CHAPTER FOUR

INSTALLMENT SALES AND CONSIGNMENT CONTRACTS

4.0 Learning objectives:
After completing this chapter, you would be able:
 Differentiate regular sales from installment and consignment
 Comprehend the concepts of installment and consignment
 Compute profit from installment sales under different alternative methods
 Record transactions involving installment sales
 Account for consignment sales from consignee point of view
 Account for consignment transaction for the consignor and understand how profit or loss
is determined from the consignment
 Learn how to prepare account sales
 Learn how cost is allocated on partial sales for Home Office and Branches

4.1 Installment Sales

4.1.1 Special Characteristics of Installment Sales
An installment sale is a sale of real or personal property or services, which provides for a service of
payments over a period of months or years. A down payment usually, but not always, is required. Since,
the seller must wait a considerable period of time to collect the full sales price, it is customary to provide
interest on the unpaid balances and to add carrying charges to the listed selling price.

The risk of non-collection to the seller is greatly increased when sales are made on the installment plan.
Customers generally are in weaker financial condition then those who buy or open account; furthermore,
the credit rating of the customers and their ability to pay may change significantly during the period
covered by installment contract. The risk of non-collection is guaranteed by security agreement which
enables them to repossess the property if the buyer falls to make payments.

The seller’s right to protect their security interest (uncollected balance of a sale contract) and to repossess
the property varies by type of industry, the form of the contractual arrangement, and the statutes relating
to repossessions. For the service-type business, repossession obviously is not available as a safeguard
against the failure to collect. In reality, for many types of personal property as well, the sellers’ right to
repossess may be more a threat than a real assurance against loss. The product sold may have been
damaged or may have depreciated to a point that it is worth less than the balance due on the installment
contract. A basic rule designed to minimize losses from non- payments of installment contracts is to
require a sufficient down payment, payment to cover the loss of value when property moves out of the
“new Merchandise” category. A corollary rule is that the payment schedule should not be outstripped
by the projected decline in value of the property. For example, if a customer buying an automobile on
the installment plan finds after a year or so that the car is currently worth less than the balance still owed
on the contract, the customer’s motivation to continue the payments may be reduced.

Competitive pressures within an industry often will not permit a business to adhere to these standards.
Furthermore, repossession may be a difficult and expensive process, especially if the customer is non-
cooperative or necessary to make the merchandise salable, and the resale of such merchandise may be
difficult. For these reasons, doubtful accounts expense is likely to be significantly higher on installment
sales than regular credit sales.

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A related problem is the increased collection expenses when payments are spread over an extended
period. Accounting expense also are multiplied by the use of installment sales, and large amounts of
working capital are tied up in installment receivables. In recognition of these problems, many business
executives have concluded that the handling of installment receivables is a separate business, and they
therefore sell their installment receivable to finance companies which specialize in credit and collection
activities.

From the above discussion, it is understood that installment sales pose some challenging problems. The
most basic problems are:
 Difficulty of matching costs with related revenue
 Greater risk of non-collection or higher doubtful accounts expense
 Repossession of highly damaged or depreciated property
 Higher collection expenses
 Reconditioning and repairing costs for repossessed property
 Substantial amount of working capital is tied up in receivables

4.1.2 Methods for Recognition of Profits on Installment Sales

The determination of net income on installment sales is complicated by the fact that the amounts of
revenue and related costs and expenses are seldom known in the period when the sale is made.
Substantial expenses such as collection, accounting, repairs, and repossession are likely to be incurred
in subsequent periods. In some business, the risk of non-collection may be go great as to raise doubts as
to the recognition of any revenue or profit at the point of sale. The first objective in development of
accounting policies for installment sales should be reasonable matching of costs and revenue. However,
in recognition of the diverse business conditions under which installment sales are made, three
approaches are used:
1. Recognition of Gross Profit at the Time of Sale (Accrual Method)
2. Cost Recovery method; and
3. Recognition of Gross Profit through the use of installment method of accounting.
1. Accrual Method of Gross Profit Recognition (At the Time of Sale)
To recognize the entire gross profit at the time of an installment sale is to say in effect that installment
sales should be treated like regular sales on credit. The merchandise has been delivered to the customer
and an enforceable receivable of definite amount has been acquired. The excess of the receivable
contract over the cost of merchandise delivered is realized gross profit in the traditional meaning of the
term. The journal entry consists of a debit of installment contracts receivable and a credit to installment
sales. If a perpetual inventory system is maintained, another journal entry is needed to transfer the cost
of merchandise from the inventories account to the cost of installment sales account. No recognition is
given to the seller’s retention of title to the merchandise because the normal expectation is completion
of the contract through collection of receivable. Implicit in this recognition of gross profit at the time of
sale is the assumption that all expenses relating to the sale will be recognized in the same period so that
the determination of net income consists of matching realized revenue with expired costs.
These expenses include collection expenses and doubtful expenses. The journal entries to record such
expenses would consist of debits to expense accounts and credits to asset valuation accounts such as
Allowance for Doubtful Accounts and Allowance for Collection Costs. The Allowance accounts would
be debited in later periods as uncollectible installment contracts become known and as collection costs
are incurred.
2. Cost Recovery Method of Gross Profit Recognition
In some cases accounts receivable may be collectible over a long period of time. In addition the terms

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of sale may not be definite, and the financial position of customers may be extremely unpredictable,
thus making it virtually impossible to find a reasonable basis for estimating the degree of collectiblity
of the receivable. In such cases, either the installment method or the cost recovery method of accounting
may be used for installment sales. Under the cost recovery method, no profit is recognized unit all costs
of the item sold have been fully recovered. After all costs have been recovered, additional collections on
the installment receivables would be recognized as revenue (profit), and only current collection expenses
would be charged to such revenue. The cost recovery method of accounting is rarely used.

3. Installment Method of Gross Profit Recognition

The third approach to the measurement of income from installment sales is to recognize gross profit in
installments over the term of the contract on the basis of cash collections.

Collection of receivables rather than sales is used as the basis for realization of gross profit. In other
words, a modified cash basis of accounting is substituted for the accrual basis. This modified cash basis
of accounting is known as the installment method of accounting.

