Installment Method of Revenue Recognition

It is the method of paying for a purchase in the form of installments. These installments may be spanned over days, weeks, months or even years. This method of revenue recognition shows that the seller has allowed the buyer to pay the sale price of the product in the form of installments. There is a high risk of non-payment from the customer side is associated with this method. This risk exists due to the long term of payment period.

The circumstance where the installment method is used is when the lump sum cash payment is not easy to pay for the customers. Moreover this method is also used when a customer makes a periodic number of payments to the seller and is unable to pay the entire money in a single instance. Installment method of revenue recognition is mostly used in high dollar purchases such as purchase of real estate, home, machinery or expensive equipment purchase and the purchase appliances from installment based selling shops.

The installment based method of revenue recognition is better as compared to accrual biases of revenue recognition as installment based method also calculates the risk associated with payment strategy. While using the installment method of revenue recognition the gross profit margin on the sale is deferred until the entire actual cash is received. After the entire actual cash is received the gross margin percentage is multiplied by cash to get the idea of gross profit. Mathematically it can be shown as under:-

Gross Profit Percentage x Received Cash in form of installments

Although Installment method is more conservative in terms of risk calculations however it is difficult to record and track installments.

 

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