can anyone explain this question?
On January 1, 2005, Rex Co. sold a used machine to Lake, Inc. for $525,000. On this date, the machine had a depreciated cost of $367,500
Lake paid $75,000 cash on January 1, 2005 and signed a $450,000 note, bearing interest at 10%.
The note was payable in three annual installments of $150,000 beginning January 1, 2006. Rex appropriately accounted for the sale under the installment method. Lake made a timely payment of the first installment on January 1, 2006 of $195,000, which included interest of $45,000 to date of payment.
At December 31, 2006, Rex has deferred gross profit of
A. $105,000
B. $99,000
C. $90,000
D. $76,500
Correct!
The gross profit percentage on the machine is 30% [($525,000 – $367,500)/$525,000]. Total gross profit is $157,500 ($525,000 – $367,500). This amount is deferred until cash is collected.
Under the installment method, 30% of each cash receipt is recognized gross profit. The $150,000 installments must be principal amounts, because they sum to the face value of the note. Interest is paid in addition to the installment amounts. As of December 31, 2006, only one $150,000 installment was collected.
Total gross profit on sale
$157,500
Less gross profit recognized on cash collections:
($75,000 + $150,000).30
(67,500)
Equals deferred gross profit at 31 December 2006
$90,000
.