Example 4.1: At the beginning of Year 3, SANCHO Company sold merchandise on installment basis
for Br 200,000 that have cost of Br 130,000. The first payment is to be collected at the end of Year 3.
The cash collection performances are as follows:
Year 1.......................................................................................... Br.90,000
Year 2.......................................................................................... Br.60,000
Year 3.......................................................................................... Br.50,000
Required: Determine the realized gross profit to be reported each year under Accrual Method; Cost
Recovery Method; and Installment Method
Solution:
1. Accrual Method
Year 1 Installment Sales............................................................ Br.200,000 100%
Cost of Installment Sales ................................................. 130,000 65%
Realized Gross Profit....................................................... Br.70,000 35%
Year 2 Realized Gross Profit....................................................... -0-
Year 3 Realized Gross Profit....................................................... -0-
The Br. 70,000 gross profit is realized in Year 1. Therefore, there is no gross profit to be realized in
Year 2 and Year 3 from this installment sale.
2. Cost Recovery Method
The gross profit to be realized is the difference between the cash collection and unrecovered cost:
Cash Unrecovered Realized Gross Profit Remark
Collection Cost
Year 1 90,000 130,000 90,00 – 130,00 = (40,000) 40,000 cost is not recovered
Year 2 60,000 40,000 60,000 – 40,000 = Br 20,000 Cost is fully Recovered
Year 3 50,000 0 50,000 – 0 = Br.50,000 Cost is fully Recovered
Total 200,000 Br. 70,000

3. Installment Method
Under installment method of gross profit and revenue recognition, each cash collection consists of
certain percentage of gross profit and certain percentage of cost recovery

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 Cash Percentage of Realized Gross Profit
Collection Gross Profit
Year 1 90,000 35% 90,000 @ 35% = 31,500
Year 2 60,000 35% 60,000 @ 35% = 21,000
Year 3 50,000 35% 50,000 @ 35% = 17,500
Total 200,000 70,000

Exercise 4.1: Presented below is summarized information for Johnston Co., which sells
merchandise on the installment basis.
2010 2011 2012
Sales (on installment plan) $250,000 $260,000 $280,000
Cost of sales 155,000 163,800 182,000
Gross profit $ 95,000 $ 96,200 $ 98,000
Collections from customers on:
2010 installment sales $ 75,000 $100,000 $50,000
2011 installment sales 100,000 120,000
2012 installment sales 100,000
Required:
(a) Compute the realized gross profit for each of the years 2010, 2011, and 2012.
(b) Prepare in journal form all entries required in 2012, applying the installment-sales method
of accounting. (Ignore interest charges.)
Solution
(a) 2010 2011 2012

Rate of gross profit Gross profit 38% 37% 35%

( )
Sales

Gross profit realized:

38% of $ 75,000 $28,500
38% of $100,000 $38,000
37% of $100,000 37,000
38% of $ 50,000 $19,000
37% of $120,000 44,400
35% of $100,000 35,000
$28,500 $75,000 $98,400

(b) Installment Accounts Receivable—2012 ..................................... 280,000

Installment Sales ............................................................... 280,000

Cash ........................................................................... 270,000

Installment Accounts Receivable—2010 ............................. 50,000
Installment Accounts Receivable—2011 ............................. 120,000
Installment Accounts Receivable—2012 ............................. 100,000

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 Cost of Installment Sales ............................................................ 182,000
Inventory ......................................................................... 182,000

Installment Sales ........................................................................ 280,000

Cost of Installment Sales ................................................... 182,000
Deferred Gross Profit on Installment
Sales—2012 .................................................................. 98,000

Deferred Gross Profit on Installment Sales—2010 .......................... 19,000

Deferred Gross Profit on Installment Sales—2011........................... 44,400
Deferred Gross Profit on Installment Sales—2012 .......................... 35,000
Realized Gross Profit on Installment
Sales............................................................................. 98,400

Realized Gross Profit on Installment Sales ................................... 98,400

Income Summary ............................................................. 98,400

Exercise 4.2: On January 1, 2001, Alebel Company sells merchandise to retailers found in Piassa
and Megenagna. The company sale is regular to retailers found in Piassa and on installment
bases to retailer found in Megenagna. The retailer in Megenagna is questionable financial
strength, and thus highly uncertain as to whether the retailer in Megenagna will ever be paid
the full amount. The facts regarding the transaction and subsequent events are:
Regular sale Installment sale
Sales price of the merchandise $50,000 100,000
Cost of merchandise 30,000 80,000
Cash collected during 2001 50,000 35,000
Cash collected during 2002 - 30,000
Cash collected during 2003 - 20,000
Cash collected during 2004 - 10,000
As on December 31, 2004, it was determined that no more cash will be collected from the
transactions Alebel uses perpetual inventory system. Income taxes and interest and carrying
charges on installment sales are to be disregarded.
Required: Prepare the necessary entries for Alebel Company to record all transactions and the
necessary adjustments by assuming that the company uses:
a. Accrual basis of accounting (closing entries are not required).
b. Installment method ( including the closing entries to establish deferred gross profit and the
adjusting entries to record the realized gross profit on installment sales).
c. Cost recovery method (including the closing entries to establish deferred gross profit and the
adjusting entries to record the realized gross profit on installment sales).
Solution:
 January 1, 2001. To record the sale:
Regular sales receivables…………………50,000
Installment sales receivable……………...100,000
Regular sales………………………………..50,000
Installment sales…………………………..100,000

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 January 1, 2001. To record cost of sale
Cost of regular sale……………………….30, 000
Cost of installment sale……………….….. 80,000
Merchandises inventory…………………………110,000
 To record cash collections in the year:
2001 2002 2003 2004
Cash……………………….... 85,000 30,000 20,000 10,000
Regular sales receivables………50,000 -
Installment sales receivables…..35,000 30,000 20,000 10,000

The above three entries are the same under accrual, installment, and cost recovery methods.
 December 31, 2001. To record deferred gross profit and to close temporary account:
Installment method Cost recovery method
Installment sales…………..100,000 100,000
Cost of installment sales…………..80,000 80,000
Deferred gross profit……………….20, 000 20,000
 December 31, 2001. To record realized gross profit:
Deferred gross profit………7,000 ___
Realized gross profit……….7, 000
(35,000*20%)
 December 31, 2002. To record realized gross profit:
Deferred gross profit………6,000 ___
Realized gross profit……….6, 000
(30,000*20%)
 December 31, 2003. To record realized gross profit:
Deferred gross profit………4,000 5,000
Realized gross profit……….4, 000 5,000
(20,000*20%)
 December 31, 2004. To record realized gross profit:
Deferred gross profit………2,000 10,000
Realized gross profit……….2, 000 10,000
(10,000*20%)
 December 31, 2004.To record write-off of amount not expected to be collected:
Deferred gross profit………………………………1,000 5,000
Loss on writ-off of installment sales receivables…4,000 -
Installment sales receivables……………………5,000 5,000
N.B.
 The gross profit percentage can be determined as =(80,000/100,000) * 100%
 Since the cost is not fully covered in the first two years, no revenue is realized under cost
recovery method.

