Installment sales and cost recovery methods
Mulcahey builders (MB)re-models office buildings in low-income urban areas that are undergoing economic revitalization. MB classically accepts a 25 percent down payment when they complete a job and a note which needs that the remainder be paid in three equal installments over the next three years, plus interest. Because of the inherent uncertainty related with receiving these payments. MB has historically used the cost recovery method to identify revenue.
As of 1st January, 2013. MB's outstanding gross installment accounts receivable (not net of deferred gross profit) consist of the subsequent:
1. $400,000 due from the Bluebird Motel. MB completed the Bluebird job in 2011, and evaluated gross profit on that job is 25 percent.
2. $150,000 due from the PitStop Gas and MiniMart. MB completed PitStop job in 2010, and estimated gross profit on that job is 35 percent.
Dan Mulcahey has been considering switching from the cost recovery method to the installment sales method, because he wants to demonstrate the highest possible gross profit in 2013 and he understands that installment sales method recognizes gross profit sooner than does the cost recovery technique.
Required :
1. Evaluate how much gross profit is expected to be earned on these jobs in 2013 under the cost recovery method, and how much could be earned if MB instead used the installment sales method. Ignore interest.
2. If Dan is mainly concerned about 2013, do you think he could be happy with a switch to the installment sales method? Describe.