CHAPTER TWO

2. AGENCY AND PRINCIPAL, HEAD OFFICE AND BRANCH

2.1 Introduction
As a business enterprise grows, it may establish one or more branches to market its products over a large
territory. Frequently the development of these areas cannot be adequately accomplished by salespersons
traveling from the head office. The use of catalogs with mail orders or shipments on consignment may
increase sales but may still fail to accomplish the desired results. The establishment of sales headquarters in
several districts may be the means of achieving marketing objectives. Selling activities are conducted from
sales offices at different locations under the direction of the home office. Customers deal, not with the
headquarters of the business, but with an outlying sales unit. Contact with the organization is more easily
and quickly made. The desired goods or services are more readily available.

Chapter Objectives
After studying this chapter, you should be able to:
 Describe the characteristics of agency, principal, head office and branch.
 Distinguish agency and branch.
 Describe accounting for sales agency.
 Describe accounting for branches.
 Identify the reciprocal ledger accounts and their use.
 Explain the alternative methods of billing merchandise to branches.
 Prepare combined financial statements for home office and branch.
 Describe transactions between branches.

2.2 Characteristics of Principal and Agency and Branch

The tem branch is used to describe a business unit located at some distance from the home office. This unit
carries merchandises, makes sales, approves customers’ credit, and makes collections from its customers. A
branch may obtain merchandises solely from the home office, or a portion may be purchased from outside
suppliers. The cash receipts often are deposited in a bank account belonging to the home office; the branch
expenses then are paid from an imprest cash fund or a bank account provided by the home office. As the
imprest cash fund is depleted, the branch submits a list of cash payments supported by vouchers and
receives a check or a transfer from the home office to replenish the fund. The use of an imprest cash fund
gives the home office considerable control over the cash transactions of the branch. However, it is
common practice for a large branch to maintain its own bank accounts.

A sales agency, sometimes referred to simply as ‘agency’ on the other hand; is an organization that sells
goods on behalf of another organization. The sales agent keeps merchandises without assuming risk of non-
salability.

2.3 Distinguishing Agency and Branch

Sales Agency: Sales agency is a term applied to a business unit that performs only a small portion of the
functions associated branch. The sales agency is not an autonomous operation but acts on behalf of the
home office. The agency may display and demonstrate sample merchandise, take orders, and arrange for
delivery. The orders typically are filled by the home office because a sales agency usually does not stock
inventory. Merchandise selection, advertising, granting of credit, collection of accounts, and other aspects
of operating the business usually are conducted by the home office.

Branch: The term Branch is used to describe a business unit located at some distance from the Home
Office. Branches are economic and accounting entities. However, branches are not legal entity. Branches

BY G.N Page 1
may carry merchandise obtained from Home Office, make sales, approve customers’ credit, and make
collections from its customers. A branch usually has more autonomy and a greater range of services than a
sales agent does. However, the extent of autonomy and responsibility of a branch varies, even among
different branches of the same business enterprise. A branch typically stocks merchandises and fills
customers’ orders.

Division: Division is a business segment or a business enterprise which generally has more autonomy than
a branch. Division may be as separate company or may not be a separate company. If the division is not a
separate company, the accounting procedures are the same as Branch. If the division is a separate company
(subsidiary company), the financial accounting requires consolidation, which will be discussed in later
topics.
Differences between Sales Agency, Branch and Division
Characteristics Sales Agency Branch Division
Degree of Autonomy Low Moderate High
Accounting Entity No Yes Yes
Legal Entity No No Possible
Economic Entity No yes Possible

Article 44 of the Commercial Code of Ethiopia, defines a commercial agent as follows:

1. A commercial agent is a person or business organization, not bound to a trader by contract of
employment and carrying out independent activities, who is entrusted by a trader with representing
him/her permanently in a specified area and dealing or making agreements in the name and on
behalf of the trader.
2. Unless otherwise provided in the agency agreement, contracts entered into by a commercial agent
shall become effective without conformation by the trader.
3. A commercial agent normally acts as agent and may act as a broker. He is a trader.

Article 46: Duties of commercial agent:

1. A commercial agent shall safeguard the principal’s interests with the care due by a good trader.
2. He shall:
a) carry out all instructions of the principal;
b) inform the principal of all contacts negotiated or entered into by him;
c) Send to the principal periodical reports on his activities and all such information as may be
required on the state of affairs with in the area where he acts.

Article 47: Prohibition from carrying on private trade:

(1) A commercial agent may carry on any private trade which is not similar to the trade carried on by the
principal. The agency agreement may be cancelled and damages may be due where the agent carries on
trade similar to the trade carried on by the principal.
(2) Unless otherwise provided in the agency agreement, a commercial agent may not act in the area
specified in the agreement on behalf of traders other than the principal.
(3) In no case may a commercial agent act, in the area specified in the agency agreement, on behalf of
traders who carry on a trade similar to the trade carried on by the principal. The agency agreement may
be cancelled and damages may be due where the agent disagree this prohibition.

2.4 Accounting for Sales Agency and branches

The typical agency does not require a complete set of books. Customarily, summaries of the working fund
receipts and disbursements and records of sales to customers are sufficient. Summaries of working fund
disbursements accompanied by supporting evidences in the form of paid vouchers are sent to the home

BY G.N Page 2
office. A sales agency that does not carry an inventory of merchandise, maintain receivables, or make
collections has no need for a complete set of accounting records. All that is needed is a record of sales to
customers and a summary of cash payments supported by vouchers.

When the home office has more than one sales agency and wants to measure the profitability of each sales
agency, it will establish a separate revenue and expense general ledger in the name of the agency. The cost
of goods sold by each agency should also be recorded.
For example, Sales: Bhair Dar Agency; Rent Expense: Bahir Dar Agency; Cost of goods sold: Bahir Dar
Agency etc. If there is no desire to summarize agency operations separately, the home office may record
transactions of the agency in the revenue and expense accounts used for its own transactions. After these
accounts are closed, the income summary account reports the results for combined operations.

When the perpetual inventory system is used, shipments of the goods sold to customers of Bahir Dar
Agency are debited to Cost of goods sold: Bahir Dar Agency and credited to Inventories. When the
periodic inventory system is used, shipments of goods sold by an agency may be recorded by a debit to
Cost of Goods Sold: Bahir Dar Agency and a credit to Shipments to Agencies at the end of the accounting
period.Whereas, a memorandum record is maintained during the period listing the cost of goods sold
shipped to fill sales orders received from agencies. At the end of the period Shipments to agencies ledger
account if offset against the total of the beginning inventories and purchase to measure the cost of goods
available for sale for the home office in its own operations.

An imprest cash fund generally is maintained at the sales agency for the payment of the operating expense.
In adopting such imprest fund system for the agency working fund, the home office writes a check to the
agency for the fund. Establishing of the fund is recorded on the home office books by a debit Agency
Working Fund account and a credit to Cash. Whenever the fund runs low, the agency will request fund
replenishment at the end of each fiscal period. The request is normally accompanied by an itemized and
authenticated statement of disbursements and the paid vouchers. Upon sending the agency a check in
replenishment of, the home office, debits expense accounts or other accounts for which disbursement from
the fund were reported and credits Cash.

Office furniture or other assets located at a sales agency may be carried in a separate ledger account by the
home office or control over such assets may be achieved by use of a subsidiary ledger with a complete
record of each asset showing cost, location, and any other relevant information.

Accounting for Branches

The accounting system of one business enterprise with branches may provide for complete set of
accounting records at each branch; policies of another such enterprise may keep all accounting records in
the home office. For example, in some business firms such as branches of drug and grocery chain stores
submit daily reports and business documents to the home office, which enters all transactions by branches
in computerized accounting records kept in a central location. The home office may not even conduct
operations of its own; it may serve as an accounting and control center for the branches.

On the other hand, a branch may maintain a complete set of accounting records consisting of journals,
ledgers, and a chart of accounts similar to those of an independent business enterprise. Financial
statements are prepared by the branch accountant and forwarded to the home office. The number and type
of ledger accounts, the internal control structure, the form and content of the financial statements, and the
accounting polices generally are prescribed by the home office. Branch accounting systems may provide
for the maintenance of branch records at the home office, at both branch and home office or at branch.

BY G.N Page 3
When the home office keeps the complete records summarizing branch activities, branch transactions may
be recorded in the home office journals and legers or in a separate set of records. Data to be recorded are
supplied by the branch in the form of either original documents evidencing branch transactions or
memorandum records summarizing branch transactions supported by original vouchers.
A system where by both the branch and the home office maintains detailed records of branch transactions is
sometimes adopted. In such a case, the branch may maintain the books of original entry for all transactions
in duplicate. Copies of the books of original entry are sent to the home office, where data are posted to
branch accounts maintained separately or included in the home office general ledger. At the end of the
period the home office adjusts and closes the branch accounts and determines the branch earnings.

When the branch accounting records are maintained at the branch; the branch keeps the books of original
entry and posts to ledger accounts. Financial statements are prepared the branch periodically and are
submitted to the home office and verified by the company’s internal auditors.

This chapter focuses on a branch operation that maintains a complete set of accounting records.
Transactions recorded by a branch should include all controllable expenses and revenues for which the
branch manager is responsible. If the branch manager has responsibility over all branch assets, liabilities,
revenues and expenses, the branch accounting records should reflect this responsibility. Expenses such as
depreciation are not subject to control by branch manager; therefore, both the branch plant assets and the
related depreciation ledger accounts generally are maintained by the home office.

2.5 Reciprocal Ledger Accounts and their Reconciliation

The accounting records maintained by a branch include a Home Office ledger account that is credited for
all merchandises, cash, or other assets provided by the home office; it is debited for all cash, merchandise,
or other assets sent by the branch to the home office or other branches. The Home Office account is a
quasi-ownership equity account that shows the net investment by the home office in the branch. At the end
of an accounting period when the branch closes its accounting records, the income summary account is
closed to the Home Office account; a net loss decreases this balance.