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 4.1.3 The Installment Method of Accounting
Under the installment method of accounting, each cash collection on the contract is regarded as including
both a return of costs and a realization of gross profit in the ratio in which these two elements were
included in the selling price. The gross profit is deferred and credited to Deferred Gross Profit. At each
collection the gross profit is realized and the realization is debited and credited to Deferred Gross Profit
and Realized Gross Profit, respectively.

The installment method is acceptable under income tax regulations. In fact, the opportunity to postpone
the recognition of taxable income has been responsible for the popularity of the installment method of
accounting for income tax purposes. Although the income tax advantages are readily apparent, the
theoretical support for the installment method of accounting is less imperative.

Objection to Installment Method of Accounting

There is no sound accounting reason for the use of the installment method for financial accounting
purposes in the case of closed transactions in which collection is dependent upon lapse of time and the
probabilities of realization are properly evaluated. The postponement of recognition of revenues until
they can be measured by actual cash receipt is not in accordance with the concept of an accrual
accounting. Any uncertainty as to collectibles should be expressed by a separately calculated and
separately disclosed estimate of uncollectible rather than by a postponement of the recognition of
revenue.
The circumstances in which the use of the installment method of accounting was permitted were:
1) Collection of installment receivables is not reasonably assumed
2) Receivables are collectible over an extended period of time; and
3) There is no reasonable basis for estimating the degree of collectibles.
In such situations, either the installment method or the cost Recovery method of accounting may be
used.
Illustration 4.1: Single Sale of Real Estate on the installment plan
On November 1, Year 1, ZF Real Estate, which maintained accounting records on a calendar year basis,
sold a building for Br 215,000 whose construction cost was Br 140,000. Commission and other expenses
pertaining to the sale was Br 15,000. The Br 15,000 was an expense treated as deductions in determining
the gross profit on the sale rather than as charges to specific expense accounts. The net amount of
receivable from the sale was therefore Br 200,000, of which 70% represented the cost i.e. the return on
the investment and 30% represented deferred gross gain. All collections from the buyer including the
down payment were regarded as consisting of 70% cost recovery of 30% realization of Gross Profit or
gain. The contract of sale called for a down payment of Br 65,000 and a promissory note, with payment
every six months in the amount of Br 30,000 plus interest (finance charges) of the annual interest rate
of 10% on the unpaid balance.
Required: Record the transaction under the installment method.
Solution
ZF Real Estate
Year 1. Journal Entries to Record Sale of Building on Installment Plan
Nov. 1 Cash....................................................................................... 50,000
Notes Receivable ...................................................................150,000
Building .............................................................. 140,000
Deferred Gain on Sale of Building ..................... 60,000
Recording building on installment plan. Net cash is the difference between the Br
65,000 down payment and the Br 15,000 commission expense (65,000 – 15,000)

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Dec.31 Deferred Gain on sale of Building .........................................15,000
Realized Gain on sale of building........................... 15,000
Realized Gain Computed at 30% of cash collected on the contract during Year1

Dec.31 Interest Receivables.......................................................................2,500

Interest Revenue ............................................................ 2,500
To accrue interest for two months at 10% on notes receivables of Br.150,000. Br.
150,000 @ 10% @ 2/12 = 2,500

Year 2 Cash........................................................................................ 37,500

May.1 Interest Receivable................................................. 2,500
Interest Revenue .................................................... 5,000
Notes Receivable ................................................... 30,000
Collected Semiannual installment on notes receivable plus interest for six months
at 10% on Br.150,000

Nov. 1 Cash........................................................................................ 36,000

Interest Revenue .................................................... 6,000
Notes Receivable ................................................... 30,000
Collected Semiannual installment on notes receivable plus interest for six
months at 10% on unpaid balance of Br.120,000 (Br.150,000 – 30,000)

Dec.31 Deferred Gain on sale of Building .........................................18,000

Realized Gain on sale of building........................... 18,000
Realized Gain Computed at 30% of cash collected on the contract during Year2
(Br.60,000 @ 30% = Br.18,000)

Dec.31 Interest Receivables ...............................................................1,500

Interest Revenue ..................................................... 1,500
To accrue interest for two months at 10% on notes receivables of Br.90,000.
Br. 90,000 @ 10% @ 2/12 = 1,500

Year 3 Cash........................................................................................ 34,500

May.1 Interest Receivable................................................. 1,500
Interest Revenue .................................................... 3,000
Notes Receivable ................................................... 30,000
Collected Semiannual installment on notes receivable plus interest for six
months at 10% on Br.90,000

Nov. 1 Cash........................................................................................ 33,000

Interest Revenue .................................................... 3,000
Notes Receivable ................................................... 30,000
Collected Semiannual installment on notes receivable plus interest for six
months at 10% on unpaid balance of Br.60,000 (Br.90,000 – 30,000)

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Dec.31 Deferred Gain on sale of Building .........................................18,000
Realized Gain on sale of building........................... 18,000
Realized Gain Computed at 30% of cash collected on the contract during
Year2 (Br.60,000 @ 30% = Br.18,000)

Dec.31 Interest Receivables ...............................................................500

Interest Revenue ..................................................... 500
To accrue interest for two months at 10% on notes receivables of Br 30,000.
Br 30,000 @ 10% @ 2/12 = 500

Year 4 Cash........................................................................................ 31,500

May 1 Interest Receivable................................................. 500
Interest Revenue .................................................... 1,000
Notes Receivable ................................................... 30,000
Collection of the final Semiannual installment plus interest for six months at 10%
on Br.30,000.

