment income for 2011 $23,664

Installment income after 2011 You figure installment income for years after 2011 by

applying the same gross profit percentages to 49.3% of the total payments you receive on the buyer’s note during the year

The example of installment sales agreement in reality will be presented in appendix 3

4 Impacts on the financial statements

Nowadays, the installment sale becomes very popular in Vietnam and around the world Thus, they also pay more attention to the impact of the installment sale on the Company's results of operations, especially Merchandise companies In particular, this is the impact

of installment sale on financial statement, specifically, it effects on the amount of tax refund and account current portion of long term debt The following part below will mention about these impacts

4.1 Balance sheet

Transactions related to buying or selling installment affect account ―Note Receivable‖ for the seller and account ―Note Payable‖ for the buyer in their balance sheet There transactions use two kinds of account, Note Receivable and Note Payable, instead of using Account Receivable or Account Payable because interest is an obvious important part