In the home office accounting records, a reciprocal ledger account with a title such as Investment in Branch
is maintained. This noncurrent asset account is debited for cash, merchandise, and services provided to the
branch by the home office, and for net income reported by the branch. It is credited for cash or other assets
received from the branch, and for net losses reported by the branch. Thus the Investment in Branch reflects
the equity method of accounting. A separate investment account generally is maintained by the home office
for each branch. If there is only one branch, the account title is likely to be Investment in Branch; if there
are numerous branches, each account title includes a name or number to identify each branch.
Expenses Incurred by Home Office and Allocated to Branches
Some businesses follow a policy of notifying each branch of expenses incurred by the home office on the
branch’s behalf. Plant assets located at a branch generally are carried in the home office accounting
records. If a plant asset is acquired by the home office for the branch, the journal entry for the acquisition is
a debit to an appropriate asset account such as Equipment: Branch and credit to Cash or an appropriate
liability account. If the branch acquires a plant asset, it debits the Home Office ledger account and credits
cash or an appropriate liability account. The home office debits an asset account such as Equipment:
Branch and credits Investment in Branch.

The home office also usually acquires insurance, pays property and other taxes, and arranges for
advertising that benefits all branches. Clearly, such expenses as depreciation, property taxes, insurance, and
advertising must be considered in determining the profitability of a branch. A policy decision must be
made as to whether these expenses data are to be retained at the home office or are to be reported to the

BY G.N Page 4
branches so that the income statement prepared for each branch will give a complete picture of its
operations. An expense incurred by the home office and allocated to the a branch is recorded by the home
office by a debit to Investment in Branch and a credit to an appropriate expense ledger account; the branch
debits an expense account and credits Home Office.
If the home office does not make sales, but functions as only as an accounting and control center, most or
all of its expenses may be allocated to the branches. To facilitate, comparison of the operating results of the
various branches, the home office may charge each branch interest on the capital invested in the branch.
Such interest expense recognized by the branches would be offset by interest revenue recognized by the
home office and would not be displayed in the combined income statement of the business enterprise as a
whole.

2.6 Alternative Methods of Billing Merchandise Shipments to Branches

The shipment of merchandise to home office does not constitute a sale because ownership of the
merchandise does not change. Three alternative methods are available to the home office for billing
merchandises shipped to its branches. The shipments may be billed at:
1. at home office cost,
2. at a percentage above home office cost
3. At the branches retail selling price.

1. Billing of merchandise at home office cost: this is the simplest procedure and most widely used. It
avoids complication of unrealized gross profit in inventories and permits the financial statements of
branches to give a meaningful picture of operations. However, billings of merchandises at home office
cost attributes all gross profit of the enterprise to the branches, even though some of the merchandises
may be manufactured by the home office. Under these circumstances, home office cost may not be the
most realistic basis for billing of shipments to branches. generally;
Advantage: widely used because of its simplicity
Disadvantage: attributes all gross profits of the business to the branches.
2. Billing of merchandise at a percentage above home office cost: this method may be intended to
allocate a reasonable gross profit to the home office. When merchandise is billed to a branch at a price
above home office cost, the net income reported by the branch is understated and the ending
inventories are overstated for the enterprise as a whole. Adjustments must be made by the home
office to eliminate the excess of billed prices over cost (intercompany profits)in the preparation
ofcombined financial statementsfor the home office and the branch. These factors must be recognized
by the home office and given effect up on its accounting records in summarizing branch operations.
Generally :
Advantage: is able to allocate a reasonable gross profit to the home office.
Disadvantage: the net income reported by the branch may be understated and the ending inventories at
branch are overstated for the enterprise as a whole.
3. Billing of merchandise at the branches retail-selling price: Billing shipments to a branch at branch
retail selling prices may be based on a desire to strengthen internal control over inventories and to
conceal information concerning branch earnings from branch officials. The inventories ledger account
of the branch shows the merchandise received and sold at retail selling prices. Consequently, the
account will show the ending inventories that should be on hand at retail prices. The home office record
of shipments to a branch, when considered along with sales reported by the branch, provides a
perpetual inventory stated at selling prices. If the physical inventories taken periodically at the branch
do not agree with the amounts thus computed, an error or theft may be indicated and should be
investigated promptly. generally:
Advantage: to increase the internal control over inventories at branches.

BY G.N Page 5
 Disadvantage: no gross profit assigned to the branches and the branch’s net loss will equal its operating
expenses.

Illustrative Journal Entries for Operations of a Branch (at home office cost)
To illustrate accounting for the operations of a branch, assume that on September 1, Abay Company
establishes its branch in Gondar. Abay Company bills merchandise to Gondar Branch at home office cost
and that Gondar branch maintains complete accounting records and prepares financial statements. Both
home office and branch use the perpetual inventory system Equipment used at branch is carried in the
home office accounting. Certain expenses such as advertising and insurance, incurred by the home office
on behalf of the branch, are billed to the branch. Transactions and events during the first year (2005) of
operations of Gondar Branch are summarized as follows:
1. Cash of Birr 2,000 was forwarded by the home office to Gondar Branch.
2. Merchandise with a home office cost of Birr 80,000 was shipped by the home office to Gondar
branch.
3. Equipment was acquired by Gondar branch for Birr 1,000, to be carried in the home office
accounting records. (Other plant assets for Gondar Branch generally are acquired by the home
office.
4. Credit sales by Gondar branch amounted to Birr 100,000; the branches cost of merchandises sold
were Birr 55,000.
5. Collections of trade accounts receivable by Gondar branch amounted to Birr 72,000.
6. Payments for operating expenses by Gondar branch totals Birr 20,000.
7. Cash of Birr 47,500 was remitted by Gondar branch to the home office.
8. Operating expenses incurred by the home office and charged to Gondar branch totaled Birr 5,000.

Required: 1. Record the above transactions and events by the home office and by branch
2. Prepare reciprocal ledger accounts
3. Record the adjusting and closing entries by the home office and the closing entries by the
branch.

1. Home Office Accounting Records Gondar Branch Accounting Records

1. Investment in 1. Cash 2,000
Gondar Branch 2,000 Home Office 2,000
Cash 2,000
2. Investment in
Gondar Branch 80,000 2. Merchandise
Merchandise Inventories 80,000
Inventories 80,000 Home office 80,000
3. Equipment
Gondar Branch 1,000 3. Home office 1, 000
Investment in Cash 1,000
Gondar Branch 1,000
4. None 4. Trade A/ Receivable 100,000
Sales 100,000
Cost of Goods Sold 55,000
Merchandise
Inventories 55,000
5. None 5. Cash 72,000
Trade A/ R 72,000
6. None 6. Operating Expenses 20,000

BY G.N Page 6
 Cash 20,000
7. Cash 47,500 7. Home Office 47,500
Investment in Cash 47,500
Gondar Branch 47,500
8. Investment in 8. Operating Expense 5,000
Gondar Branch 5,000 Home Office 5,000
Operating
Expenses 5,000
Note: If the branch obtains merchandises from outsides as well as from the home office, the merchandise
acquired from the home office may be recorded in a separate merchandise inventories from home office
ledger account.
In the home office accounting records, the Investment in Gondar ledger account has a debit balance of Birr
38,500 before the accounting records are closed and the branch net income of Birr 20,000 ( 100,000-
55,000-20,000-5000= 20,000) is transferred to the Investment in Gondar Branch ledger account) as shown
below in the table.

2. Reciprocal Ledger Accounts in the Home Office Records

Investment in Gondar Branch Account

Date Explanation Debit Credit Balance (Dr.)
2005 Cash sent to branch 2,000 2,000
Merchandise billed to branch at home office cost 80,000 82,000
Equipment acquired by branch carried in home
Office accounting records 1,000 81,000()
Cash received from branch 47,500 33,500
Operating expenses billed to branch 5,000 38,500
Reciprocal Ledger Accounts in Gondar Branch Records
Home Office Account
Date Explanation Debit Credit Balance (Cr.)
2005 Cash received from home office 2,000 (2,000)
Merchandise received from home office 80,000 (82,000)
Equipment acquired by branch 1,000 (81,000)
Cash sent to home office 47,500 (33,500)
Operating expenses billed home office 5,000 (38,500)

Therefore, the reciprocal ledger account in accounting records of Home Office prior to adjusting and
closing entry; and reciprocal ledger accounts in accounting records of Gondar Branch prior to closing entry
are as shown above.

3) Home office Adjusting and closing entries and Branch closing entries

Home Office Accounting Records Gondar Branch Accounting Records

Adjusting and Closing entries Closing Entries
________________________________________________________________________
1. None 1. Sales 100,000
Cost of goods sold 55,000
Operating Expenses 25,000
Income Summary 20,000
2. Investment in 2. Income

BY G.N Page 7
 Gondar Branch 20,000 Summary 20,000
Income Gondar Branch 20,000 Home Office 20,000
3. Income Gondar
Branch 20,000 3. None
Income
Summary 20,000

Combined Financial Statements for Home Office and Branch

 A balance sheet for distribution to creditors, stockholders, and government agencies must show the
financial position of a business enterprise having branches as a single entity.
 The starting point in the preparation of a combined balance sheet would be the adjusted trial balance of
the home office and of the branch.
 The reciprocal ledger accounts are eliminated because they have no significant when the branch and
home office report as a single entity.
 The assets and liabilities of the branch are substituted for the Investment in Branch ledger account
included in the home office trial balance. Similar accounts are combined to produce a single total
amount for cash, trade accounts receivable, and other assets and liabilities of the enterprise as a whole
in the combined financial statement.
 The balance of the Home office account is against the balance of the Investment in Branch account;
also any receivables and payables between the home office and the branch (or between branches) are
eliminated.
 The operating results of the enterprise are shown by an income statement in which the revenue and
expenses of the branches are combined with corresponding revenue and expense for the home office.
Any intercompany profits or losses are eliminated.

Working Paper for Combined Financial Statements

A working paper for combined financial statements has three purposes.
1. to combine ledger account balances for like revenue, expenses, assets and liabilities,
2. to eliminate the reciprocal accounts,
3. to eliminate any intercompany profits or losses
Note that any eliminations or offsetting of balances is done only in the working paper. No entry is to be
made in the accounting of either Home Office or Branch because its only purpose is to facilitate the
preparation of combined financial statements.

Illustration: The following working paper provides the information for combined financial statements.
The adjusted trial balance for the home office is assumed figures. The adjusted trial balance for the Gondar
branch is based on the foregoing transactions and events.

