What Is Deferred Gross Profit?
A business' net income from running its operations for the time period is equal to its revenues minus its expenses in that same time period. Gross profit is equal to that business's revenues minus its cost of sales, where cost of sales is the sum of all expenses incurred to acquire the products intended for sale that were sold. Deferred gross profit is a special account that is used in the installment sales method to represent still unrecognized revenue.
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Revenues and Expenses
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Revenues are the sums that a business receives in exchange for providing its customers with its products, while expenses are the sums that a business spends in order to produce revenues. Under the most common accounting basis, these transactions are recorded at the times of their occurrence, though exceptions exist. Installment sales method is one such exception.
Gross Profit
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Gross profit is equal to revenues minus cost of sales. Revenues include net sales from the business' main revenue-producing activities and all other revenues, such as bond interest and so on. Cost of sales is a group of expenses incurred in acquiring sold products and is more often called cost of goods sold or cost of goods manufactured depending on the nature of the business. It includes expenses such as purchase costs, materials, and direct labor.
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Installment Sales Method
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Installment sales method is used when the buyer makes the payment on the amount owed in installments spread across multiple time periods. It permits the gross profit from these sales to be spread across the multiple time periods of the payments and is an exception to the normal rules of revenue recognition. It is only usable because collections on installment sales tend to be less sure than other sales.
Deferred Gross Profit
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For example, a business makes $200,000 in installment sales, incurred $120,000 in the cost of those sales, and thus produced a gross profit of $80,000. It collected $50,000 in cash on the amount owed to it in that first year. Installment sales method permits it to record a percentage of the cash collected as revenue in the first year that is equal to gross profit divided by sales. In this case, that percentage is 40 percent. The business records $20,000 of the $50,000 as revenue and the rest as deferred gross profit. If in the second year the business collects another $50,000 from these sales, it then records another $20,000 as revenue and deducts a corresponding amount from its deferred gross profit.
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