CHAPTER THREE

ACCOUNTING FOR INSTALLMENT AND CONSIGNMENT SALS

3.0 Learning objectives:
After completing this chapter, you should be able to:
➢ Differentiate regular sales from installment and consignment Sales
➢ Explain the characteristics of installment and consignment Sales
➢ Record transactions involving installment sales
➢ Compute profit from installment sales under different alternative methods
➢ 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
➢ Discuss the accounting for consignee and consignor.
➢ Describe the accounting for defaults and repossessions on installment sales.

PART ONE: INSTALLMENT SALES CONTRACT

3.1 Introduction
This part focuses on explaining about the accounting treatment for installment sales. Real or
personal property is often sold on contract under which a down payment is made and the remainder
of the sales price is collected in a series of installment payments. Because payments may be
deferred for an extended period, there may be uncertainty as to the collectability of the sales price.
Uncertainty about collectability may justify departure from the accrual basis of accounting.
Circumstances in which such a departure is considered appropriate are discussed in the first section
of this chapter and alternative methods of reporting income are illustrated.
Business enterprises often try to attain their objectives of maximizing profit by expanding sales.
Hence, instead of sticking to the cash sales they design various mechanisms that allow them to
maximize profit. One among the methods is a credit sale where customers with insufficient amount
of finance are given a chance to pay for goods later. Nevertheless, there are circumstances where
customers face difficulty in settling their account even after sometime. This is the case particularly
when the goods are of high price wherein customers cannot afford to pay the whole price of the
item at a time. As a result, enterprises had to design a mechanism through which they can sell high
priced items. This mechanism is called installment sales.
Although an installment sale permit boosting up sales by a significant amount, it has an inherent
risk of default by customers. This is mainly due to the fact that customers are allowed extended
period of time over which they have to settle their account. Accountants must therefore examine
the issues that surround installment sales and develop the most effective techniques possible for
measuring, controlling and reporting it.
The installment sales contract is a special type of credit arrangement which provides for a
schedule of predetermined periodic collections from the sale of real estate, merchandise, or other
personal property. In other words, installment sales are sales where payment is required in periodic
installments over an extended period of time. In respect to the usual credit sale, the collection
interval is comparatively short and title passes unconditionally to the buyer concurrent with the

1 completion of the sale; however, installment sales contracts are more frequently characterized by
 (1) a cash down payment at the date of sale followed by periodic (frequently equal) payments
over a relatively long period of time,
(2) a transfer of title which remains conditional until the debt is fully discharged.
In view of the typically long collection period, and the concomitant increase in risk, a variety of
contractual arrangements are used to provide some additional measure of protection to the seller.
Most of these agreements involve some form of title retention by the seller; among these are the
following:
1. Conditional sales contracts: whereby the seller retrains legal title of transferred property
until the schedule of installment collections is completed.
2. Hire-purchase contracts: A hire purchase (HP) agreement is a credit agreement. With hire
purchase you hire an item (a car, a laptop, a television) and pay an agreed amount in monthly
payments. You do not own the item until you have made the final payment. Personal
Contract Plans (PCPs) are a type of hire purchase agreement. whereby the vendor, in effect,
leases the property to the buyer until the final installment (rental) payment is made, at which
time title is conveyed to the buyer for some nominal consideration.
3. Custodial arrangements: A custodial agreement is an arrangement wherein one holds an
asset or property on behalf of the actual owner (beneficial owner). Such agreements are
generally entered into by state agencies, or companies to administer various benefit
programs. The legal title to property is vested in a third party (a trustee) until payment
therefore is completed, at which time title transfers to the purchaser, this arrangement is
primarily applicable to sales of real estate.
In other types of agreements, title passes to the purchaser under a mortgage or lien arrangement.
Such contracts enable the vendor to reclaim possession of transferred property in those instances
where the purchaser is in default.
Despite these safeguards, losses from installment sales tend to be significantly larger than those
from short-term credit sales. This may be attributed, in part, to such unique variables as the
extended collection period, the relatively small value of many items of repossessed merchandise
(whether due to physical deterioration, obsolescence, or depreciation), increased collection
expenses, and necessary costs of repossession.
Despite this disadvantage to the seller, the practice of selling on an installment basis continues to
grow in significance. Although credit losses resulting from installment sales are often significant,
and processing and collection costs are increased, the profitability of the firm may still be improved
through an increase in installment sales volume.
Accordingly, the accountant must carefully appraise the measurement of net income where the
amount of revenue from installment sales contracts is significant.
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
2 ➢ Substantial amount of working capital is tied up in receivables
 3.2 Methods of Recognition of Profit on Installment Sales
Three methods have evolved to account for and report the effects of installment sales of inventory
on a firm’s financial statements. One method, the point-of-sale, is consistent with the conventional
income measurement method related to the accrual basis of accounting. The other two methods
(cost recovery and installment) are used to account for installment sales when the collection of
the sales price is highly uncertain. In such cases, profit recognition is deferred and associated with
the collection of cash.
Gross Profit Recognized at the Time of Sale (Accrual Method)
Revenue is generally recognized from the sale of a tangible asset at a specific point in the earnings
process of a business, typically when:
(1) the earnings process is complete or virtually complete, and
(2) an exchange has taken place.
In the case of a cash sale or short-term credit sale, revenue is generally recognized when title to
the goods transfers or, from a practical point of view, when the goods are shipped to the customer.
Related expenses are matched against the reported revenue to determine profit. To provide a
complete measure of profitability, it may be necessary to establish allowances and accrue expenses
in the current period for expenses expected to be incurred in future periods (for example, warranty
expenses) or to recognize losses from the failure to collect the full sales price.
Theoretically, accounting for installment sales should parallel the accounting procedures
considered acceptable for accounting for short-term credit sales, even though title to the asset may
not transfer until some point in the future. In other words, total revenue, current and future
expenses related to the sale should be reported in the accounting period in which the goods are
delivered by the seller to the buyer and a claim is established against the buyer. The passing of
title is not considered relevant when determining the point at which profit should be recognized
from the sale. Both parties to the transaction intend and expect to fulfill the terms of the agreement,
and the transfer of title from the seller to the buyer is expected at some future date.
Gross Profit Recognized as Cash is Collected
In most circumstances, recognizing revenue and matching related expenses at the point of sale is
considered the appropriate method of accounting for an installment sale. However, for some
installment sales, bad debt losses on installment receivables may be significant and, more
importantly from an income determination point of view, may be difficult to estimate because of
the extended period of collection and lack of prior experience. Because of the uncertainty of these
future losses and expenses and in recognition of the diverse condition under which installment
sales are made, several alternatives to the point-of-sale method of recognizing revenue have
evolved. These methods recognize profit in the period in which the sales price is collected, rather
than in the period in which the sale is made.
1. 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 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