Abay Company
Working Paper for Combined Financial Statements of Home Office and Branch
For the Year Ended December 31, 2005
(Perpetual Inventory System: Billing at Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Explanation
Dr(Cr) Dr(Cr) Dr(Cr) Dr(Cr)
Income Statement
Sales (280,000) (100,000) - (380,000)
Cost of goods sold 80,000 55,000 - 135,000

BY G.N Page 8
Operating Expenses 65,000 25,000 - 90,000
Net Income 135,000 20,000 - 155,000
Totals - 0- -0- -0-
Statement of Retained
Earnings
Retained earnings Jan 1, 2005 (50,000) - - (50,000)
Net Income(From I/s) (135,000) (20,000) - (155,000)
Dividend Declared 75,000 _ - 75,000
Retained Earnings Dec. 31,2005 _ _ - 130,000
Balance Sheet - -0-
Cash 27,500 5,500 - 33,000
Trade Accounts Receivable 56,000 28,000 - 84,000
Merchandise Inventories 43,000 25,000 - 68,000
Investment in Gondar branch 38,500 (a) (38,500) -
Equipment 75,000 - 75,000
Accumulated depreciation Eqt. (5000) - - (5,000)
Accounts Payable (25,000) - - (25,000)
Home Office - (38,500) (a) 38,500 -
Common stock, Birr 100 par (100,000) _ - (100,000)
Retained earnings (From S R/E ) (130,000)
-0- -0- -0- -0-

Note:
(a) To eliminate reciprocal ledger accounts.

Then the combined financial statements are prepared from the above working paper
Abay company
Income Statement
For the Year Ended December 31, 2005

Sales…………………………………………………380,000
Less: Cost of goods sold…………………………….135, 000
Gross profit on sale ……………………………….…245,000
Less: Operating Expenses ………………………….…90,000
Net Income ………………………………………….155, 000
Basic earnings per share of common stock
(NI/Common stock 155,000/1000)……………………….155
Abay company
Statement of Retained Earnings
For the Year Ended December 31, 2005
Beginning Retained earnings Jan 1, 2005…………....50,000
Add: Net Income (From I/s)…………………….….155, 000
Subtotal……………………………………..…205,000
Less: Dividend Declared ……………………….…....75,000
Ending Retained Earnings Dec. 31, 2005…………..280,000
Abay company
Balance Sheet
December 31, 2005

BY G.N Page 9
 Assets
Cash …………………………………………………33,000
Trade Accounts Receivable………………………….84, 000
Merchandise Inventories …………………………….68, 000
Equipment……………………………….. 75,000
Less: Accumulated depreciation Eqt……..(5,000)…...70,000
Total assets ………………………………………….255, 000
Liabilities
Trade Accounts Payable..................................................…...25,000
Stockholders’ equity
Common stock, Birr 100 par………………...100,000
Ending Retained earnings (From S R/E.…….130, 000…….230, 000
Total liabilities & stockholders’ equity…………………...255, 000

Billing of merchandiseat a percentage above home office cost: Illustrative Journal Entries for
Operations of a Branch (above home office cost)

For example, assume that merchandises costing at Birr 12,000 are shipped by a home office to branch, and
the branch is billed for the merchandise at 10% above cost or Birr 13,200.The shipment may recorded as
follows:

Transaction Home Office Books Branch Books

Transfer of Investment Branch 13,200 Shipments
merchandise at Home Shipments to Branch............12,000 From HO..........13,200
office cost Br. 12,000 Unrealized Home Office.....13,200
and billing to branch Intercompany Profits .....................1200
at Br. 13,200

The branch records the goods at their billed price. The home office book debits the Branch account at the
billed price and credits Shipments to Branch for the actual cost of the merchandise; and Unrealized
Intercompany profit is credited for the difference between the billed price and the actual cost of the
merchandise shipped. Branch and home office accounts are then reciprocal. Merchandise shipments
reported at cost of merchandise can be subtracted from the sum of the beginning inventory and the
purchases in arriving at the cost of merchandise available for home office sales. The balance intercompany
profit account is properly recognized as an offset against the branch account in arriving at the actual
investment in branch.

As the branch sells the goods acquired from the home office and recognizes profit for the difference
between the billed price and the sales price, the difference between the cost and the billed price, reported
by the home office in the unrealized profit account, is properly recognized as earned. At the time of
shipment, the home office defers recognition of such earnings until the end of the fiscal period. At this
time, the unrealized profit account is reduced to a balance equal to the unrealized profit actually present in
the branch inventory, and the amount of the reduction is added to the income reported by the branch.

For example, referring to the preceding illustration, unrealized profit of Birr 1,200 is recorded on the books
of the home office upon the shipment of merchandise, cost Birr 12,000, at a billed price of Birr 13,200.

BY G.N Page 10
At the end of the period the branch reports an inventory of Birr 11,000. The actual cost of the branch
inventory is Birr 10,000 (11,000/1.10).The unrealized profit balance of Birr 1,200 is excessive and should
be reduced to Birr 1,000 (11,000-10,000). The branch recognizes cost of goods sold at Birr 2,200(13,200-
11,000). The actual cost of the goods sold by the branch is Birr 2000, (2200/1.10). Therefore the earnings
reported by the branch are understated and should be increased by Birr 200.

Assume that the branch books report net income of birr 6000, journal entries to summarize branch and
home office books are as follows:

Transaction Home Office Books Branch Books

1) To close branch earnings to 1) none 1) Income
home office account on branch 2)investment in Branch 6,000 summary 6,000
books Branch Home
2)To recognize branch earnings on income 6,000 office 6,000
home office books
To bring unrealized profit account
Unrealized inter-
to required balance and to correct
Company profit 200
branch earnings Branch none
Income 200
To close branch earnings into Branch
income summary account Income 6,200
Income none
Summary 6,200

The balance of unrealized intercompany profit is now Birr 1,000 and reports the overstatement in the
branch investment balance at the end of the period. The credit of 200 to the branch income account on the
home office books corrects the branch earnings for the overstatement of the branch cost of goods sold.

Similar information as in the previous example, except that the home office bills merchandise shipped to
Gonder branch at 25% markup of the cost or 20% of billed price. Thus, the shipment of merchandise
costing $80,000 will be recorded at the home office and branch as follows:
1. Investment in Gondar Branch…100,000 1. Merchandise
Merchandise Inventories………..80,000 Inventories 100,000
Unrealized inter- Home office 100,000
Company profit…………..…. 20,000
2. Credit sales by Gondar branch amounted to Birr 100,000; the branches cost of merchandises sold were
Birr 68, 750. the journal entry on the book of Ho and branch are as follow:
2. None 2. Trade A/ Receivable 100,000
Sales 100,000
Cost of Goods Sold 68, 750
Merchandise
Inventories 68, 750
The other transactions are similar with the forgone transaction.
The following working paper provides the information for combined financial statements. The adjusted
trial balance for the home office is assumed figures. The adjusted trial balance for the Gondar branch is
based on the foregoing transactions and events.

Abay Company
Working Paper for Combined Financial Statements of Home Office and Branch

BY G.N Page 11
 For the Year Ended December 31, 2005
(Perpetual Inventory System: Billing above Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Explanation
Dr(Cr) Dr(Cr) Dr(Cr) Dr(Cr)
Income Statement
Sales (280,000) (100,000) - (380,000)
Cost of goods sold 80,000 68,750 (a) (13,750) 135,000
Operating Expenses 65,000 25,000 - 90,000
Net Income 135,000 6,250 (b) 13,750 155,000
Totals - 0- -0- -0-
Statement of Retained
Earnings _
Retained earnings Jan 1, 2005 (50,000) (50,000)
Net Income(From I/s) (135,000) (6,250) (b)(13,750) (155,000)
Dividend Declared 75,000 _ - 75,000
Retained Earnings Dec. 31,2005 _ _ - 130,000
Balance Sheet - - -0-
Cash 27,500 5,500 - 33,000
Accounts Receivable 56,000 28,000 - 84,000
Merchandise Inventories 43,000 31,250 (a) (6,250) 68,000
Investment in Gondar branch 58,500 (c) (58,500) -
Allowance for Overvaluation of
Inventories: Gondar Branch (20,000) - (a) 20,000 -
Equipment 75,000 - - 75,000
Accumulated depreciation Eqt. (5000) - - (5,000)
Accounts Payable (25,000) - - (25,000)
Home Office - (58,500) (c) 58,500 -
Common stock, Birr 100 par (100,000) _ - (100,000)
Retained earnings (From S R/E ) (130,000)
-0- -0- -0- -0-

Note:
(a) To reduce ending inventories and cost of goods sold of branch to cost, and to eliminate unadjusted
balance of Allowance of Overvaluation of Inventories: Gondar Branch.
(b) To increase income of home office by portion of merchandise markup that was realized by branch
sales.
(c) To eliminate reciprocal ledger accounts.

Combined Financial Statements: the combined financial statements are the same as the preceding
combined financial statements when the merchandises are shipped at home office cost; because the amount
in the combined column of the working paper are the same as the working paper prepared on page 10.

