Let us assume that it is desired to cancel a contract, the original amount of which was $3,600, $900 being profit and the payments amounting in all to $400; i.e., the original amount of $3,600 has been reduced by $400 after debiting interest and all charges. For the sake of simplicity, this reduction in balance is regarded as the amount paid in, as in practice, of course, it is only the reduction on the debt which affects the profits earned.

The original profit would be credited to Gain on Sales account, and reference to the annual analytical sheets of that account (Section 269), or to the sub-ledger if similar to that of Form 15 (Section 23), will show that at the closing of the books $80 of profit had been earned and $820 remained in the Gain account. Three figures have then been determined, viz.:

1. Cost of the property, $3,600 - $900 = $2,700.

2. Balance remaining in Gain account, $900 - $80 = $820.

3. Balance due on the contract, $3,200.

And there is still to be determined -

4. Cancellation profits.

It is required to debit Real Estate with the property reacquired, and Gain on Sales with the amount remaining therein; and to credit Contracts with the balance to be extinguished, and Cancellation Profits with the earned profit not yet written off to Profit and Loss account.

Since the debits are $3,520 ($2,700 + $820), and the credit is $3,200, the remaining credit must be $320. The journal entry, therefore, is as follows:

Property Account.......................

$2,700

Gain on Sales.......................

820

To Contracts................................

$3,200

" Cancellation Profits...................

320

To cancel contract No...........................

By means of these entries, the Gain on Sales account is kept "clean" and all amounts relating to this transaction are eliminated. This is a matter of importance, especially in the case of subdivision contracts. (See Section 181.)