3
degree of collectability 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.
Many accountants consider this method too conservative for most firms engaging in installment
sales on a regular basis. However, the method is used when there is a great deal of uncertainty as
to the collectability of the receivable balance or the recovery of the receivable balance by
repossessing the goods sold. Thus,
On the Income Statement:
1. Realized Gross Profit: gross profit is recognized each period to the extent of the collections
of installment sales only after the cost of the installment sales are recovered.
2. Interest: interest on installment payments should be accounted for separately from the
gross profit realized on the collection of installment sales.
3. Repossession: gain or loss is recognized for the difference between the fair market value
of the repossessed merchandise and the uncollected installment sale less the deferred gross
profit on the installment sale.
On the Balance Sheet
1. Installment Receivable: receivables from installment sales contracts should be reported by
year of collectability.
2. Deferred Gross Profit: deferred gross profit on installment sales should be reported as
unearned revenue.
2. 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. Thus, the gross profit
on an installment sale is deferred and recognized in the periods in which cash is collected. The
amount reported as profit in each period is dependent on the amount of cash collected in that period
and the gross profit percentage applicable to the year of the original sale.
STEPS:
i. Compute gross profit rate (GPR) on the installment sales.
Gross Profit Rate (GPR) = Installment sales – Cost of goods sold (CGS) x 100
Installment sales
OR
Gross Profit Rate to date (GPR) = Cash collection to date – CGS to date x 100
Cash collection to date
ii. Recognize gross profit as cash is received (apply this rate to cash collections of
current year’s installment sales).
iii. Gross profit not realized is deferred until a future period.
Such that,
On the income statement
1. Realized Gross Profit: gross profit is recognized each period equal to the collections on

4 the installment sale multiplied by the gross profit percentage on the installment sales
 a. Gross Profit Percentage: the gross profit percentage is equal to the gross profit on the
installment sale divided by the installment sale.
b. Interest: interest on installment payments should be accounted for separately from the
gross profit realized on the collection of installment sale.
2. Repossession: gain or loss is recognized for the difference between the fair market value
of the repossessed merchandise and the uncollected installment sale less the deferred
gross profit on the installment sale.
On the Balance Sheet
1. Installment Receivable: receivables from installment sales contracts should be reported by
year of collectability.
2. Deferred Gross Profit: deferred gross profit on installment sales should be reported as
unearned revenue.
3.3 Accounting for Installment Sales
Example: To illustrate the application of the Installment & Cost Recovery Methods assume that
on June 1, 2018, Booker productions sell a large amount of merchandise to a retailer on installment
basis. The buyer agrees to pay every year beginning 2018. The demand for the merchandise is
unknown, the retailer has questionable financial strength, and thus it is highly uncertain as to
whether Booker will ever be paid the full sales price. The facts regarding the transaction and
subsequent events are:
Sales price for merchandise Br.140,000 100%
Cost of merchandise sold 84,000 60%
Gross margin Br. 56,000
Cash collections in 2018 40,000
Cash collections in 2019 55,000
Cash collections in 2020 15,000
Total cash collections Br.110,000
Required: Prepare the necessary entries for Brook Production Company to record all
transactions and the necessary adjustments by assuming that the company uses:
1. Accrual basis of accounting 3. Cost recovery
2. Installment method
Solution:
1. Accrual Method
Installment Accounts Receivable………………………..140,000
Installment Sales…………………………………………………….140,000
To record sales on installment basis.
Cost of Installment Sales………………………………….84,000
Merchandise inventory……………………………………………….84,000
To record cost of merchandise sales.
2. Installment Method
For 2018:
Installment Accounts Receivable………………………140,000
Installment Sales.……..……………………………………………..140,000
To record sales on installment basis.
Cost of Installment Sales………………………………….84,000
Merchandise inventory……………………………………………….84,000
To record cost of merchandise sales.
Cash……………………………………………………….40,000
Installment Accounts Receivable……………………………………..40,000
5 To record cash collections during 2018
 Installment sales…………………………………………140,000
Cost of installment sales………….…………………………………...84,000
Deferred gross margin…………………….…………………………..56,000
To close installment sales and cost of installment sales accounts.
Deferred gross margin (Br. 40,000 X 0.4)………………...16,000
Realized gross margin………………………………………………...16,000
To record realized gross margin in 2018
For 2019:
Cash…………………………………………………....55,000
Installment Accounts Receivable………..…………………………55,000
To record cash collections on installment sales of 2018.
Deferred gross margin………………………………….22,000
Realized gross margin (55,000*.4).…………………………..……22,000
To record realized gross profit on installment sales of 2018.
For 2020:
Cash……………………………………………………15,000
Installment Accounts Receivable………………………………….15,000
To record cash collections on installment sales of 2018.
Deferred gross margin…………………………………...6,000
Realized gross margin (15,000 X 0.4) …………………………………6,000
To record realized gross profit on installment sales of 2018.
3. Cost Recovery Method
For 2018:
Installment Accounts Receivable………………………140,000
Sales………………………………………………………………..140,000
To record sales on installment basis.
Cost of Installment Sales………………………………….84,000
Merchandise inventory……………………………………………….84,000
To record cost of merchandise sales.
Cash……………………………………………………….40,000
Installment Accounts Receivable……………………………………..40,000
To record cash collections during 2018
Installment sales…………………………………………140,000
Cost of installment sales………….…………………………………...84,000
Deferred gross margin…………………….…………………………..56,000
To close installment sales and cost of installment sales accounts.
No realized gross profit from installment sales. This is because the cash collected (Br 40,000)
is less than the cost (Br 84,000).
For 2019:
Cash…………………………………………………....55,000
Installment Accounts Receivable………..…………………………55,000
To record cash collections on installment sales of 2018.
Deferred gross margin …………..……………….………….11,000
Realized gross margin (40,000 + 55,000 - 84,000)……………..……11,000*
To record realized gross profit on installment sales of 2018.
For 2020:
Cash……………………………………………………15,000
Installment Accounts Receivable………………………………….15,000