Home Office Adjusting and Closing Entries and Branch Closing Entries
Home Office Accounting Records Adjusting and Closing Entries
Investment in Gondar Branch 6,250

BY G.N Page 12
 Income: Gondar Branch 6,250
(To record net income reported by Gondar Branch)

Allowance for Overvaluation of Inventories: Gondar Branch 13,750

Realized Gross Profit: Gondar Branch sales 13,750
(To reduce allowance to amount by which ending inventories of Branch exceed cost)

Realized Gross profit: Gondar Branch 13,750

Income: Gondar branch 6,250
Income Summary 20,000
(To close branch net income and realized gross profit to income summary ledger account)
After the foregoing journal entries have been posted, the ledger accounts in the home office general ledger
used to record branch operations are as follows:

Investment in Gondar Branch

Date Explanation Debit Credit Balance (Dr.)
2005 Cash sent to branch 2,000 2,000
Merchandise billed to branch at markup
of 25% above home office cost ,or 25%
of Billed price 100,000 102,000
Equipment acquired by branch carried 1,00
on home office accounting records 0 101,000
Cash received from branch 47,500 53,500
Operating expenses billed to branch 5,000 58,500
Net income for 2005 reported by branch 6,250 64,750
Allowance for Overvaluation of Inventories: Gondar Branch
Date Explanation Debit Credit Balance(Cr.)
2005 Markup on merchandise shipped to 20,0
branch during 2005 ( 25% of cost) - 00 20,000
Realization of 25% markup on
merchandise sold by branch during 2005 13,750 - 6,250

Realized Gross Profit: Gondar Branch Sales

Date Explanation Debit Credit Balance(Cr.)
2005 Realization of 25% markup on
merchandise sold by branch during 2005 13,750 (13,750)
Closing entry 13,750 -0-
Income: Gondar Branch
Date Explanation Debit Credit Balance (Cr.)
2005 Net income for 2005 reported by branch 6,250 (6,2500
Closing entry 6,250 - -0-

In the separate balance sheet for the home office, the Birr 6,250 credit balance of the Allowance of
Overvaluation of Inventories: Gondar Branch ledger account is deducted from the Birr 64,750 debit
balance of Investment in Gondar Branch account, thus reducing the carrying amount of the investment
account to a cost basis with respect to shipments of merchandise to the branch. In the separate income
statement for the home office, the Birr 13,750 realized gross profit on Gondar Branch sales may be
displayed following gross margin on sales Birr 200.000 (280,000-80,000)=Birr 200,000).

BY G.N Page 13
 Gondar Branch Accounting Records Closing Entries
Sales 100,000
Operating expenses 25,000
Cost of Goods Sold 68,750
Income summary 6,250
(To close revenue and expense ledger accounts)

Income summary 6,250

Home Office 6,250
(To close the net income in the income summary account to the Home Office account)

After the closing entries have been posted by the branch, the following Home Office ledger account in the
accounting records of Gondar: Branch has a credit balance of Birr 64,750, the same as the debit balance of
the

Investment in Gondar; Branch account in the accounting records of the home office:
Home Office
Date Explanation Debit Credit Balance(Cr.)
2005 Cash received from home office - 2,000 2,000
Merchandise received from home office - 100,000 102,000
Equipment acquired 1,000 - 101,000
Cash received from branch 47,500 - 53,500
Operating expenses billed by home office - 5,000 58,500
Net income for 2005 reported by branch - 6,250 64,750

Treatment of Beginning Inventories Priced Above Cost

If the a home office and branch use the periodic inventory system, the home office debits Investment in
Branch for the billed price of the merchandise shipped, credits Shipments to Branch for the home office
cost of the merchandises shipped, and credits any excess of the billed price over cost to Allowance to
Overvaluation of Inventories : Branch. The branch debits Shipments from Home Office and credits Home
Office at billed price. At the end of the accounting period, the home office reduces (debits) Allowance for
Overvaluation of Inventories: Branch for the amount of Overvaluation applicable to the branch’s cost of
goods sold and credits the amount of the reduction to the Realized Gross Profit: Branch ledger account.

Illustration: Referring to the Abay Company, assume that both the home office and Gondar Branch
adopted the periodic inventory system and the beginning inventories are carried at an amount above home
office cost by Gondar Branch for the second year of operations(2006).

The beginning inventories for 2006 were carried by Gondar Branch at 31,250, or 125% of the cost of Birr
25,000 (25,000X1.25=31,250). Assume that during 2006 the office shipped merchandise to Gondar Branch
that cost Birr 60,000 and was billed at Birr 75,000, and that Gondar branch sold for Birr 112,250 the
merchandise that was billed at Birr 66,250. The journal entries to record shipments and sales under the
periodic inventory system are illustrated below:

Home Office Accounting Records Gondar Branch Accounting Records

1. Investment in 1. Shipments from
Gondar Branch 75,000 Home Office 75,000

BY G.N Page 14
 Shipments to Home Office 75,000
Gondar Branch 60,000
Allowance for Overvaluation
of inventories: Gondar Branch 15,000
2. None 2.Cash (or Trade A/R) 112,250
Sales 112,250

The flow of merchandise for Gondar branch during 2006 is summarized as follows:
Abay Company
Flow of Merchandise for Gondar Branch, during 2006
Billed Home Markup (25% of cost;
Price Office Cost or 20% of Billed price)

Beginning inventories Br. 31,250 Br. 25,000 Br. 6,250

Add: Shipments from home office 75,000 60,000 15,000
Available for sale 106,250 85,000 21, 250
Less: ending inventories (40,000) (32,000) (8,000)
Cost of goods sold 66,250 53,000 13,250

The following four home office ledger accounts show the end of period adjusting and closing entries of the
branch on December 31, 2006:
Branch Closing Entries:
(1)Inventory (ending) 40,000
Cost of Goods Sold 66,250
Inventory (beg.) 31,250
Shipments from Home Office 75,000

2) Sales 112,250
CGS 66,250
Operating expenses 24,000
Income Summary 22,000
(3) Income Summary 22,000
Home Office 22,000
Home Office Adjusting (1 and 2) and Closing Entries (3):
(1) Investment in Branch 22,000
Income: Mason Branch 22,000
(2) Allowance for Overvaluation of Inventories 13,500
Realized Gross Profit:Mason Branch 13,500

(3) Realized Gross Profit 13,250

Income: Mason Branch 22,000
Income Summary 55,250

The activities for the branch for 2006 are reflected in the following two home office ledger accounts and
the reciprocal Home Office ledger account of the branch:

Investment in Gondar Branch

Date Explanation Debit Credit Balance(Cr.)

BY G.N Page 15
 2006 Balance, Dec. 31,2005 - - 64,750
Merchandise billed to branch at markup
of 25% above home office cost ,or 20%
of Billed price 75,000 - 139,750
Cash received from branch - 109,750 30,000
Operating expenses billed to branch 4,000 - 34,000
Net income for 2006 reported by branch 22,000 - 56,000

Allowance for Overvaluation of Inventories: Gondar Branch

Date Explanation Debit Credit Balance(Cr.)
2006 Balance, Dec.31,2005 - - (6,250)
Markup on merchandise shipped to branch
during 2006 ( 25% of cost) - 15,000 (21,250)
Realization of 25% markup on
merchandise sold by branch during 2006 13,250 - (8,000)

Realized Gross Profit: Gondar Branch sales

Date Explanation Debit Credit Balance(Cr.)
2006 Realization of 25% markup on -
merchandise sold by branch during 2006 - 13,250 (13,250)
Closing entry 13,250 - -0-
Income: Gondar Branch
Date Explanation Debit Credit Balance(Dr.)
2006 Net income for 2006 reported by branch - (22,000)
Closing entry 22,000 22,000 -0-

The Home Office account in the branch ledger shows the following activity and closing entry on December
31, 2006:
Home Office
Date Explanation Debit Credit Balance(Cr
.)
2006 Balance Dec. 31, 2005 (64,750)
Merchandise received from home office 75,000 (139,750)
Cash sent to home office 109,750 (30,000)
Operating expenses billed by home office 4,000 (34,000)
Net income for 2006 reported by branch 22,000 (56,000)

Abay Company
Working Paper for Combined Financial Statements of Home Office and Branch
For the Year Ended December 31, 2006
(Periodic Inventory System: Billing above Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Explanation
Dr(Cr) Dr(Cr) Dr(Cr) Dr(Cr)

BY G.N Page 16
 Income Statement
Sales (400,000) (112,250) (512,250)
Inventories, Dec 31, 2005 50,000 31,250 (b) (6,250) 75,000
Purchases 300,000 - - 300,000
Shipments to Gondar Branch (60,000) - (a) 60,000 -
Shipments from home office 75,000 (a)(75,000) -
Inventories, Dec, 2006 (50,000) (40,000) (c) 8,000 (82,000)
Operating expenses 100,000 24,000 124,000
Net Income 60,000 22,000 (d)13,250 94,250
Totals - 0- -0- -0-
Statement of Retained Earnings
Retained earnings Jan 1, 2006 (130,000) - - (130,000)
Net Income(From I/s) (60,000) (22,000) (d) (13,250) (95,250)
Dividend Declared 75,000 _ - 75,000
Retained Earnings Dec. 31,2005 -0- -0- 150,250
Balance Sheet -0-
Cash 30,500 5,000 - 35,500
Accounts Receivable 70,000 25,000 - 95,000
Inventories, Dec,2006 50,000 40,000 (c) (8,000) 82,000
Allowance for Overvaluation of (21,250)* - (a)15,000* -
Inventories: Gondar Branch (b) 6,250* -
Investment in Gondar branch 56,000 - (e)(56,000) -
Equipment 137,700 - - 137,750
Accumulated depreciation Eqpt. (60,000) - - (60,000)
Accounts Payable (40,000) - - (40,000)
Home Office - (56,000) - (e) 56,000 -
Common stock, Birr 100 par (100,000) - - (100,000)
Retained earnings (From S R/E ) - - - (150,250)
Balance -0- -0- -0- -0-

Note:
a)To eliminate reciprocal ledger accounts for merchandise shipments
b)To reduce beginning inventories of branch to cost
c)To reduce ending inventories of branch to cost
d)To increase income of home office by portion of merchandise markup that was realized by
branch sales.
e) To eliminate reciprocal ledger account balances.
*21,250-15,000-6250= 0
Reconciliation of Reciprocal Ledger Accounts
At the end of an accounting period, the balance of Investment in Branch ledger account in the accounting
records of the home office may not agree with the balance of Home office account in the accounting
records of the branch because certain transaction may have been recorded by one office but not by the
other. The lack of agreement between the reciprocal ledger accounts balances causes no difficulty during
an accounting period, but at the end of each period the reciprocal account balances must be brought into
agreement before combined financial statements are prepared.