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Note: If a sale on the installment plan results in a loss, the entire loss must be recognized in the year
of the sale.
Sales of merchandise on the installment plan by a dealer (Merchandising Businesses)
Assume a large volume of installment sales of merchandise by company which used the installment
method of accounting because the collectibles of the receivable cannot be estimated. The first
requirement is to keep separate all sales made on the installment plan as distinguished from ordinary
sales. The accounting records for installment receivables usually are maintained by contract rather
than by customer; if several articles are sold on the installment plan to one customer; it is convenient
to account for each contract separately. However, it is not necessary to compute the rate of gross profit
on each individual installment sales or to apply a different rate to collections on each individual
contract. The average rate of gross profit on all installment sales during a given year generally is
computed and applied to all collections received (net of interest and carrying charges) on installment
receivables originating in that year.
Illustration 4.2: View Company sells merchandise on the installment plan as well as on regular
terms i.e. on cash or 30-day open accounts and uses a perpetual inventory system. For the installment
sale the customer’s account is debited for the full amount of the selling price, including interest and
carrying charges, and is credited for the amount of the down payment. At the beginning of Year 5,
View Company’s ledger included the following accounts.
Installment contracts receivable – Year 3 ..............................................Br 20,000 debit
Installment contracts receivable – Year 4 .................................................85,000 debit
Deferred interest and carrying charges on installment sales ....................17,500 credit
Deferred gross profit – year 3 installment sales ........................................ 4,500 credit
Deferred gross profit – year 4 installment sales ....................................... 19,460 credit
The gross profit rate on installment sales (excluding interest and carrying charges) uses 25% in Year
3 and 28% in Year 4. During Year 5, the following transactions relating to installment sales were
completed by View Company:
1. Installment sales, cost of installment sales and deferred gross profit for Year 5 are listed below:
Installment sales not including Br.30,000 deferred interest and
Carrying charges ............................................................................ Br 200,000 debit
Cost of installment sales.................................................................. 138,000 debit
Deferred gross profit – Year 5 installment sales ............................... 62,000 credit
Rate of gross profit on installment sales (62,000 / 200,000)................ 31%

2. Cash collection on installment contract during Year 5 are summarized below:

Sales Price Interest and Total Cash
Carrying Charges Collected
Installment Receivable Year 5 80,000 10,000 90,000
Installment Receivable Year 4 44,500 12,500 57,000
Installment Receivable Year 3 17,000 1,850 18,850
Total 141,500 24,350 165,850

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3. Customers who purchased merchandise in Year 3 were unable to pay the balance of their
contracts, Br 1,150. The contracts consisted of Br 1,000 sales price and Br.150 in interest and
carry charges, and included Br.250 of deferred gross profit (Br 1000 @ 25% = Br 250). The
current fair value of the merchandise repossessed was Br. 650.
4. Deferred Gross Profit was Realized in Year 5 on cash collected during the year
Relating to Year 5 sales, Br.80000 @ 31% ........................................... Br 24,800
Relating to Year 4 sales, Br.44,500 @ 28% .......................................... 12,460
Relating to Year 3 sales, Br.17000 @ 25% ........................................... 4,250
Total....................................................................................................... Br 41,510
Recording Transactions: the journal entries to record the transactions for View Company
relating to installment sales for Year 5 are given below:
View Company
General Journal
Installment Sales Receivable Year 5.................................................... 230,000
Installment Sales ....................................................................... 200,000
Deferred interest & carrying charges on installment sales ……….......30,000
To record installment sales during Year 5
Cost of installment sales ...................................................................138,000
Inventories ........................................................................ 138,000
To record cost of installment sales
Cash......................................................................................................165,850
Installment Receivable Year 5............................................. 90,000
Installment Receivable Year 4............................................. 57,000
Installment Receivable Year 3............................................. 18,850
To record cash collections on installment accounts during Year 5
Inventories (repossessed merchandise) .................................................... 650
Deferred gross profit Year 3 installment sales ......................................... 250
Deferred interest & carrying charges on installment sales ....................... 150
Doubtful Accounts Expense ..................................................................... 100
Installment Sales Receivables...................................................................... 1,150
To record default on installment contracts originating in Year 3 and repossession of merchandise
Adjusting Entries: the adjusting journal entries for View Company at December 31, Year 5, are
as follows:
View Company
General Journal
Installment sales...................................................................................... 200,000
Cost of installment sales .............................................................. 138,000
Deferred Gross Profit................................................................... 62,000
To record deferred gross profit on Year 5 installment sales
Deferred Gross Profit – Year 5 installment sales....................................24,800
Deferred Gross Profit – Year 4 installment sales....................................12,460
Deferred Gross Profit – Year 3 installment sales.................................... 4,250
Realized Gross Profit on installment sales................................ 41,510
To record realized gross profit

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 Deferred interest and carrying charges on installment sales...................24,350
Revenue from interest and carrying charges .......................... 24,350
To record interest and carrying charges earned during Year 5
The Realized Gross Profit on Installment Sales and Revenue from interest and carrying accounts
would be closed to the Income Summary account at the end of Year 5. The accounts relating to
installment sales appear in the general ledger at the end of Year 5 as follows:
Account Balances at end of Year 5
Installment Contract Receivables – Year 4................................................... Br.28,000 debit
Installment Contract Receivable – Year 5 .................................................... 140,000 debit
Deferred interest and carrying charges on installment.................................. 23,000 credit
Deferred Gross Profit – Year 4 installment sales.......................................... 7,000 credit
Deferred Gross Profit – Year 5 installment sales.......................................... 37,200 credit
These amounts may be rearranged in slightly different form to test the accuracy of the
deferred gross profit on installment contracts at the end of Year 5:
View Company
Proof of Deferred Gross Profit
December 31, Year 5
Contract Deferred Net Contract Gross Deferred
Receivables Interest & CC Receivables Profit % GP
Year 4 accounts Br.28,000 Br.3,000 Br.25,000 28 Br.7,000
Year 5 accounts 140,000 20,000 120,000 31 37,200
Totals 168,000 23,000 145,000 44,200

Note: Instead of separating the collections applicable to the sales price and to the interest and
carrying charges, it would be possible to determine the gross profit rate by inclusion of the interest
and carrying charges in the selling price in the computation of the gross profit rate.