6 To record cash collections on installment sales of 2018.

 Deferred gross margin…………………………………...15,000
Realized gross margin…………………………………………….15,000*
To record realized gross profit on installment sales of 2018.
*Schedule for the computation of realized gross profit under the cost recovery method:
Year Cash Recovery of Balance Gross
Receivable Original Cost Unrecovered Profit
Beg. Br 84,000 -
2018 40,000 40,000 44,000 0
2019 55,000 44,000 0 11,000
2020 15,000 0 0 15,000
Note that as the cost is fully recovered in 2019 and 2020, realized gross margin of Br.11,000 and
Br.15,000 is recognized respectively. The presentation of the installment sales and the realized
gross profit on installment sales on the income statement under the two alternative methods is
given below:
Booker Company
Income Statement
For the Year Ended December 31, 2018 (Installment Method)
Installment Regular Total
Sales Sales
Sales Br.140,000 Br.450,000 Br.590,000
Cost of sales 84,000 310,000 394,000
Gross profit 56,000 140,000 196,000
Less: Deferred gross profit on installment sales of 2018 40,000 40,000
Realized gross profit on current year’s sales Br 16,000 140,000 156,000
Add: Realized gross profit on prior years’ installment sales -0-
Total realized gross profit 156,000
Operating expenses 120,000
Income before income tax 36,000
Income tax (30%) 10,800
Net income Br. 25,200
Booker Company
Income Statement
For the Year Ended December 31, 2018 (Cost Recovery Method)
Installment Regular Total
Sales sales
Sales Br.140,000 Br.450,000 Br.590,000
Cost of sales 84,000 310,000 394,000
Gross profit 56,000 140,000 196,000
Less: Deferred gross profit on installment sales of 2018 56,000 40,000
Realized gross profit on current year’s sales Br. 0 140,000 140,000
Add: Realized gross profit on prior years’ installment sales -0-
Total realized gross profit 140,000
Operating expenses 120,000
Income before income tax 20,000
Income tax (30%) 6,000

7
Net income Br.14,000
 The balance sheet of a business with installment sales will include the contracts receivable and the
deferred gross profit balances related to sales on the installment plan. When current assets are
viewed as including those resources reasonably expected to be realized in cash or sold or consumed
during the normal operating cycle of the business, installment contracts receivable qualify for
inclusion under the current heading regardless of the length of time required for their collection.
In reporting installment contracts receivable under the current heading, disclosure of the maturity
dates of such contracts will provide readers of the balance sheet with a better appreciation of the
company’s financial position; accordingly, annual maturities of receivables should be indicated by
parenthetical or footnote disclosure or by listing receivables according to their annual maturities.
Conflicting positions have been taken with respect to the appropriate classification on the balance
sheet of the deferred gross profit balance. It has been suggested that this balance be reported as:
1. A liability item to be included under the deferred revenues heading,
2. An asset valuation account to be subtracted from installment contracts receivable,
3. A capital item to be included as a part of retained earnings.
Deferred gross profit on installment sales is generally reported in the liability section of the balance
sheet as deferred revenue. Accountants following this practice take the position that the installment
sale has actually increased the working capital position of the company but that the recognition of
an increase in capital must await the conversion of the installment receivable into cash. The
presentation of the installment accounts receivable and the deferred gross profit account on the
balance sheet both under the installment and cost recovery methods is shown below:
Booker Company
Balance Sheet (partial)
December 31, 2018 (Installment Method)
Assets Liabilities & Stockholders’’ Equity
Current assets: Current liabilities:
Cash Xxx Accounts payable xxx
Accounts receivable (regular) Xxx Income tax payable xxx
Installment accounts receivable-2018 100,000 Deferred gross profit on 40,000
installment sales-2018
Total current assets Xxx Total current liabilities xxx
3.4 Defaults and Repossessions
Default on an installment contract and repossession of the article sold calls for an entry on the
books of the seller that reports the merchandise reacquired, cancels the installment receivable
together with the related deferred gross profit balance, and records the gain or loss on the
repossession. As in the case of goods acquired by trade-in, a repossessed article should be recorded
at an amount that will permit a normal gross profit on its resale
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
– Deferred interest and Carrying Charges
However, in most cases a default by a customer lead 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