Illustration: Assume that the home office and branch accounting records of Omedad Company on
December 31, 2004 contain the following data:

BY G.N Page 17
 Investment in Lee Branch (in the accounting records of Home Office)
Date Explanation Debit Credit Balance(Dr.)
2004
Nov.3 Balance - - 30,750
0 Cash received from branch 10,000 20,750
Dec.10 Collection of branch trade A/receivable 1,000 19,750
27 Merchandise Shipped to branch 5,000 - 24,750
29

Home office (in the accounting records of Lee Branch)

Date Explanation Debit Credit Balance
2004
Nov.30 Balance - - 30,750
Dec. 7 Cash sent to home office 10,000 - 20,750
28 Acquired equipment 3,000 - 17,750
30 Collection of home trade accounts receivable - 3,000 20,750

Comparison of the two reciprocal ledger accounts discloses four reconciling items; described as follows:

1. On Dec.29, 2004, the home office shift merchandises costing Birr 5,000 to the branch. The home office
debits its reciprocal ledger accounts with the branch on the date merchandise is shipped , but the branch
credits its reciprocal account with the home office when the merchandise is received a few days later.

Home office debit investment in branch but the branch did not credit the Home office account. The
required journal entry on Dec.31, 2002, in the branch accounting records assuming use of the perpetual
accounting system is as follows:
Inventories in transit 5,000
Home office 5,000
(To record shipment of merchandise in transit from home office)
2. On Dec. 27, 2004, trade accounts receivables of the branch were collected by the home office. The
collection was recorded by the home office by a debit to Cash and a credit to Investment in Lee Branch. No
journal entry was recorded by Lee Branch; therefore, the following journal entry is required in the
accounting records of Lee Branch on December 31, 2004
Home office 1,000
Trade Accounts Receivable 1,000
(To record the collection of accounts receivable by home office)

3. On Dec.28, 2004 the branch acquired equipment for Birr 3,000. Because the equipment used by the
branch is carried in the accounting records of the home office, the journal entry made by the branch was a
debit to Home Office and a credit to Cash. No journal entry was made by the home office; therefore, the
following journal entry is required on Dec. 31, 2004, in the accounting records of the home office:
Equipment: Lee Branch 3,000
Investment in Lee Branch 3,000
(To record Equipment acquired by Branch)
4. On Dec.30, 2004; trade accounts receivables of the home office were collected by Lee Branch. The
collection was recorded by Lee Branch by a debit to Cash and a credit to Home Office. No journal entry
was made by the home office; therefore, the following journal entry is required in the accounting records
of the home office on December 31, 2004.
Investment in Lee Branch 2,000

BY G.N Page 18
 Trade Accounts Receivable 2,000
(To record collection of accounts receivable by Lee Branch)
The effect of the foregoing end of period journal entries is to update the reciprocal ledger accounts, as
shown by the following reconciliation:

Omedad Company – Home Office and Lee Branch

Reconciliation of Reciprocal Ledger Accounts
December 31, 2004
Investment in Lee Branch Home Office Account
(in the home office accounting records) (in branch accounting records)
Balances before adjustment Birr 24,750 dr Birr 20,750 cr
Add (1) Merchandise shipped to
Branch by home office - 5,000
(4) Home Office trade accounts
Receivable collected by branch 2,000 -
Less (2) Branch trade accounts receivable
Collected by home office - (1,000)
(3) Equipment acquired by branch (2,000)
Adjusted balances Birr24, 750Birr 24,750

2.7 Transactions between Branches

Efficient operations may require on occasion require that merchandise or other assets be transferred from
one branch to another. Generally, a branch does not carry a reciprocal ledger account with another branch
but records the transfer in the home office ledger account. The branch which transfers the merchandises to
another branch debits Home Office and credits Inventories (assuming that the perpetual inventory system is
used). On the receipt of the merchandise, the other branch debits Inventories and credits Home Office. The
home office records the transfer between branches by a debit to Investment in Branch (transferor) and
credits Investment in Branch (transferee).

The transfer of merchandise from one branch to another do not justify increasing the carrying amounts of
inventories by freight costs incurred because of the indirect routing. The amount of freight costs properly
included in inventories at a branch is limited to the cost of shipping the merchandise directly from the
home office to its present location. Excess fright costs are recognized as of the home office; the assumption
here is that the home office makes the decisions directing all shipments. If branch managers are give the
authority to order transfers of merchandises between branches, the excess freight costs are recognized as
expenses attributable to the branches whose managers authorized the transfers.

Illustration: Assume the home office shipped merchandises costing Birr 1,000 to branch A and paid
freight costs of Birr 300. Subsequently, the home office instructed branch A to transfer this merchandise to
branch B. Freight costs of Birr 200 were paid by branch A to carry out this order. If the merchandises had
been shipped directly from home office to branch B, the freight costs would have been Birr 400. The
journal entries to record these events, assuming perpetual inventory system are as follows:

In the Accounting Records of Home Office

Investment in Branch A 1,300
Inventories 1,000
Cash 300
(To record shipment of merchandise and payment of freight costs)

BY G.N Page 19
 Investment in Branch B 1,400
Excess Freight Expense –Interbranch Transfers 100
Investment in Branch A 1,500
(To record transfer of merchandise from branch A to Branch B under the instruction of home office.The
excess freight expense of Birr 100((300 +200)-400 =100).

In the Accounting Records of Branch A

Inventories 1,000
Freight in or (inventories) 300
Home Office 1,300
(To record receipt of merchandise from home office with freight cost paid in advance by home office)
Home office 1,500
Inventories 1,000
Freight in (or Inventories) 300
Cash 200
(To record transfer of merchandise to Branch B under the instruction of home office and payment of freight
costs of Birr 200).

In the Accounting records of Branch B

Inventories 1,000
Freight in (or inventories) 400
Home Office 1,400
(To record receipt of merchandise from home Branch a transferred under instruction of home office and
normal freight costs billed by home office)

BY G.N Page 20
 CHAPTER THREE
3. INSTALLMENT AND CONSIGNMENT CONTRACTS
3.1 Introduction
Business enterprises always want to achieve the highest possible sales in order to maximize their profit.
Attaining maximum sales by following a strict cash sales policy does not help them to meet their objective.
Hence, instead of sticking to the cash sales they design various sales mechanisms that allow them to
maximize profit. Among the mechanisms is allowing credit sales where customers are given time to pay
after some time for the goods purchased. Though giving such credit sales to customers, who do not have
the capacity to pay cash immediately at the time of sale, helps the seller to increase sales volume, it has the
risk of un collectability. This risk mainly arise because of the fact that customers are allowed an extended
period of time over which they have to settle their account. When the credit sales give the customers an
extended period where in collection of cash is made is called installment sales. If installment sales
transactions represent a significant part of total sales, full disclosure of installment sales and any expenses
allocable to installment sales is desirable.
The increasing size of the market is making more complexity and difficulty for the businessman to come in
direct contact with the customers living at far off distance. Generally, this situation forced businessman to
enter into an agreement with a reliable local trader who can sell goods on his behalf and in his risk for
agreed amount of commission. Such a dispatch of goods from one person to another person at a different
place for the purpose of warehousing and ultimate sale is termed as consignment sales. Sellers seeking new
and expanded wholesale and retail markets for goods can use consignment sales to economic advantage in
many cases.

Chapter Objectives

After completing this chapter, the student should be able to:

 Explain the characteristics of installment sales.
 Identify the methods of recognition of profit on installment sales.
 Describe the accounting for installment sales.
 Describe the accounting for defaults and reposition.
 Describe what consignment sales is?
 Distinguishing between sales on consignment and regular sales.
 Describe the accounting for consignor and consignee.

3.2 Characteristics of Installment Sales

The term installment sale describes any type of sale for which payment is required in periodic installment
over an extended period. In installment sales, customers make initial payment at the time of purchasing
goods and pay the balance on periodic installments. An installment sale helps the seller to increase sales by
giving the customers an extended period of time for making payments, but increases the risk of
uncollectability. Use of installment sales is justified in situations where receivables are collected over an
extended period of time and there is no reasonable basis for estimating the degree of collectability. The
method is used extensively in tax accounting and has relevance because of the increased emphasis on cash
flows. The installment sale method allows the taxpayer to defer the inclusion of income until the payments
is made in cash or a cash equivalent.

To protect themselves against this greater risk of uncollectability, sellers of real or personal property on
installment basis generally select a form of contract called security agreement that enables them to
repossess the property if the purchaser fails to make payments. The sellers’ right to protect their security
for the uncollectible balance of sales contract and to repossess the item sold varies by type of industry, the
form of contract, and the law relating to repossessions. For example, for a service type enterprise,

BY G.N Page 21
repossessions obviously are not available as a safeguard against the failure to collect. The concept of
installment sales was first developed for sales of real estate and high priced durable goods, and later it has
spread through other types of sales such as sales of merchandise.

3.2.1 Methods of Recognition of Profit on Installment Sales

Recognizing of revenue from installment sales is some difficult than revenue recognition from cash sales.
The difficulty arises in matching the revenues with expenses. The question here is whether to recognize the
gross profit from installment sale are recognized in full in the accounting period in which the sale made or
spread over the term of the installment contract. Normally according to the generally accepted accounting
principles for recognizing revenues under the accrual basis of accounting, revenues are recognized in the
period in which a sale is made. However, in installment sales, because of the uncertainty involved in
collecting the accounts to be received over an extended period of time may suggest the postponement of
revenue recognition until the probability of collection can be reasonably estimated.

There are two general approaches in recognizing gross profit on installment sales:
1. The gross profit may be recognized in the period in which the sales were made
2. The gross profit may be recognized in the period in which cash is collected on the installment sales
contract.

3.2.1.1 Gross Profit Recognized in the Period of Sale

In this approach the installment sales is recognized in the period in which the sales were made which is
similar to that employed for regular sales. Gross profit may be recognized at the time of sale, the point at
which goods are exchanged for legally enforceable claims against customers.

3.2.1.2 Gross profit Recognized in the Period in which Cash is Collected

In this approach the gross profit is recognized related to the periods in which the installment receivables are
collected rather than to the periods in which sales was made. Thus the inflow of cash rather than the time
become the criterion for revenue recognition.

The following procedures can be applied in recognizing gross profit related to the periods in which cash is
collected. However; the installment sales plan that is employed must be considered carefully in making a
choice as to the procedures that will measure net income most satisfactorily.