Financial statement presentation of installment sales accounts

The presentation of accounts relating to installment sales in the financial statements raises some
interesting theoretical issues, regardless of whether the accrual basis or the installment method of
accounting is used.
Income Statement
A partial income statement for Year 5 for View Company, which uses the installment method of
accounting, is presented below. This statement is based on the installment sales information
illustrated, plus additional assumed data for regular sales

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 View Company
Partial Income Statement
For Year Ended December 31, Year 5
Regular Sales Combined
Sales...................................................... Br.300,000 Br.500,000
Cost of goods sold ............................... 222,000 360,000
Gross profit on sales ............................. Br.78,000 140,000
Less: Deferred GP on Year 5 sales....... 37,200
Realized GP on Year 5 sales ................ Br.78,000 Br.102,800
Add: Realized GP on prior years’
installment sales................................... 16,710
Total Realized Gross Profit ................. Br.119,510
If the accrual basis of accounting were used for all sales, a gross profit of Br.140,000 would be
reported in Year 5. Revenue from interest and carrying charges on installment contracts may be
added to sales to arrive at total revenue; in a classified income statement, such revenue generally is
reported as Other Revenue.
Balance Sheet
Installment contracts receivable, net of deferred interest and carrying charges, are classified as
current assets, although the collection period often extends more than a year beyond the balance
sheet date. This rule is applicable whether the accrual basis or the installment method of accounting
is used. The definition of current assets specifically includes installment accounts and notes
receivable if they conform generally to normal trade practices and terms within the industry. This
classification is supported by the concept that current assets include all resources expected to be
realized in cash or sold or consumed during the normal operating cycle of the business.
The classification of deferred gross profit on installment sales in the balance sheet when
installment method of accounting is used for financial accounting purposes is controversial. A
common practice for many years was to classify it as a deferred credit at the end of the liability
section. Critics of this treatment pointed out that no obligation to an outsider existed and that the
liability classification was improper.
The existence of a deferred gross profit account is based on the argument that the profit element
of an installment sale has not yet been realized. Acceptance of this view suggest that the related
installment receivable will be overstated unless the deferred gross profit account is shown as a
deduction from installment contracts receivable.
4.1.4 Defaults and Repossessions
If a customer defaults on an installment contract for services and no further collection can be made,
it is a default without the possibility of repossession. A similar situation exists for certain types of
merchandise which have no significant resale value. The journal entry required in such cases it to
write off the uncollectible installment contract receivable, cancel the deferred gross profit related
to the receivable, and debit Doubtful Accounts Expense for the difference. In other words, the
Doubtful Accounts Expense is equal to the Unrecovered Cost contained in the installment contract
receivable.
 Doubtful Accounts Expense = Unrecovered Cost = Installment Receivables – Deferred GP

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 – Deferred interest and Carrying Charges
However, in most cases a default by a customer leads to repossession of merchandise. The
doubtful accounts expense is reduced by the current fair value of the property repossessed, and
it is possible, though not likely, for repossession to result in a gain. The principal difficulty in
accounting for defaults followed by repossession is estimation of the current fair value of the
merchandise at the time of repossession. The current fair value should allow for any necessary
reconditioning costs and provide for a normal gross profit on resale.
 Doubtful Accounts Expense = Unrecovered Cost = Installment Receivables – Deferred GP
– Deferred interest and Carrying Charges – Current fair value repossessed inventory
 Current fair value = expected resale value – reconditioning cost – normal gross profit
In the previous example of repossession by View Company, the following are accomplished:
1. It eliminated the defaulted installment contracts receivable of Br.1,150
2. It cancelled deferred gross profit of Br.250 and deferred interest and carrying charges of Br.150
3. It recognized an asset equal to Br.650 current fair value of the repossessed merchandise; and
4. It recognized doubtful accounts expense of Br.100, the difference between the unrecovered
cost in the defaulted receivable Br.750 and the current fair value of the repossessed
merchandise Br.650

4.1.5 Other accounting issues relating to installment sales

Special accounting issues arise in connection with:
1. Acceptance of used property as a trade-in
2. Computation of interest on installment contracts receivable
3. The use of the installment method of accounting solely for income tax purposes, and
1. Trade-in
Trade-in is acceptance of a used property as partial payment for a new one. An accounting problem
is raised only if there is an Overallowance. An overallowance is the excess of the trade-in
allowance over the current fair value of the used property. An overallowance on trade-ins is
significant as it actually represents a reduction in the stated selling price of the new merchandise.
Example 4.2:
Assume that an article with a cost of Br 2,400 is sold on an installment contract for Br 3,300. Used
merchandise is accepted as a trade-in at a “value” of Br 1,100, but the dealer expects to spend Br
50 in reconditioning the used merchandise before reselling it for only Br 1,000. Assume further
that the customary gross profit rate on used merchandise of this type is 15%, which will cover the
selling costs, various overhead costs, and also provide a reasonable gross profit on the resale of
the used merchandise. The current fair value of the trade-in and the amount of the overallowance
may be computed as follows:
Trade-in allowance given to customer ............................................................. Br 1,100
Deduct current fair value of trade-in
Estimated reseal value of article traded-in .................................. Br 1,000
Less: Reconditioning Costs ............................................. Br 50
Gross Profit Margin (Br.1,000 @ 15%) .......................... 150 200
Current fair value of article traded in ......................................................... 800
Over allowance on trade-in ............................................................................... Br.300

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Assuming that a perpetual inventory system is used, the journal entry to record the installment sale
and the merchandise traded in follows:
Inventories (Trade-in) ............................................................................. 800
Installment Contracts Receivable (Br.3,300 – 1,100)............................. 2,200
Cost of Installment Sales ........................................................................ 2,400
Installment sales (3,300 – 300) ................................................. 3,000
Inventories (new) ...................................................................... 2,400
To record sale of merchandise for Br 3,000, consisting of gross sales price of Br.3,300 minus an
overallowance of Br 300 given on the trade-in

2. Interest on Installment Contracts Receivable

Installment contracts usually provide for interest and other so-called “carrying charges” to be paid
concurrently with each installment payment. Such deferred payment charges, regardless of the
label placed on them, represent a cost of borrowing to the buyer and logically may be referred to
as “Interest”. However, only the portion of the payment which is applied to reduce the principal of
the contract is considered in the measurement of realized gross profit under the installment
method of accounting. The interest revenue for financial accounting purpose should be computed
periodically by the application of the effective interest rate to the unpaid balance of the installment
contracts receivable.
3. Installment Method for Income Tax Purposes Only
The popularity of the installment method for income tax purposes is explained by its capacity for
postponing the recognition of taxable income and the payment of income taxes.