8 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
Example: To illustrate the procedure for defaults and repossessions, assume the following data:
Total installment sales in 2002……………………………..Br.200,000
Gross profit rate on installment sales of 2002……………………..36%
In 2003 a customer defaults on a contract for Br.1,200 that had originated in 2002. A total of
Br.500 had been collected on the contract in 2002 prior to the default. The article sold is
repossessed; its value to the company is Br.360, allowing for reconditioning costs and a normal
gross profit on resale. The entry to record the default and the repossessed merchandise follows:

Merchandise-Repossessions………………………………360
Deferred Gross Profit-2002……………………………….252
Loss on Repossessions……………………………………..88
Installment Contracts Receivable-2002………………….700
Cancellation of the installment contracts receivable balance of Br.700 is accompanied by
cancellation of deferred gross profit of Br.252 (36% of Br.700). The repossessed merchandise is
reported at a value of Br.360. A loss of Br.88 is recognized on the repossession, representing the
difference between the installment contract balances cancelled, Br.448 (Br.700-Br.252), and the
value assigned to repossessed merchandise Br.360.
When perpetual inventories system is maintained, repossessed goods are debited to the inventory
balance; when periodic inventory system is used, repossessions are recorded in a separate nominal
account and this balance is added to purchases in calculating cost of goods sold. When goods are
repossessed in the year in which the sale is made and before the gross profit percentage has been
calculated, it may be necessary to assume a gross profit percentage in recording the gain or loss
from the repossession. A correcting entry is made at the end of the period when the actual gross
profit percentage is known.
If the repossessed merchandise in the preceding example is recorded at a value in excess of Br.448,
the difference between the balance in the installment contracts receivable account and the deferred
gross profit account, a gain would have been reported on the repossession. Ordinarily, however,
conservatism would suggest that no more than the unrecovered cost, the difference between the
receivable balance and the deferred gross profit balance, be assigned to the repossessed goods. No
gain, then, would be reported at the time of the repossession; recognition of any gain would await
the sale of the repossessed goods. Any gain or loss on defaults and repossessions is normally
recognized on the income statement as an addition to or a subtraction from the realize gross profit
on installment sales.

3.5 Other accounting issues relating to installment sales

Special accounting issues arise in connection with:

9 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

3.5.1 Trade-Ins
Trade-in is acceptance of a used property as partial payment for a new one. In certain sales on
the installment plan, companies will accept a trade-in as part payment on a new contract. When
the amount allowed on the goods traded in is a value that will permit the company to realize a
normal gross profit on its resale, no special problem is involved. The trade-in is recorded at the
value allowed, cash is debited for any payment accompanying the trade-in, installment contracts
receivable is debited for the balance of the sales price, and installment sales is credited for the
amount of the sale. Frequently, as a special sales inducement, an over allowance is given on the
trade-in. Such an over allowance is, in effect, a reduction in the sales price, and the accounts should
properly report this fact. Under such circumstances, the trade-in should be recorded at no more
than the company would pay on its purchase; the difference between the amount allowed and the
value of the article to the company should be reported either as a charge to an over allowance
account or as a reduction in installment sales. In either case, the gross profit on installment sales
should be regarded as the difference between the cost of the goods sold and net sales (the total
installment sales less any trade-in over allowance).
Example: To illustrate application of the foregoing, assume that a certain article that cost Br.675
is sold for Br.1,000. A used article is accepted as down payment, and Br.300 is allowed on the
trade-in. The company estimates reconditioning costs of Br.20 on this article and a sales price of
Br.275 after such reconditioning. The company normally expects a 20% gross profit on sales of
used goods.
Required: calculate trade ins and over allowance and prepare the necessary journal entries?
Solution:
The value of the trade-in and the amount of the over allowance are calculated as follows:
Amount allowed on trade-in…………………………………………….………….Br.300
Value of article traded in:
Sales value of article…………………………………………………Br.275
Less: Reconditioning costs……………………………………Br.20
Gross profit to be realized on resale (20% of Br.275)……. 55 75 200
Over allowance…………………………………………………………………… Br. 100
The sale can now be recorded as follows:
Merchandise-Trade-ins………………………………..200
Over allowances on installment sales trade-ins……….100
Installment contracts receivable-2002………………...700
Installment sales……………………………………..1,000
Cost of installment sales……………………………….675
Merchandise-new……………………………………....675
The cost percentage on the installment sale is calculated as follows: cost, Br.675; net sales,
Br.1,000, less over allowance, Br.100, or Br.900; cost percentage, 675/900, or 75%. The gross
profit on installment sales, then, is 25%, and 25% of Br.200, the down payment on the sale, may
be considered realized to date. The article traded in is recorded at Br.200. This cost when increased
by reconditioning costs measures the utility of the article to the business and permits a normal

10 gross profit on its resale.