1. Collections regarded as first recovery of cost. This is the most conservative approach under which
collections on installment sales are first regarded as recover of costs. After the recovery of the cost,
all further collections are regarded as profit. This method is more acceptable only when there is
doubt as to any recoverable value associated with the balance of the installment receivables or the
goods subject to repossessions.
2. Collections regarded as first the realization of profit. Under this approach collections are first
regarded as representing the realization of profit on the contract. After recognition of the full profit
on the transaction, all further collections are regarded as a recovery of cost. This procedure lacks
sufficient conservatism under most circumstances in view of the probability that the defaults and
repossessions over the life of contracts will impair the original profit margin.
3. Collections regarded as both return of cost and realization of profit. In this procedure, each
collection on installment receivable is regarded as representing both a return of cost and a
realization of gross profit in the ratio in which these two factors are found in the original sales price.
The gross profit on installment sales in this method is spread over the full life of the installment
contract. Continuing expenses on an installment contract are matched against the gross profit that is

BY G.N Page 22
 recognized in successive periods; the possible failure to realize the full amount of the gross profit in
the event of default by the buyer is anticipated.

When gross profit is recognized in proportion to collections on installment receivables it is called

installment method.

3.2.2 Accounting for Installment Sales

The installment sales method is one of several approaches used to recognize revenue. Methods such as the
cost recovery method and the cash method are two of several other methods used to recognize revenue.
Revenue recognition is deferred when collection of sales price is not reasonably assured and no reliable
estimates can be made. The installment method places emphasis on collection of cash, rather than the
period of sale, as installment sales lead to income realization in the period of collection. This does not
mean that revenue is considered unrealized until the entire sales price has been collected but rather the
revenue realization is proportionate to collection. This is due to the fact that the ultimate profit is more
uncertain in installment sales than in ordinary sales because collection is more doubtful.

Under the installment sales of accounting, the gross profit (sales less cost of goods sold) on installment
sales are deferred to those periods in which cash is collected. Operating expenses such as selling and
administrative expenses are treated as expenses in the period they are incurred. Thus the installment
method of accounting normally implies the deferral of gross profit but the recognition of selling and
administrative expenses in the period of their incurrence. The deferred gross profit on installment sales is
generally treated as unearned revenue and classified as current liability.

The following procedures apply under the installment sales method:

1. During the year, record both sales and cost of sales in the regular way using separate installment
sales accounts and compute the rate of gross profit on installment sales transactions.
2. At the end of the year, apply the rate of gross profit to the cash collections of the current year’s
installment sales to arrive at the realized gross profit.
3. The gross profit not realized should be deferred to future years.
In any years in which collections from prior years’ installment sales are received, the gross profit rate of
each year’s sales must be applied against cash collections of accounts resulting from the year’s sales to
arrive at the realized gross profit.

Example One: To illustrate the installment sales method of accounting, assume the following data for X
Enterprise.
2006 2007 20058
Installment sales Birr 200,000 Birr 250,000 Birr 240,000
Cost of installment sales (150,000) (190,000) (168,000)
Gross Profit 50,000 60,000 72,000
Gross profit rate 25% 24% 30%
Cash received in:
From 2006 sales 60,000 100,000 40,000
From 2007 sales -0- 100,000 125,000
From 2008 sales -0- -0- 80,000

Required: Determine the realized and deferred gross profit and pass the necessary journal entries at the end
of each year.

Solution

BY G.N Page 23
1) To record installment sales
2006 2007 2008
Installment A/ Receivable 200,000 250,000 240,000
Installment Sales 200,000 250,000 240,000

2) To record cash collections on installment receivables

Cash 60,000 200,000 245,000

Installment A/ Receivable (2003) 60,000 100,000 40,000
Installment A/Receivable (2004) - 100,000 125,000
Installment A/Receivable (2005) - - 80,000

3) To Record cost of goods sold

Cost of installment sales 150,000 190,000 168,000

Inventories 150,000 190,000 168,000

4) To close installment sales and cost of installment sales

Installment Sales 200,000 250,000 240,000
Cost of installment sales 150,000 190,000 168,000
Deferred Gross Profit 50,000 60,000 72,000

5) To record realized gross profit

Deferred Gross Profit (2003) 15,000 25,000 10,000
Deferred Gross Profit (2004) - 24,000 30,000
Deferred Gross Profit (2005) - - 24,000
Realized Gross Profit 15,000 49,000 64, 000
The realized gross profit above is computed by applying the gross profit rate on the cash collections of each
year. I.e. 25 % (60,000); 25% (100,000); 25% (40,000) for the year 2003.For the year 2004, 24 %
(100,000); and 24 %( 125,000) and 30 %( 80,000) for the year 2005.
6) To close the realized gross profit to income summary
Realized Gross Profit 15,000 49,000 64,000
Income Summary 15,000 49,000 64,000

The deferred gross profits at the end of each year are as follows:

For the year 2003, Birr 35,000 (50,000-15,000) = 35,000

For the year 2004, Birr 46,000 (60,000+35,000-49,000) = 46,000
For the year 2005, Birr 54,000 (72,000+46,000-64,000) = 54,000

Example Two: Alpha PLC sold a piece of land for Br. 110,000 and the acquisition cost was Br. 40,000.
Commission and expenses pertaining to the sale were Br.10, 000. The net account receivable was Br.100,
000 of which 40% is considered as return in an investment in land and 60% was considered as deferred
gross profit. All collections from the buyer were regarded as consisting of 40% cost balance and 60% as
realized gain.

The contract of sale called for a down payment of Br.20, 000 and promissory note with payments every six
month in the amount of Br. 7,500 plus interest at the annual rate of 8% on the unpaid balance for six years.

BY G.N Page 24
One half of the down payment was considered as deductions towards expenses and commissions. The land
was sold on November 1, 2000 and the accounting period ends on December 31 of each year.

Required: Prepare journal entries for the first three years of installment collection.

3.2.3 Defaults and Repossessions

Since customers in installment sales are given an extended period of time in making payments, the seller
involves a greater risk for the collectivity of installment sales receivable. To protect themselves against this
greater risk of uncollectability, sellers of real or personal property on installment basis generally select a
form of contract called security agreement that enables them to repossess the property if the purchaser fails
to make payments.

The accounting for defaults and repossessions, on an installment contract recognizes and repossessions of
the article sold needs an entry on the book of the seller. The seller reports the merchandise reacquired;
written off the related installment receivable account that is not collectible; and also removes the related
applicable deferred gross profit from the ledger.
Repossessed merchandise should be recorded in the repossessed merchandise inventory account at its fair
value. The objective is to put any asset reacquired on the books at its fair value or, when fair value is not
ascertainable, at the best possible approximation of fair value.

Illustration: Assume the following data:

Total installment sales for the year 2000 Birr 80,000

Gross profit rate on installment sales in the year 2000 30%

In 2001, a customer defaults on a contract for Birr 500 that had originated in the year 2000. A total of Birr
230 had been collected on the contract in 2000 prior to the default. The merchandise sold is repossessed
and its fair value to the company is Birr 150, allowing for reconditioning costs and a normal gross profit on
resale. The journal entry to record the default and repossessions is as follows:

Merchandise –Repossessions 150

Deferred gross profit-2000 (30%x270) 81
Loss on repossessions (270-(150+81) 39
Installment contract receivable (500-230) 270
Writing off the installment sales receivable balance of Birr 270 is accompanied by removal of deferred
gross profit of Birr 81(30% of Birr 270). The repossessed merchandise is at its fair value of Birr 150. A
loss of Birr 39 is recognized on the repossession, representing the difference between the installment
contract balances canceled Birr 270, the deferred gross profit Birr 81 and the value assigned to repossessed
merchandise [270-(150+81)=39].
If the repossessed merchandise in the above given example is recorded at a value above the Birr 270, the
difference between the balance in the installment contract receivable account and the deferred gross profit
account, will be a gain. However, the conservatism principle suggests no gain would be recognized at the
time of repossession and recognition of the gain should wait the sale of the repossessed goods. Any gain or
loss on defaults and repossessions is reported on the income statement as an addition or subtraction from
the realized profit on installment sales.
Assume that the merchandise from the preceding example has a value Birr 200 the journal entry to record
the defaults and repositions is as follows:

Merchandise – Repossessions 200

BY G.N Page 25
Deferred gross profit (30% of 270) 81
Installment contract receivable (500-230) 270
Gain on repossessions 11

3.3 What is Consignment?

Instead of making direct sales, individuals and businesses often place goods with others who make sales for
them. These types of transactions are commonly called consignment sales. Consignment is the act of
consigning, which is placing a person or thing in the hand of another, but retaining ownership until the
goods are sold or person is transferred. This may be done for shipping, or for sale in a store (i.e. a
consignment shop). Also commonly used in the drug dealing trade. Therefore, consignment is the transfer
of goods by their owner to another party who is to act as a sales agent, where legal title to the goods
retained by the owner until their sale. The party who owns the goods is known as the consignor; the party
who makes the sell of the goods on the owner’s behalf is known as the consignee.
3.3.1 Distinguishing between Sales on Consignment and Regular Sales
A proper distinction between a sale and consignment should be made though both involve the shipment of
merchandise. This is particularly important in the determination of inventories and cost of merchandise
sold and for the proper measurement of income. When the merchandises are shipped on consignment,
ownership (title) of the merchandise does not pass to the consignee until the merchandises are sold but
remains on the hands of the consignor. Therefore, the consignor includes the merchandises as part of
inventory at the end of the fiscal period. Moreover, unlike regular sales the consigner recognizes no
revenue at the time when the merchandises are shipped (transferred) to the consignee.

In general, the following distinctions can be made between regular and consignment sales:
1. In consignment, the legal ownership of the goods (merchandises) remains with the consignor and
the property in the goods does not pass to the consignee. Consigned goods are included in the
inventory of the consignor, but excluded from the consignee’s inventory. However, in regular sales
the ownership of goods passes directly from the seller to the buyer.
2. In consignment, the risk attaching to the goods does not pass to the consignee. The loss or damage
to goods is to be borne by the consignor, provided that the consignee has taken responsible care of
the goods and the loss or damage is due to his negligence. However, in regular sales the risk
attaching to the goods passes along with ownership to the buyer.
3. In consignment, the relationship between the consignor and consignee is that of principal and agent
guided by laws that govern relationship of principal and agent. On the other hand, the relationship
between the seller and the buyer in regular sales is that of creditor and debtor. The person to whom
the goods are sold is the debtor.
4. A consignment good is returnable if it cannot be sold in consignment sales; where as in regular
sales the goods sold are not returnable except for some special reasons such as damage or wrong
quality of goods.
5. Revenue from consignment sales is recognized when the goods are transferred to third party (sold)
by the consignee; whereas revenue from regular sales is recognized when the seller transfers
ownership and goods to the seller.

