Question:
On 12/31/07, Company A sold equipment for $1,800,000. The equipment had a carrying amount of $1,200,000. At the time of the sale the buyer paid $300,000 cash and signed a $1,500,000 note bearing interest of $1,500,000 note bearing interest at 10% payable in five annual installments of $300,000. Company A accounts for the sale under the INSTALLMENT METHOD. On 12/31/08 the buyer paid $300,000 principal and $150,000 interest. What are the journal entries for Company A at the time of the sale?
I am note sure whether the interest should be included in the Installment Receivables / Deferred Gross Profit amounts or if interest is entered separately.
This is a CPA question that asks about the amount of revenue that should be recognized on 12/31/08 but I need clarity on how to do the journal entries.
To determine the journal entries for Company A at the time of the sale using the installment method, we first need to calculate the gross profit on the sale and then allocate it between the cash received and the note receivable.
Step 1: Calculate Gross Profit
Gross Profit = Selling Price - Carrying Amount
Gross Profit = $1,800,000 - $1,200,000
Gross Profit = $600,000
Step 2: Calculate Cash Received
Cash Received = Cash received on sale + Cash received on principal payment
Cash Received = $300,000 + $300,000
Cash Received = $600,000
Step 3: Allocate Gross Profit
Deferred Gross Profit = Gross Profit - Cash Received
Deferred Gross Profit = $600,000 - $600,000
Deferred Gross Profit = $0
Installment Receivable = Selling Price - Cash Received
Installment Receivable = $1,800,000 - $600,000
Installment Receivable = $1,200,000
Step 4: Journal Entries
On 12/31/07, the journal entries for Company A are as follows:
Debit: Installment Receivables (Asset) - $1,200,000
Credit: Deferred Gross Profit (Liability) - $0
Credit: Cash - $600,000 (Cash received on sale)
The interest is not included in these journal entries. The interest will be accounted for separately in subsequent periods when received.
Note: The interest portion of the note receivable will not be recognized as revenue until it is received. This is because the installment method recognizes revenue and profit over time as cash is received.
To determine the journal entries for Company A at the time of the sale, let's break down the transaction step by step.
1. Recording the sale:
When Company A sells the equipment, there are two components involved: the cash received and the note receivable. At the time of the sale, the journal entry would be as follows:
Debit: Cash $300,000
Debit: Note Receivable $1,500,000
Debit: Installment Receivables/Deferred Gross Profit $300,000
Credit: Equipment $1,200,000
Credit: Revenue $1,800,000
The cash received and the note receivable are recorded at their respective amounts, while the installment receivables/deferred gross profit account represents the portion of the profit yet to be recognized.
2. Determining treatment of interest:
In this scenario, it seems that the buyer is making installment payments with a portion of each payment going towards both principal and interest. The interest is being calculated at a 10% interest rate on the note receivable.
To correctly account for the interest, Company A needs to recognize it separately from the installment receivables/deferred gross profit. Interest is typically recorded as interest revenue in the income statement and as interest receivable in the balance sheet until it is collected.
3. Calculating interest revenue:
To calculate the interest revenue for the first year, you can use the following formula:
Interest Revenue = (Note Receivable balance - Principal received) * Interest rate
In this case, the principal received on 12/31/08 was $300,000, and the interest rate is 10%. The calculation would be:
Interest Revenue = ($1,500,000 - $300,000) * 10% = $120,000
4. Recording interest revenue:
The journal entry to record the interest revenue would be as follows:
Debit: Interest Receivable $120,000
Credit: Interest Revenue $120,000
This entry recognizes the amount of interest accrued but not yet received.
Now, with these entries, the journal entries to be recorded on 12/31/08 would be as follows:
Debit: Cash $300,000
Credit: Note Receivable $300,000 (to reduce the note receivable)
Debit: Interest Receivable $120,000
Credit: Interest Revenue $120,000
The cash received will reduce the note receivable, and the interest revenue will recognize the interest earned.
Please note that the entries provided are based on the information given and assumptions made. It is advised to consult professional guidance or reference authoritative accounting sources to ensure accuracy in specific situations.