 It was just assumed in the example just given above that the company employs a perpetual
inventory system for merchandise. When a periodic inventory system is used, trade-ins are
recorded in a separate nominal account and this balance is added to purchases in summarizing cost
of goods sold at the end of the period.
3.5.2 Interest on Installment Contracts
Installment contracts frequently provide for a charge for interest and other so-called “carrying
charges” to be paid concurrently on the balance due. The interest charge is ordinarily payable
with the installment payment that reduces the principal. Although interest is included in the
payment, use of the installment method requires the only portion of a payment which reduces the
principal balance of the installment contact receivable should be considered in computing the gross
profit realized. 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.
Example: To illustrate the accounting for installment sales that carry interest, assume that on
January 1 of year 1 a corporation sold land costing Br. 120,000 for a Br. 50,000 down payment
and a Br 150,000, 3-year, 8% note; the note was to be repaid in 3 annual installments of Br. 58,205
on December 31 of year 1, year 2, and year 3 (58,205 x 2.57710 = 150,000). Following is a
schedule of the cash payment and interest income based on the information given:
Amortization Schedule:
Beginning Balance Interest Income Cash Payment Ending Balance
150,000 + 12,000 - 58,205 = 103,795
103,795 + 8,304 - 58,205 = 53,894
53,894 + 4,312 - 58,205 = 1
Required: Based on the foregoing information the journal entries to record the sale of land on
installment plan using the three alternative accounting methods are shown below.
Solution:
1. Installment Method
For Year 1:
Cash………………………………………………50,000
Notes Receivable………………………………..150,000
Land………………………………………………………120,000
Deferred Gross Profit.……………………………………..80,000
To record the installment sale of land.
Deferred Gross Profit…………………………………….. 20,000
Realized Gross Profit (50,000x (80,000/200,000))…………….20000
To record realized gross profit.
Cash……………………………………………...58,205
Interest Income…………………………………………....12,000
Notes Receivable……………………………………….…46,205
To record cash collections in Year 1.
Deferred Gross Profit……………………………18,482
Realized Gross Profit (40% x 46,205)…………………….18,482
To record realized gross profit in year 1.
For Year 2:
Cash……………………………………………58,205

11
Interest Income…………………………………………….8,304
Notes Receivable……………………………………….....49,901
 Deferred Gross Profit………………………….19,960
Realized Gross Profit (40% x 49,901)……………………19,960
For Year 3:
Cash…………………………………………….58,205
Interest Income………………………………………….….4,311
Notes Receivable……………………………………….…53,894
Deferred Gross Profit…………………………...21,558
Realized Gross Profit (40% x 53,894)…………………….21,558
2. Cost Recovery Method
For year 1:
Cash………………………………………………50,000
Notes Receivable………………………………..150,000
Land…………………………………………………..…120,000
Deferred Gross Profit.…………………………………….80,000
To record the installment sale of land.
Cash……………………………………………….58,205
Interest Income…………………………………………....12,000
Notes Receivable……………………………………….…46,205
Note that there is no realized gross profit because the cash collections on principal amount of
the sale (96,205) are less than the cost of the land that is sold (120,000).
For Year 2:
Cash……………………………………………….58,205
Interest Income………………………………………..…..8,304
Notes Receivable…………………………………….…...49,901
Deferred Gross Profit…………………………………………..26,160
Realized Gross Profit (50,000+46,205+ 49,901 -120,000)……...26,160
For Year 3:
Cash…………………………………………..….58,205
Interest Income……………………………………………..4,311
Notes Receivable……………………………………….…53,894
Deferred Gross Profit………………………........53,894
Realized Gross Profit …….……………………………….53,894

3.5.3 Installment Method for Income Tax Purposes

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.

PART TWO: CONSIGMENT SALES CONTRACTS

3.6 Introduction
This part focuses on explaining about the accounting treatment for consignment sales. Business
enterprises often try to attain their objectives of maximizing profit by expanding sales. Another
method by which business enterprises can expand their sales in order to maximize their profit is
thorough consignment sales. This method is particularly useful to minimize the risk of
uncollectability due to customers default on credit sales and when reaching distant areas through

12 establishment of branches or forming a sales agency becomes costly.