4.2 Consignment Contract

4.2.1 Definition of Consignment Sales
Consignment represents a bailment i.e. a contract for delivery of goods to a bailee. That is a person
or party to whom goods are delivered for a purpose (such as sale, safekeeping, repairs, etc) without
transfer of ownership. It is a transfer of merchandise from the owner to another person who acts as
the sales agent of the owner. There are two parties to consignment contract: consignor and
consignee
 Consignor (bailor) is the owner who retains title to the merchandise
 Consignee (bailee) is the sales agent who has physical possession to the merchandise
Consignees are responsible to consignors for merchandise placed in their custody until it is
sold or returned. Because consignees do not acquire title to the merchandise, they neither
include it in inventories nor record an accounts payable or other liability. The only obligation
of the consignee is to give reasonable care to the consigned merchandise to account for it to
consignors. When merchandise is sold by a consignee, the resulting accounts receivable is
the property of the consignor. At this point the consignor records a sale, gross profit or loss. The
shipment of merchandise on consignment may be referred to by the consignor as a Consignment-
Out and by the consignee as a Consignment-In

4.2.2 Distinction between a Consignment and a Regular Sale

A clear distinction between the two is necessary for proper measurement of income. Regular sales
and consignment, both, involve the shipment of merchandise. Title does not pass when
merchandise is shipped under consignment agreement. Thus, no revenue and profit should be
recognized at the time of the consignment shipment, because there is no change in ownership of

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 merchandise. If the consignee’s business should fail, the consignor would not be in a position of a
creditor, instead the consignor is the owner of unsold merchandise that was initially consigned.
Some reasons why a manufacturer or wholesaler prefers to consign merchandise rather than to
make outright sales are:
 The consignor may be able to persuade dealers to stock the items on a consignment
basis where they will not be willing to purchase the merchandise out right (regular sales)
 The consignor avoids the risk inherent in selling on account to credit customers of
questionable financial strength
 From the stand point of a consignee the acquisition on consignment rather than by out
right purchase requires less amount of capital investment and avoids the risk of loss if
the merchandise can not be sold and become obsolete.

4.2.3 Right and Duties of the Consignee

When merchandise is shipped on consignment, a contract is needed on such points as:
 Credit terms to be granted to customers by the consignee
 Expenditures of the consignee to be reimbursed by the consignor
 Commission allowed to the consignor – that may be 5% or 10%, etc
 Frequency of reporting and payment by the consignee
 Handling and care of the consigned merchandise
The general rights and duties of the consignee may be summarized as follows:
Rights of Consignee Duties of Consignee
1. To receive compensation or commission for 1. To give reasonable care and protection in relation
merchandise sold for the account of the consignor to the nature of the consigned merchandise
2. To receive reimbursement for expenditures such as 2. To keep the consigned merchandise separate from
freight & insurance made in connection with owned inventories or be able to identify the
consignment consigned merchandise. Similarly, the consignee
must identify and segregate the consignment
accounts receivable from other receivables.
3. To sell consigned merchandise on credit if the 3. to use care in extending credit on sales of
consignor has not forbidden credit sales consigned merchandise and to be diligent in
setting prices on consigned on consigned
merchandise and in collecting consignment
Accounts Receivables
4. to make the usual warranties as to the quality of the 4. to render complete report of sales of consigned
consigned merchandise and to bind the consignor merchandise and to make appropriate and timely
honor such warranties payments to the consignor
In granting credit as in caring for the consigned merchandise, the consignee is obliged to act
prudently and to protect the property rights of the consignor of consigned merchandise are the
property of the consignor.
 Because the receivables from the sale of consigned merchandise are the property of the
consignor, the consignor bears any credit losses provided that the consignee has
exercised due care in granting credit and making collections.
 However, the consignee may guarantee fee collection of consignment account
receivable; under this type of consignment contract, the consignee is said to be a del
credere agent

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The consignee also must follow any special instructions by the consignor as to care of the
consigned merchandise. If the consignee acts prudently in providing appropriate care and
protection for the consigned merchandise, the consignee is not liable for any damage to the
merchandise that may occur.

4.2.4 The Account Sale

The report rendered by the consignee to the consignor is called an Account Sale which includes
information such as:
 The quantity of merchandise received and sold
 Expenditures made by the consignee that must be reimbursed by the consignor
 Cash advances made by the consignor to the consignee
 Amounts owed or remitted to the consignor
The consignee makes payments to the consignor as portions of the merchandise are sold or
payments may not be required until all the consigned merchandise either has been sold or has been
returned to the consignor.
Example 4.3: ABC Electronics Trading (located in Addis Ababa) ships 10 units of Television Sets
to Sherafa Trading at Awasa on consignment basis on August 1, 2006. Each unit is to be sold at
Br.400. The consignee is to be reimbursed for freight costs Br.135 and it to receive a commission
of 20% of the authorized selling price. After selling all the consigned merchandise, Sherafa
Trading has to send the consignor an account sales.

4.2.5 Accounting for the Consignee

The receipt of the consignment shipment could be recorded by the consignee in several ways. The
objective is to create a memorandum record of the consigned merchandise; no purchase has been
made and no liability exists. Therefore the receipt of the consignment could be recorded by a
memorandum notation in the general journal, or by an entry in a separate ledger of consignment
shipments, or by a memorandum entry in a general ledger account entitled Consignment In. The
journal entries to record different transactions by Consignee are as follows:
a) To record the payment of freight costs on the shipment from the consignor
Consignment-in – ABC Electronics ....................................... 135
Cash.............................................................................. 135
b) Sold 10 TV Sets at a stipulated selling price
Cash ...................................................................................... 4,000
Consignment-in – ABC Electronics ............................ 4,000

c) Commission of 20% earned on TV sets sold

Consignment-in – ABC Electronics ....................................... 800
Commission Revenue – Consignment Sales................ 800
d) Payment in full to Consignor
Consignment-in – ABC Electronics ..................................... 3,065
Cash .....................................................................................3,065

After posting all the four journal entries above; the consignment-in account in the accounting
records of the consignee appears as follows:

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 Consignment In – ABC Electronics
Date Explanation Debit Credit Balance
Received 10 units of TV Sets to be sold for Br
400 each at a commission of 20% of selling
price....................................................................
Fright Costs paid by consignee .......................... 135 135 dr
Sales of the merchandise (Br 400 @ 10 units)... 4,000 3,865 cr
Commission revenue (Br 4,000 @ 20%) ........... 800 3,065 cr
Payment to Consignor........................................ 3,065 -0-

After selling all the consigned merchandise Sherefa Trading sends ABC
Electronics an Account Sales which is presented in the following manner:
Sherefa Trading
Awasa
ACCOUNT SALES
August 31, 2006
Sales for account & risk of: ABC Electronics
Addis Ababa
Sales: 10 TV sets @ Br.400................................................... Br.4,000
Charges:
Freight Costs.......................................................................... Br.135
Commission (20% @ Br.4,000) ............................................ Br.800 935
Balance (Payment to Consignor) ........................................... Br.3,065
Consigned TV sets on hand ................................................... None

There might be several variations from the pattern of journal entries illustrated above:
 If a freight cost on consigned goods is charged to Freight in account, it should later be
reclassified by a debit to Consignment In and a credit to Freight In
 If an advance is made by the consignee to the consignor, it is recorded as a debit to the
Consignment In account, and the final payment is reduced by the amount of advance
 If merchandise is received on consignment from several consignors, a controlling
account entitled Consignments In may established in the general ledger, and a
supporting account for each consignment set up in a subsidiary consignments ledger.
 Consignment In may have debit balance or credit balance. A debit balance will exist in
a Consignment In account if the total of expenditures, commissions, and advances to
the consignor is larger than the proceeds of sales of that particular lot of consigned
merchandise. A credit balance will exist if the proceeds of sales are in excess of the
expenditures, commissions, and advances to the consignor. The total of the
Consignment In accounts with debit balance should be included among the current
assets in the balance sheet; the total of the Consignment In accounts with credit balance
should be classified as a current liability

4.2.6 Accounting for Consignors

When a consignor ships merchandise to the consignees, it is essential to have a record of the
location of this portion of inventories. Therefore, the consignor may establish in the general ledger

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a Consignment Out account for every consignee. If consignment shipments are numerous, the
consignor may prefer to use a controlling account for subsidiary Consignment-Out ledger account.
The Consignment-Out ledger account represents a special category of inventories.
Should gross profit on consignments be determined separately?
There are different alternatives as an accounting method for consignors: A separate determination
of net income on consignment sales and a separate determination of gross profits on consignment
sales. Another possibility to consider is a separate determination of consignment revenue apart
from other sales revenue. Determination of a separate net income from consignment sales seldom
is feasible, because this would require allocations of many operating expenses on a rather arbitrary
basis. Thus, determination of net income from the consignment sales cannot be justified.

The determination of gross profits from consignment sales as distinguished from gross profits on
other sales is much simpler, because it is based on the identification of direct costs associated with
the consignments.
Illustration of Accounting Methods for Consignor
The choice of accounting methods by the consignor depends on whether
1. Consignment gross profit are measured separately from the gross profit on regular sales; or
2. Sales on Consignment are merged with regular sales with out any effort to measure gross profit
separately for the two categories of sales
The journal entries required under these alternative methods of accounting for consignment
shipments now will be illustrated, first under the assumption that gross profits on consignment
sales are to be determined separately and second under the assumption that consignment sales are
to be merged with regular sales
Example 4.4:
ABC Electronics Trading (located in Addis Ababa) ships 10 units of Television Sets which has
cost Br 250 each to Sherafa Trading at Awasa on consignment basis on August 1, 2006. Each unit
is to be sold at Br 400. The cost of packing the merchandise for shipment was Br 30; all costs
incurred in the packing department are charged to the Packing Expense account. The consignee
paid freight charges of Br 135 to an independent truck line to deliver the shipment. All 10 TV sets
were sold by the consignee for Br 400 each. After deducting the commission of 20% and the freight
charges of Br 135, the Consignee sent the Consignor a check for Br 3,065. The Consignor uses
perpetual inventory system.

Required: Make the necessary journal entries and determine the balance of consignment out
account assuming that:
1. Gross profit on consignment sales are determined separately; and
2. Gross profits on consignment sales are not determined separately

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 1. Gross profit on consignment sales are determined separately
a) Shipment of merchandise costing Br.2,500 Consignment out – ST ................. 2,500
on consignment Inventories .......................... 2,500
b) Packing expenses of Br.30 allocated to Consignment out – ST ....................... 30
consigned merchandise. It is recorded as Packing Expenses ............... 30
packing expense
c) Consignment sales of Br.4,000 reported by Cash ............................................. 3,065
consignee and payment of Br.3,065 received Consignment out – ST ..................... 135
after the consignee deducts Br.135 Commission Expense....................... 800
freight charges and commission of Br.800 Consignment Sales ............... 4,000
d) Cost of consignment sales recorded, Br.2,665 (Br Costs of Consignment sales......... 2,665
2,500 + Br 135 + Br 30 = Br.2,665) Consignment out -ST.......... 2,665
e) Summary of Consignment Out Account
Consignment-Out: Sherefa Trading
Cost of goods shipped 2,500
Packing Expenses 30
Freight Costs 135
2,665 Consignment costs
2,665 2,665

f) Presentation in income statement:

Consignment Sales............................................................... Br 4,000
Less: Cost of consignment sales .......................................... Br 2,665
Commission ............................................................... 800 3,645
Gross Profit on consignment sales....................................... Br 535

2. Gross profits on consignment sales are not determined separately

a) Shipment of merchandise costing Br 2,500 on Consignment-Out: ST.................. 2,500
consignment Inventories .......................... 2,500
b) Packing expenses of Br 30 allocated to consigned No journal entry required, total packing
merchandise. It is recorded as expense is reported among
packing expense
c) Consignment sales of Br 4,000 reported by Cash ............................................. 3,065
consignee and payment of Br.3,065 received Freight Expense................................ 135
after the consignee deducts Br.135 freight Commission Expense ....................... 800
charges and commission of Br.800 Sales...................................... 4,000
d) Cost of consignment sales recorded, Br Costs of goods sold...................... 2,500
2,500 Consignment out -ST.......... 2,500

