Installment Sale
Categories: Credit
In the ye olden days of paisley suits and broadcast TV, before credit cards became ubiquitous as a way of buying things now and paying for them later, there was a thing called layaway. This program essentially worked as an installment plan. In July, you would set aside a Star Wars Millennium Falcon toy you wanted to get your kid for Christmas. Then, each month, you gave the store a small bit of money. By December, you had paid off the Falcon and could take it home to wrap and set under the tree.
An installment sale represents the real estate version of this.
At least, it's often used for real estate. Technically, it could apply to any situation where payments are made in chunks over time rather than all at once. Kmart could have used the term in 1982 to account for the sale of that Millenium Falcon. In terms of accounting rules (as set out by Generally Accepted Accounting Principles, or GAAP), it just means that the seller recognizes the revenue as it comes in, rather than when the sale is made.
As we said, the structure comes up most often in the real estate market. Important note, though: an installment sale is different than a mortgage. In a mortgage, you get a loan from a bank, pay for the property all at once with the money the bank gave you and then repay the bank in little monthly chunks. It may feel like you're paying in installments, but the seller got the full price all at once.
An installment sale means the seller gets the funds in chunks as well. Under tax law, an installment sale means at least one payment happens after the tax year when the original sale took place. The number of installments (and the amounts) can be negotiated on a case-by-case basis.
So...you're buying a small island in the Caribbean for $50 million. You are going to pay $25 million immediately, then $10 million next year, followed by $5 million payments in each of the three years after that. Also, since you aren't paying up front, you have to pay interest on those future installments. So you agree to pay 5% annual interest on the $10 million and $5 million installment payments you're making over the next four years.
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Finance: What is Installment Method?0 Views
Finance a la shmoop what is an installment method? okay well first let's
start with a question what's an installment? basically it's a
way of buying things really wanted those silver plated golf clubs that guaranteed [Golf ball on a tee and golf club appears]
to make you play like Tiger when he was good you know the young Tiger not the
new whining Tiger who can't break par... well those golf clubs cost thirteen
hundred bucks ouch don't have the dough don't even have the [Man with empty jean pockets]
credit just put it on the Amex well you probably want to get some financial
therapy over your spending habits but if you can get past that well then you can [Man laying on couch in financial therapy]
likely by the clubs by paying in installments
so you'd pay say a hundred bucks each month for thirteen months and boom the
clubs are bought and paid for okay so now let's think about how this purchase
gets accounted for on the books of the guy who just sold you those clubs well [Balance sheet appears]
in this case have you simply agreed to pay for the clubs with money payable
three months later well it would have shown up on the sellers books as an
account receivable right like he was to receive money from you ninety days later
in this case however you are paying off the clubs for thirteen lucky weeks in [Accounts receivable sheet for installment payments]
which you install your payment in one thirteenth segment one hundred bucks
each right so on the books of the seller as each week goes by he collects his
hundred bucks from you and were this straight accounts receivable the number
would simply decline to twelve hundred dollars and eleven hundred dollars, then a
grand and so on well the key accounting difference here
is that when applying an accounts receivable style tracking system the
revenue is recognized all upfront and the value of the account receivable
declines in one-thirteenth parts until it's fully depreciated to zero. In the
installment method however the key difference is that revenues are not
recognized until the cash actually shows up in the bank of the golf club seller
right so really the two accounting methods are about as different as young [Man discussing accounting methods and young Tiger Woods appears]
Tiger and new Tiger and isn't he eligible for the Senior Tour yet?