 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
A consignment arrangement is a method of marketing a product in which the possession of goods
is transferred to another party who is to act as an agent in selling the goods. The transfer of goods
on consignment is not considered a sales transaction. However, both parties must establish
adequate procedures to control and account for goods on consignment. In consignment shipments,
the firm that makes the consignment retains title to goods. Unsold items are considered as part of
inventory of the enterprise that ships the merchandise on a consignment basis.
3.7 Nature of the Consignment Agreement
A consignment constitutes the transfer of possession of merchandise without the transfer of title
from the owner, called the consignor, to another person, called the consignee. The consignee acts
as an agent on behalf of the consignor for the purpose of selling the goods for a commission.
Legally, the consignment is a bailment and, accordingly, the laws of agency and bailment apply in
the determination of the rights and responsibilities of both the consignor and the consignee.
3.8 Distinction between Consignment Sales and Regular (Ordinary) Sales
The shipment of consigned goods to the consignee is not treated as a sale. Although a transfer of
goods has taken place, it is not the intent of either the consignor or the consignee that sale and
purchase transactions take place. Title to the goods remains with the consignor, and recognition of
the sale is deferred until the goods are transferred to a third party by the consignee. In other words,
the intent of the parties is to transfer title directly from the consignor to the third party. At that
time, the transaction is recorded as a sale on the books of the consignor. Accordingly, inventory
on consignment must be reported as part of the consignor’s inventory until it is sold by the
consignee to a third party.
A consignment arrangement offers certain advantages to both the consignor and the consignee. A
consignor may prefer shipping goods on consignment for the following reasons:
1. Wider markets for a product: Dealers may not be willing to assume the risk of purchasing
certain goods, such as a new product or an item that may become obsolete, but may be willing
to carry them on consignment.
2. Control over selling price: If goods are sold directly to the consignee, the consignor may
find it difficult to establish and control the selling price of goods.
3. Recovery of an asset: Since legal title does not transfer to the consignee, the consignor has

13
the right to possession of all unsold goods or the right to payment for goods sold if the
 consignee declares bankruptcy. Creditors of the consignee do not have the claim against the
consigned assets that they would have if the goods had been sold to the consignee.
The consignee may find a consignment arrangement attractive primarily for the following reasons:
1. Avoids risk of ownership: Goods that do not sell or that become obsolete, deteriorate, or
decline in market value may be returned to the consignor.
2. Requires less capital: The consignee does not incur a liability and does not make a cash
payment on the goods until they are sold. Thus, the consignee’s capital investment will be
lower if the goods are held on consignment.
Even with these advantages, consignment arrangements have been declining in use as a result of
changing business practices, such as the tendency toward more liberal return policies on non-
consignment sales.
3.9 Advantages and Disadvantages of Consignment sales
Advantages of Consignment Sales
Here are the advantages of consignment sales to both the consignor and the consignee:
Advantages to the consignor are:
➢ Saves on inventory holding costs by sending goods to the consignee
➢ Does not need to spend time creating listings to sell items
➢ Does not need to set up a retail storefront
➢ Makes it easier to convince consignee to stock their goods
Advantages to the consignee are:
➢ Does not need to pay upfront for the goods
➢ Unsold goods can be returned at no cost, thus reducing risk
➢ Does not need to pay for goods until the goods are sold to end users
Disadvantages of Consignment Sales
Here are the disadvantages of consignment sales to both the consignor and the consignee:
Disadvantages to the consignor are:
➢ Receives less revenue than selling directly to end users (the use of a consignee reduces the
amount of revenues earned)
➢ Risk and ownership are retained and any unsold goods are returned at no cost to the
consignee
➢ Goods on consignment may not be given enough promotion or visibility by consignees
Disadvantages to the consignee are:
➢ Inventory holding costs if a large amount of goods are unsold
➢ Potential difficulty in managing inventory related to consignment
3.10 Operation of the Consignment
Before goods are transferred on consignment, a written agreement should specify clearly the intent
of the parties. The agreement should address such issues as the amount and type of the consignee’s
expenses to be reimbursed by the consignor, how the consignee’s commissions are to be computed,
when commissions are to be paid, the credit terms and conditions, if any, to be considered by the
consignee in granting credit, and the responsibility for collection of receivables and losses on
receivables. The agreement should be complete and attempt to avoid potential points of conflict.
For items not provided for in the agreement that result in litigation, the laws of bailment and agency
apply. Some of the most important rights and duties of the consignee are the following:
a. Rights of the Consignee
Compensation: The consignee has a right to be compensated for services performed. Usually, this
compensation is stated as a percentage of the sales price, or the consignee is permitted to retain all

14 the sales price above a specified amount.

 Reimbursement for Advances and Necessary Expenses: Unless otherwise provided for in the
agreement, the consignor, as owner of the goods, is responsible for all costs incurred that are
directly related to the sale of the goods (for example, freight and insurance on the goods while in
transit to the consignee’s place of business). Before the goods are sold, several expenses that are
directly related to the sale may be paid by the consignee for the convenience of the consignor. In
addition, in some cases the consignee may make an advance to the consignor before the sale is
made to a third party. The consignee has the right to be reimbursed for such advances and expenses.
Normally, recovery is made by deducting the expenses and advances from the amounts collected
from the sale of the consigned goods. If the collections are insufficient to cover these expenses and
advances, the consignee has a direct claim against either unsold goods or receivable balances on
items already sold.
Granting of Credit: Unless limited by an express agreement, the consignee has the right to sell
goods on credit and extend normal credit terms. Of course, the consignee must exercise due care
and act prudently in the granting of credit. The consignee is referred to in such cases as a del
credere agent and generally receives additional compensation for assuming this risk.
Warranty of Consigned Goods: The consignee has the right to make warranties that are normal
for the product being sold.
b. Responsibilities of the Consignee
Care and Protection for Consigned Goods: The consignee must provide care and protection
reasonable for the type of goods being held and care for the goods in accordance with specific
instructions of the consignor.
Identification of Consigned Goods and Receivables: Although physical separation is not required,
the consignee must establish sufficient controls and provide adequate accounting records to
identify consigned goods and consignment receivables.
Due Care in Granting and Collecting Receivables: The consignee must exercise reasonable effort
to assure that the goods are sold at the specified price, that normal credit terms are granted, that a
normal warranty is made, and that a reasonable effort is made to collect the sales price.
Timely Periodic Reporting of Sales and Collections: The consignee must report the sales and
collections activities during the period and settle the account with the consignor as provided for in
the consignment agreement. The report rendered by the consignee to the consignor is called an
account sale, which includes such information as:
✓ The quality of merchandise received and sold on consignment,
✓ 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.