3.3.2 Advantages of Consignment Sales

Advantages of consignment sales to the consignor
Consignment sale has the following advantages for the consignor:

It provides the manufacturer with the opportunity to have the merchandise exposed to the buying
market, instead of having it stored and isolated in a warehouse while waiting for an order from a

BY G.N Page 26
 buyer. The dealer (consignee) incurring neither the liability nor the risk involved with the purchase
of the goods is generally willing to accept goods on a consignment basis.
The consignor avoids the risk of inherent in selling on credit to dealers of questionable financial
strength.
The consignor, who still owns the consigned goods, can control the selling price of the consigned
goods. This may be difficult or impossible when the goods are actually sold to the dealer.
The consignor, particularly for the sale of grain and livestock, may obtain selling specialists. The
compensation for such services is frequently a commission, which may be a percentage of sales
price or a fixed amount for each unit of the goods sold.
Advantages of consignment sales to consignee
The consignee may favor the acquisition of goods on consignment for the following reasons:

The consignee avoids the risk of ownership due to lack of inability to sale, obsolescence, and
decline in market value.
The consignee requires less capital investment as there is no payment for receipt or possession of
consigned goods.

3.3.3 Rights and Responsibilities of the Consignee

In the transfer of goods on consignment, a written contract should be prepared expressing the nature of the
relationship. The contract covers such matters as:
credit terms to be granted by the consignee to customers;
expenses of the consignee to be reimbursed by the consignor;
commissions or profits to be allowed to the consignee;
care and handling of consignment inventories and proceeds from consignment sales;
remittances and settlements by the consignee ; and
Reports to be submitted by the consignee.

The rights and duties of the consignee are established and defined by the laws of bailment and of agency,
as modified by the Uniform Commercial Code. The following rights and duties are among the most
important once:

Consignee’s rights

1. The consignee is entitled to reimbursement for necessary expenditures on consigned goods and to
compensation for sales. Necessary expenditures depends upon the nature of the consigned goods
and ordinarily include freight, insurance, taxes, storage, handling charges, repairs under warranties,
and such other charges as are by custom born by the consignor.
2. Granting of normal credit terms, sometimes followed by guaranteeing collection as Del cruder
agent, with additional compensation for assuming such risk.
3. The consignor has the right to offer the customary warranties on goods that are sold, and the
consignor is bound by the terms of such warranties.

Consignee’s duties (responsibilities)

1. The consignee must protect the consigned goods with due care. In addition the consignee should
exercise due care in granting and collecting receivables; such as selling goods at specified price,
granting normal credit terms, making normal warranty, exert reasonable effort to collect the sales
price.

BY G.N Page 27
 2. The consignee should render timely periodic reporting of sales and collections called account sales
to the consignor which contains the information about;
Consignment goods recorded and sold,
Sales price,
Expenses incurred by consignee and chargeable to consignor,
Advances made by consignee,
Amounts owed due (payable) to consignor or due from (receivable) consignor and remittances.
3. If the consignee has merchandises other than consigned goods, the consignee must keep the goods
of the consignor apart from other merchandises. In addition, the consignment account receivable
should not be combined with the consignee’s own receivable.

3.3.4 Accounting for Consigned Goods

3.3.4.1 Accounting for Consignee
When the profits from consignment sales are to be separately determined, the consignee maintained an
account called consignment -In for each consignment. This account is debited for all expenses to be
absorbed by the consignor and is credited for the full proceeds from consignment sales. The commission or
profit on consignment sales is transferred from the consignment -In account to a separate revenue account,
and the resulting balance in the consignment -In account reports the amount that is owed to the consignor in
settlement.

Consignee’s Records: The consignee records the following entries:

1. Transfer of goods to the consignee: the consignee records the receipt of goods on consignment by
a memorandum in the journal or in a separate book maintained for such purpose. Supplementary
records showing all details with respect to goods received on consignment should be kept. This
may be maintained in a subsidiary ledger account.
2. Expenses of consignor identified with the consignment: The consignee is not affected by
transactions of the consignor.
3. Expenses of the consignee identified with the consignment: consignee records expenses that are to
be absorbed by consignor by debiting consignment –In and crediting appropriate asset or liability
accounts. When an expense account that is to absorbed entirely or in part by the consignor is
originally debited on the consignee’s book, Consignment-In is debited and the expense account is
credited for the amount chargeable to the consignor.
4. Sales by the consignee: When the merchandises shipped to the consignee are sold to customer; the
consignee records consignment sales by debiting the appropriate asset account and crediting
Consignment-In account.
5. Commission or profit accruing to the consignee: The consignee records the commission or profit
on consignment sales by debiting Consignment-In and crediting appropriate revenue account. After
the commission or profit is recorded, the credit balances in Consignment-In recorded shows the
amount that is owed to the consignor in final settlement. Since no part of the consignee’s expenses
has been assigned to consignment commissions or profits, the consignment revenue account must
be regarded as gross profit balance.
6. Remittance and account sales rendered by the consignee: remittance of cash to the consignor is
recorded by the consignee by debiting Consignment- In and crediting Cash. If the consignee makes
the full amount cash to consignor, the entry to record the payment closes the Consignment-In
account. Sometimes the consignee is required to make advance cash payments to the consignor up
on receiving the goods on consignment. Such advances may be recorded by debiting an asset
account, Advances to consignor, and a credit to Cash. The advances are recognized as reductions in
the amount owed to the consignor when settlement is made. When remittance is made by the

BY G.N Page 28
 consignee for the difference between the amount owed on consignment sales and the amount
originally advanced, the account reporting the liability to the consignor is debited, the advances
account is credited and cash is credited.

3.3.4.2 Accounting for Consignor

When the profits from consignment sales are to be separately determined, the consignor maintains a
Consignment-Out account for each consignment. Consignment-Out account is debited for the cost of
merchandise shipped to the consignee and for all other expenses related to the consignment; it is credited
for sales made by the consignee. Profit or loss from consignment sales is ultimately transferred from the
Consignment-Out account to the income summary account in which new results from all activities are
summarized.

Consignor’s Records: In general the consignor makes the following entries for the given transactions:
1. Transfer of goods to the consignee: The transfer of goods from the consignor to the consignee is
recorded by the consignor as a debit to Consignment- Out and credit to Merchandise Shipments on
consignment if periodic inventory system is used or Inventory account if perpetual inventory
systems are used. In the determination of the cost of goods available for regular sales, Merchandise
Shipments on Consignment is treated as a deduction from the sum of the beginning inventory and
purchases.
2. Expenses of consignor identified with the consignment: The consignor records expenses that are
related to the consignment by debiting Consignment-Out and crediting cash or liability accounts.
When an expense account was originally debited for an expense that is related to the consignment,
Consignment-Out is debited and the expense account is credited for the amount identified with the
consignment.
3. Expenses of the consignee identified with the consignment sales by the consignee- commission
charge by the consignee: the consignor makes no entries for transactions of the consignee until a
statement is received from consignee.
4. Remittance and account sales rendered by the consignee: When the consignor receives an account
sale, cash is debited for the cash remittance, Consignment Out is debited for the total expense
charged to the consignor’s account by the consignee, and Consignment Out is credited for the gross
sales reported by the consignee. It is also possible to debit Cash and credit Consignment- Out for
the net proceeds from consignment sales and the balance of Consignment-Out would be the same in
both cases.
When the consignor needs advance cash receipts on consignment shipments, the advance cash receipt may
be recorded by debiting cash and crediting a liability account, Advances from consignee. At the time of
settlement a debit will be made to cash and advances account; and a credit will be made to the
Consignment-Out account recognizing revenues and expenses reported by the consignee.

The consignment account shows the net result from consignment transactions, when all of the consigned
goods have been sold. A credit balance in Consignment-Out shows that consignment revenue has exceeded
consignment expenses, resulting in a profit; a debit balance indicates that the consignment expenses have
exceeded consignment revenue resulting in a loss. The balance of profit or revenue is then transferred to an
income summary account by a closing entry.

Illustration: The following transactions are carried out by S Company (consignor) and F Company
(consignee).

1. S company shipped consignments to F Company 10 sets of refrigerators, which cost Birr 5,000
each.

BY G.N Page 29
 2. Authorized selling price was Birr 8,000 each.
3. Cost of packing the merchandise for shipment Birr 600. All costs incurred in the packing
department are charged to the packing expense.
4. Freight charges paid by consignee amounted to Birr 2700.
5. Consignee was entitled for sales commission of 20%.
6. All refrigerators sets were sold by the consignee at Birr 8000 each.
7. After deducting the commission of 20% and freight charges of Birr 2,700; F Company sent a check
for Birr 61,300 and the account sales to S Company.

