How does the installment sales method work for revenue recognition?

The installment sales method is a revenue recognition approach used when collectibility is uncertain and payments are received over an extended period. Instead of recognizing all profit at the point of sale, profit is deferred and recognized proportionally as cash is collected.

The key formula:

Gross Profit Rate = Total Gross Profit / Total Sales Price

Profit Recognized = Cash Collected x Gross Profit Rate

Worked Example:

Meridian Home Furnishings sells a custom kitchen package for $80,000 on January 1, 2026. The cost of the package is $56,000. The buyer pays in four annual installments of $20,000.

• Gross Profit = $80,000 - $56,000 = $24,000
• Gross Profit Rate = $24,000 / $80,000 = 30%

Balance sheet treatment: At the point of sale, Meridian records an installment receivable of $80,000 and deferred gross profit of $24,000. Each year, as cash arrives, the receivable decreases and a portion of the deferred gross profit is recognized as income.

When is this method used?

Under older standards, it applied when collection was not reasonably assured. Under current IFRS 15 / ASC 606, the installment method is not explicitly named, but a similar outcome occurs when a company determines that collectibility is not probable at contract inception. The entity would then recognize revenue only to the extent of cash received (a constraint on variable consideration).

Comparison with full accrual recognition: Under the normal accrual method, Meridian would recognize the entire $24,000 profit in 2026. The installment method is more conservative, matching profit to actual cash inflows.

Exam tip: CFA Level I may test you by giving a gross profit rate and asking how much profit is recognized in a particular year based on collections. Always multiply cash collected by the gross profit rate.

Explore our CFA Level I FRA module for more practice on revenue recognition methods.