3.11 Accounting for Consigned Goods

The factors that distinguish the consignment from a sale must be recognized when the transfer of
goods and subsequent transactions are recorded. The accounting procedures followed by the
consignee and the consignor depend upon whether (1) consignment transactions are to be
summarized separately and profits on individual consignments are to be calculated separately from
profits on regular sales, or (2) consignment transactions are to be merged with other transactions
of the consignee, with no attempt to distinguish between profits on consignment sales and profits

15 on regular sales.
 When profits on consignment sales are to be separately determined, the consignee maintains a
consignment-in account for each consignment. This account is charged for all expenses that are to
be absorbed by the consignor; it is credited for the full proceeds from consignment sales. The
commission or profit on consignment sales is ultimately 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.
Accounting by the Consignee
Accounting procedures established by the consignee must recognize that goods received on
consignment are not owned. However, as noted earlier, the consignee must (1) maintain records
and controls that permit the identification of (a) goods held on consignment and (b) related
receivables and reimbursable expenses, and (2) prepare periodic reports. The consignee
normally creates a special account, Consignment-In, which is debited for reimbursable expenses
related to the consigned inventory, commissions earned by the consignee, and cash remittances to
the consignor. The account is credited for the proceeds of consignment sales to third parties.
If the consignee transacts business with more than one consignor, a separate Consignment-in
account should be established for each consignor. If the consignee deals with a number of
consignors, a controlling account could be established in the general ledger and supporting
information recorded in individual accounts in a subsidiary ledger. At the end of the period, a
Consignment-In account may contain a debit balance, representing a net receivable due from the
consignor, or the account may contain a credit balance, representing a net payable due to the
consignor. The sum of receivable balances and payable balances should be reported separately and
should not be offset against one another. Thus, the sum of the accounts with the debit balances
should be reported on the balance sheet as a current asset; the sum of the accounts with credit
balances should be reported on the balance sheet as a current liability.
Example: To illustrate the accounting for consignment sales by the consignee assume that on June
10, 2002, the XYZ Co. (consignee) received 10 radio sets on consignment basis from ABC
Company (consignor). The consignee is to be allowed a commission of 20% and is to be
reimbursed for any transportation and other costs. On July 30, XYZ sends cash to the consignor in
settlement of the account together with the following account sales.
XYZ Company, Jima
Account Sales
Sales for account of ABC Company June 30, 2002
Account sales of Video recorders, Model VR 1100
Date Explanation Amount
June 1 Consigned units on hand-0
June 10 Consigned units received-10
June 1-30 Sales-9units @ Br1,200 each 10,800
Expenses incurred:
Freight Br 500
Repairs needed on 2 units sold 60
Advertising in local newspaper 80
Commission (20% X Br 10,800) 2,160 2,800
Net payable to consignor 8,000
Remittance enclosed 8,000
Balance payable to consignor -0-
June 30 Consigned merchandise on hand 1 unit

16 The journal entries to record the transactions on the books of the consignee are shown here below:
 (1) June 10. Received 10 video recorders on consignment.
Memorandum Entry
(2) June 10. Freight charges paid by consignee on consignment shipments, Br. 500.
Consignment-in 500
Cash 500
(3) June 12. Payment for repairs needed on two video recorders, Br. 60
Consignment-in 60
Cash 60
(4) June 12. Payment for advertising by consignee chargeable to consignor, Br. 80.
Consignment-in 80
Cash 80
(5) June 15-30. Sales of 9 video recorders @ Br. 1,200 each.
Cash 10,800
Consignment-in 10,800
(6) June 30. Charge by consignee for 20% commissions earned on consignment sales
Consignment-in 2,160
Commission revenue on Consignment sales 2,160
(7) June 30. Remittance of cash in settlement of account
Consignment-in 8,000
Cash 8,000
Entry (6) must be made before the financial statements are prepared in order to reflect the revenue
earned during this period by the consignee.
The entry to record the consignment sales [entry 5 above] was based on the assumption that the
sales were cash sales only. A memorandum entry could be made for those sales on account if the
consignor were responsible for receivable collections. In such cases, the account sales report would
reflect settlement in the form of cash for the balance in the Consignment-in account, and receivable
balances transferred to the consignor would be listed. If receivables are transferred to the
consignor, it is possible, of course, that the Consignment-in account will report a debit balance
reflecting cash due from the consignor.
After the foregoing journal entries are posted to the general ledger, the Consignment-in account
appears as follows:
Consignment-In-ABC Company
6/1 Units on hand 0 6/10-6/30 Sold 9 units 10,800
6/10 Units received 10
6/10 Freight charges 500
6/12 Repairs 60
6/12 Advertising 80
6/30 Commissions revenue 2,160
6/30 Cash remittance to consignor 8,000
10,800 10,800
7/1 Units on hand 1

Observe that the money value of the inventory held on consignment is not carried on the books of
the consignee. If the consignee does not measure profits from consignment sales separately from
regular sales, the sale of the consigned merchandise is credited to the regular sales account.
Consequently, a journal entry is made debiting cost of goods sold (or purchases and crediting the
consignment-in account for the amount payable to the consignor for each unit sold (sales price
minus the commission). Costs chargeable to the consignor are recorded by debits to the

17 consignment-in account and credits to cash or expense accounts, if the costs previously were
 recorded in expense accounts. No journal entry is made for commission revenue, because the profit
element is measured by the difference between the amount credited to sales and the amount debited
to cost of goods sold (or purchases). The consignment-in account is closed by a debit for the
payment made to the consignor in settlement. This method may be less desirable, because
information relating to gross profits on consignment sales as compared with regular sales may be
needed by the consignee as a basis for business decisions.

