Exam 8: Revenue Recognition

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Revenue in most instances should be reported if a valid, measurable claim against customers exists and the seller has substantially accomplished what it must do to be entitled to receive the benefits associated with the sale. The installment sales method is said to apply when collection is doubtful as a result of customers that have over-extended themselves and thus are poor credit risks. The likelihood that problems will be encountered in collecting these accounts suggests that billing and collection expenses associated with these accounts will be large and difficult to estimate.
Critics of the use of the installment sales method suggest that none of these problems is insurmountable. Although the amount of uncollectible accounts may be large, an estimate can be derived based either on past experience or the experience of other firms in the industry. The accounts receivable involved usually are protected by the fact that title to the goods does not pass to the customer until the account is paid in full.
Critics of the installment sales method cite two additional problems. The first is that the gross margin is deferred but expenses that help to generate the gross margin are not. Accurate apportionment of these expenses is virtually impossible and, as a result, usually is not attempted. The second issue relates to a basic assumption of the installment method. This method implicitly assumes that the full amount of the sale ultimately will be collected. Every dollar collected is assumed to have a profit component equal to the gross margin rate. This would be true only if it is certain that the total sales price will be collected.