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 e) Summary of Consignment-Out Account
Consignment-Out: Sherefa Trading
Cost of goods shipped 2,500
2500 Consignment costs

2,500 2500

f) Presentation in income statement:

Included in total sales ........................................................ Br 4,000
Included in cost of all merchandise sold ........................... Br 2,500
Included in total packing expense ..................................... 30
Included in total freight expense ....................................... 135
Included in total commission expense .............................. 800

4.2.7 Accounting for partial sale of consigned goods

Determining the gross profit assuming that the entire consignment had been sold by the consignee
is relatively simple. When there is a partial sale of consigned goods, the consignor must determine
the amount of gross profit realized on the partial sale rather than the entire sale. Example: take the
previous illustration except that only four of the 10 TV sets consigned by ABC Electronics had
been sold by the end of the accounting period. The account sales received at the end of the current
period includes the following information:

Sherefa Trading
ACCOUNT SALES to ABC Electronics
August 31, 2006
Sales for account & risk of: ABC Electronics
Addis Ababa
Sales: 4 TV sets @ Br.400..................................................... Br.1,600
Charges:
Freight Costs..........................................................................Br.135
Commission (20% @ Br.1,600) ............................................Br.320 455
Balance payable to consignor ................................................ Br.1,145
Check enclosed ......................................................................Br.500
Balance due to consignor....................................................... 645 1,145
Consigned TV sets on hand ................................................... 6 TV sets

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 1. Gross profit on consignment sales are determined separately
a) Shipment of merchandise costing Br 2,500 on Consignment-Out: ST....................... 2,500
consignment Inventories ............................... 2,500
b) Packing expenses of Br 30 allocated to Consignment-Out: ST ............................. 30
consigned merchandise. It is recorded as Packing Expenses .................... 30
packing expense
c) Consignment sales of Br 1,600 reported by Cash ...................................................... 500
consignee and payment of Br 500 received. Accounts Receivable............................. 645
Charges by consignee: Br 135 freight charges; Consignment-Out: ST ........................... 135
and commission of Br 800 Commission Expense-CS ..................... 320
Consignment Sales .................... 1,600
d) Cost of consignment sales recorded, Br 1,066 (4 Costs of Consignment sales.............. 1,066
@ (Br 250 + Br 3 + Br 13.5) ) Consignment-Out: ST.............. 1,066
e) Direct cost relating to unsold merchandise in hands
of consignee deferred when profits are not
determined separately: No journal entry is required
Packing costs, 6 @ Br 3 ...................... Br 18
Freight costs, 6 @ Br 13,50 ...................... 81
Total ................................................... Br 99
f) Summary of Consignment Out Account
Consignment-Out: Sherefa Trading
Cost of goods shipped 2,500 1,066
Packing Expenses 30 1,599 Balance
Freight Costs 135
2,665 2,665
Balance 1,599
g) Presentation in balance sheet
Current Assets:
Inventories on Consignment ................................................ Br.1,599

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 2. Gross profit on consignment sales are not determined separately
a) Shipment of merchandise costing Br 2,500 on Consignment-Out: ST....................... 2,500
consignment Inventories ............................... 2,500
b) Packing expenses of Br 30 allocated to No journal entry is required; total packing expense
consigned merchandise. It is recorded as is reported among operating expenses
packing expense
c) Consignment sales of Br 1600 reported by Cash ...................................................... 500
consignee and payment of Br 500 received. Accounts Receivable............................. 645
Charges by consignee: Br 135 freight charges; Freight Expense .................................... 135
and commission of Br 800 Commission Expense -CS .................... 320
Sales........................................... 1,600
d) Cost of consignment sales recorded, Br 1,000 (4 Costs of Goods sold.......................... 1,000
@ Br 250 = Br 1,000 ) Consignment out –ST .............. 1,000
e) Direct cost relating to unsold merchandise in hands
of consignee deferred when profits are not Consignment-Out: ST ........................... 99
determined separately: Packing Expense ................. 18
Packing costs, 6 @ Br 3 ...................... Br 18 Freight Expense................... 81
Freight costs, 6 @ Br 13,50 ...................... 81
Total ................................................... Br 99
f) Summary of Consignment Out Account
Consignment-Out: Sherefa Trading
2,500 1,000
99 1,599 Balance
2,599
Balance 1,599 2,599
g) Presentation in balance sheet
Current Assets:
Inventories on consignment .................................................Br.1,599

4.2.8 Other issues in Consignment Contracts

 Return of unsold merchandise by consignee
The costs of packing and shipping merchandise to a consignee, whether paid directly by the
consignor or by the consignee, properly are included in inventories. However, if the consignee for
any reason returns merchandise to the consignor, the packing and freight costs incurred on the
original outbound shipment should be written off as expense of the current period. The place utility
originally created by these costs is lost when the merchandise is returned. Any charges borne by
the consignor on the return of shipment also should be treated as expense, along with any repair
expenditures necessary to place the merchandise in salable condition.

A clear distinction should be made between freight costs on consignment shipments and outbound
freight on regular sales. The latter is a current expense, because the revenue from sale of the
merchandise is recognized in the current period. The freight costs on consignment shipment create
an increment in value of the merchandise which is still the property of the consignor. This
increment, along with the cost of acquiring or producing the merchandise, is to be offset against
revenue in a future period when the consigned merchandise is sold.

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  Advances from consignees
Although cash advances from a consignee sometimes are credited to the Consignment Out account,
a better practice is to credit a liability account, Advances from consignees. The Consignment Out
account will then continue to show the carrying amount of the merchandise on consignment rather
than being shown net of a liability to the consignee.

 Nature of the consignment out account

There is a need to understand where Consignment Out belongs in the basic five types of accounts:
assets, liabilities, owners’ equity, revenue, and expenses. The Consignment Out account belongs in
the asset category. The account is debited for the cost of merchandise shipped to a consignee; when
the consignee reports sale of all or a portion of the merchandise, the cost is transferred from
Consignment Out to Cost of Consignment Sales. To be even, more specific, Consignment Out is a
current asset, one of the inventories group to be listed on the balance sheet as Inventories on
Consignment, or perhaps combined with other inventories if the amount is not material. The costs
of packing and transporting consigned merchandise constitute costs of inventories, and these costs
should be debited to the Consignment Out account.

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