Required: a) Prepare journal entries in both S and F Company books.

b) Prepare Consignment Out and Consignment In accounts.
c) Prepare sales account
Assume the following two Situations:

I. All the 10 sets of refrigerators are sold –Complete sales

II. Only 4 sets of refrigerators are sold - Partial sales of sets

Situation Case I- When all the 10 sets are sold

a) Journal entries in S&F books
Transaction Consignor Book Consignee Book
1 Shipment of merchandise at Birr Consignment –Out 50,000 Memorandum Entry
5,000 each on consignment. Inventory 50,000 Received 10 sets of refrigerators to be
Consigned merchandise is sold for Birr 8,000 each at a
transferred to a separate inventory commission of 20% each and at a
account- Consignment –Out. cost of Birr 5,000 each.
2 Expense of Birr 600 allocated to Consignment-Out 600
consigned merchandise (which Packing Expense 600 No entry
was previously recorded in
packing expense)
3 Consignment records of fright No entry Consignment- In 2700
charges S company
Cash 2700
4 Consignment sales of Birr 80,000 Cash 61, 300
by consignee and payment of sales Consignment-Out 2,700 Cash 80,000
proceeds recorded after deducting Commission-Exp 16,000 Consignment-In
payment and commission. Consignment S- Company 80,000
Sales 80,000
5 Commission revenue recorded by Consignment In
the consignee S Company 16,000
Commission
Revenue 16,000
6 Cost of consignment sales Cost of consignment
recorded by the consignor Sales 53,300
Consignment-Out 53,300
7 Payment by the consignee to the Consignment-In
consignor through check S Company 61,300
Cash 61,300

BY G.N Page 30
 b) Consignment-Out and consignment-In accounts
Summary of Consignment -Out account (S Company)
Date Details Debit Credit Balance (Dr)
Inventory 50,000 - 50,000
Packing Expense 600 50,600
Fright 2,700 53,300
Cost of sales - 53,300 -
Presentation on the income statement:
Consignment Sales Birr 80,000
Less: Cost of consignment sales 53,300
Commission Expense 16,000 69,300
Gross profit on Consignment Sales Birr 10,700

Summary of Consignment- In account (F Company)

Date Details Debit Credit Balance (Cr)
Cash Freight 2,700 - 2,700
Commission 16,000 - 18,700
Cash Sales - 80,000 61,300
Payment to Consignor 61,300 - -0-

C) Preparing Sales Account by F Company (Consignee)

F Truck Company
Account Sales
Sales for Account January 17, 2008
S Company
Sales of 10 refrigerators @ Birr 8,000 each Birr 80,000
Less: Charges: Freight 2,700
Commission 16,000 (18,700)
Balance check enclosed Birr 61,300
Consigned refrigerator set on hand None (0)

Case II: Partial Sales of Consigned Goods

c) Journal entries in S&F books
Transaction Consignor Book Consignee Book
1 Shipment of merchandise at Birr Memorandum Entry
5,000 each on consignment Consignment –Out 20,000 Received 10 sets of refrigerators to be
Consigned merchandise is Inventory 20,000 sold for Birr 8,000 each at a
transferred to a separate inventory ( 4X5,000 each) commission of 20% each and at a
account- Consignment –Out. cost of Birr 5,000 each.
2 Expense of Birr 600 allocated to Consignment-Out 600
consigned merchandise (which was Packing Expense 600 No entry
previously recorded in packing
expense)
3 Consignment records of fright No entry Consignment- In 2700
charges S company
Cash 2700

BY G.N Page 31
4 Consignment sales of Birr 32,000 Cash 10, 000
by consignee and payment Birr A/ Receivable 12,900 Cash 19,100
10,000 received after charging by Consignment-Out 2,700 A/ Receivable 12,900
consignee: fright Birr 2,700, Commission Consignment-In
commission (20%) 6,400. Expense 6,400 S- Company 32,000
Consignment
Sales 32,000
5 Commission revenue recorded by Consignment In
the consignee S Company 6,400
Commission
Revenue 6,400
6 Cost of consignment sales recorded Cost of consignment
by the consignor Sales 21,320
[ 4( 5000+600/10+2700/10)] Consignment
= 21,120 -Out 21,320
7 Payment by the consignee to the Consignment-In
consignor through check S Company 10,000
Cash 10,000

b) Consignment-Out and consignment-In accounts

Summary of Consignment -Out account (S Company)
Date Details Debit Credit Balance (Dr)
Inventory 50,000 - 50,000
Packing Expense 600 50,600
Freight 2,700 53,300
Cost of sales - 21,320 31,980

Presentation on the Balance Sheet

Assets
Current Assets
Inventory on Consignment Birr 31,980

Summary of Consignment- In account (F Company)

Date Details Debit Credit Balance (Cr)
Cash Freight 2,700 - (2,700)
Commission 6,400 - (9,100)
Cash Sales - 32,000 22,900
Payment to Consignor 10,000 - 12,900

c) Preparing Sales Account by F Company (Consignee)

F Truck Company
Account Sales
Sales for Account January 17, 2008
S Company

Sales of 4 sets refrigerators @ Birr 8,000 each Birr 32,000

Less: Charges: Freight 2,700
Commission 6,400 (9,100)

BY G.N Page 32
 Balance payable to consignor 22,900
Balance check enclosed (10,000)
Balance due to consignor Birr 12,900
Consigned refrigerator set on hand Six (6)

BAHIR DAR UNIVERSITY

FACULTY OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
ADVANCED ACCOUNTING I INDIVIDUAL ASSIGNMENT
Submission date February 9, 2013
Load: (15%)
Neatness have valuable
1. Consider the following transactions.
a) Rehoboth Corporation, located in Addis Ababa, establishes a branch called Yedidya in Axum,
Tigray by transferring cash of br. 20,000, office equipment br. 5,000 and Store equipment br.
30,000.

BY G.N Page 33
 b) The home office shipped merchandise at a billed price of br. 90,000 (50% above home office
cost).
c) Branch acquired equipment to be carried at home office for br. 1500.
d) Branch sales on account amounted br. 80,000 which costs br 65,000.
e) Branch collections on account amount br. 63,000.
f) Branch payment for operating expenses amount br. 7,000.
g) Branch transfer of cash to home office amount br 35,000.
h) Home office allocation of operating expenses to branch amount br. 1,500.
i) Branch transferred the operating result to home office and closed its temporary accounts.
j) Home office made adjusting and closing entries.
Required:
A. Prepare journal entries for Rehoboth Corporation and Yedidya Branch to record the above
transactions. Both use the perpetual inventory system.
B. Compute the balance of reciprocal ledge accounts.

2. The following information is available for Electra Corporation’s home office (Addis
Ababa) and its Dessie Branch at December 2009:
1. Balance on December 31, 2009:
Home Office account (Branch Books)………………………Br.452, 300
Investment in Branch: Dessie account (Home office Books)…..492,000
2. Dessie branch sent a check for Br.12, 000 cash to the home office on Dec.31 which is not
received by the home office until January 2.
3. The home office shipped merchandise costing Br.20, 000 to its Dessie branch on Dec.27, 2009 at
a transfer price of Br.25, 000. The merchandise was not received by Dessie branch until January
3, 2010.
4. Advertising expense of Br. 8,500 was allocated by the home office to Dessie branch. The
expenses were recorded at Br.5, 800 by the branch.
Required: a) Reconcile the reciprocal ledger accounts.
b) Prepare adjusting and correcting entries on December 31, 2009.
3. The home office of ABC Industries ships merchandise at its Br.200, 000 costs from Addis Ababa to
Gondar branch, and that it pays Br.2, 500 freight charges on the merchandise. A few days later, the
Bahir Dar branch experiences a merchandise shortage and the merchandise is transferred from Gondar
to Bahir Dar at Br.800 freight cost paid by the Gondar branch .The cost of shipping the merchandise
right from Addis Ababa to Bahir Dar would have been Br.2,100.
Required: Journalize the necessary entries required to record the above events on the books of:
a) ABC Industries (Home office)
b) Gondar Branch
c) Bahir Dar Branch
4. On August 31, 2000, the Alemgena Co. sold merchandise inventory to the Yirgalem Co. for Br.500,
000.Terms of the sale called for a down payment of Br. 100,000 and four annual installments of Br.
100,000 due on each August 31, beginning August 31, 2001. Each installment also will include interest
of 9 % on the unpaid balance. The book value of the merchandise inventory on Alemgena’s book on
the date of sale was Br. 300,000.The Company uses the perpetual inventory system and its fiscal year
end on December 31.

Required:
a. Compute the amount gross profit to be recognized in each of the five years of the
installment sale using the installment sales method.
b. Prepare necessary journal entries (including adjustments) for the first 3 years.

BY G.N Page 34
5. The ABX Corporation, which began business in 2000, appropriately uses the installment sales method of
accounting for its installment sales. The following data were obtained for sales made during 2000 and
2001.

2000 2001
Installment Sales Br. 360,000 Br. 350,000
Cost of Installment Sales (216,000) (145,000)
Gross Profit 144,000 205,000
Rate of Gross Profit 40% 60%

Cash collection on installment sales during:

2000 150,000 100,000
2001 - 120,000
Required:
a). How much gross profit should be recognized in 2000 and 2001?
b).what should be the balance in the deferred gross profit account at the end of 2000 and 2001?
c). Prepare summary journal entries for 2000 and 2001 to account for the installment sales and cash
collections. The company uses the perpetual inventory system.

6. The following transactions are related to Garad Trading (consignor) and Solar Music Shop
(consignee).
Jan.1. Shipment of 10 radio sets on consignment; cost to consignor Br.150 each.
Jan.1. Freight costs of consignor identified with the consignment, Br.60.The expenses were
previously recorded in freight account.
Jan.15. Freight costs paid by consignee, Br.25.
Jan.31. Sale of 10 units for Br.3000.
Jan. 31. Received account sales: 10 units sold for Br.3000, commission of 20% and freight cost of
Br.25 was deducted and the balance remitted.
Jan.31. Adjustment to record the cost of sales.

Required:
a) Prepare journal entries for the following transactions on the books consignor and consignee.
b) Prepare consignment out and consignment in account.
7. Consider the information given in 1. Assume that from the consigned goods, only 5 radio sets were
sold and consignment sales of Br. 1500 were reported by consignee with payment of Br.800 received
after deducting freight of Br.25 and commission of 20%.

Required: a) Prepare journal entries for consignor and consignee.

b) Prepare consignment out and consignment in accounts.
c) Prepare account sales

REFERENCES

1. Modern Advanced Accounting, 9th Edition, Larson E. John and Mosich, A.N., McGraw Hill USA,
2003.

BY G.N Page 35
 2. Advanced Accounting: Concepts and Practice, 8th Edition, Pahler, Arnold J., and Mori, Joseph E,
South Western Publishing, 2003.
3. Advanced Financial Accounting, 6th Edition, E.Baker, C.Lembke and C.King, McGraw Hill USA.
4. Commercial Code of Ethiopia
5. http://www.inventoryops.com/ConsignmentInventory.htm, April 15th, 2010
6. http://domin.dom.edu/faculty/pollraym/acct420/partnerships.doc, May 2nd,2010

BY G.N Page 36