Accounting by the Consignor

The journal entries to be made on the books of the consignor vary, depending on (1) whether
consignment transactions are recorded in separate ledger accounts for the purpose of determining
profits on consignment sales or are simply combined with the regular account balances and (2)
whether a perpetual or periodic inventory system is used.

If consignment transactions are recorded in separate accounts in order to measure gross profit
separately, a Consignment-Out account is established for each consignment shipment. If
consignment shipments are too numerous, the account may serve as a controlling account for
individual consignments that are recorded in a subsidiary ledger. Practice may vary as to the type
of transactions charged to this account. One commonly used alternative is to debit Consignment-
Out for the cost of goods shipped on consignment and all other expenses related to the consignment
sales incurred by both the consignor and consignee; the account is credited for the amount of
consignment sales. The Consignment-Out account is in the nature of an inventory account rather
than a receivable account, since title to the goods is retained by the consignor.

The consignor may establish an accounting system in which the revenue and expenses related to
the consignment transactions are recorded in the regular accounts if gross profit is not to be
measured separately, rather than in separate accounts as discussed before. If this is the case, then
some modification is required in the accounting methods and control procedures adopted by the
consignor. The modifications are necessary to provide a record of the goods on consignment, to
identify inventoriable cost related to goods on consignment, and to maintain a record of the relative
position with each consignee.

The journal entries on the books of the consignor for the two alternatives discussed in the two
preceding paragraphs are presented below. The transactions reported in the account sales report to
XYZ Company constitute the primary support for these entries. It is assumed in this illustration
that the consignor has adopted a perpetual inventory system. The modifications required when a
periodic inventory system is used are discussed in a later section.
I. Consignment Transactions Recorded In Separate Accounts
(1) June 6 Shipment of 10 video sets on consignment, cost to consignor, Br. 750 each.
Consignment-Out 7,500
Inventory 7,500
(2) June 6 Payment of packing expenses incurred by consignor, Br. 400
Consignment-Out 400
Cash 400
(3) June 30 Consignment sales of 9 units, Br. 10,800 reported by consignee and payment of
Br.8,000 cash received. The consignee charges freight costs of Br.500, repairs expense
Br.80, advertising expense Br. 80 and commission of Br.2,160 as reported per account sales
report.
Cash 8,000
Consignment-Out 2,800

18 Consignment Sales 10,800

 (4) June 30 Adjust Consignment-Out for cost consignment sales
Cost of Consignment Sales 9,860
Consignment-Out 9,860
(5) June 30 Adjust expense accounts to defer inventoriable cost of goods related to unsold
consigned merchandise at end of period (One unit in consignment inventory).
No adjusting entry
After the foregoing journal entries are posted, the Consignment-Out account will appear as
follows:
Consignment-Out: XYZ Company
6/6 Shipment of 10 video recorders 6/10-6/30 Cost of sales
on consignment 7,500 of 9 units 9,860
6/6 Packing expense 400
6/30 Transactions reported by consignee
Freight charges 500
Repairs 60
Advertising 80 6/30 Cost allocated to one
Commissions 2,160 2,800 Unsold unit 840
10,700 10,700
7/1 Beginning balance-inventoriable
cost allocated to one unit 840

II. Consignment Transactions Recorded in Regular Accounts

(1) June 6 Shipment of 10 video sets on consignment, cost to consignor, Br. 75 each.
Consignment-Out 7,500
Inventory 7,500
(2) June 6 Payment of packing expenses incurred by consignor, Br. 400
Packing Expense 400
Cash 400
(3) June 30 Consignment sales of 9 units, Br. 10,800 reported by consignee and payment of Br.
8,000 cash received. The consignee charges freight costs of Br. 500, repairs expense Br. 80,
advertising expense Br. 80 and commission of Br. 2,160 as reported per account sales report.
Cash 8,000
Freight Expense 500
Repairs Expense 60
Advertising Expense 80
Commission Expense 2,160
Sales 10,800
(4) June 30 Adjust Consignment-Out for cost consignment sales
Cost of Goods Sold 6,750
Consignment-Out 6,750
(5) June 30 Adjust expense accounts to defer inventoriable cost of goods related to unsold
consigned merchandise at end of period. (One unit in consignment inventory)
Consignment-Out 90
Packing Expense 40
Freight Expense 50

19
After the foregoing journal entries are posted, the Consignment-Out account will appear as
follows:
 Consignment-Out: XYZ Company
6/6 Shipment of 10 video recorders 6/10-6/30 Cost of sales
on consignment 7,500 of 9 units 6,750
6/30 Cost allocated to one
6/30 Adjustment of expense accounts 90 Unsold unit 840
7,590 7,590
7/1 Beginning balance-inventoriable
cost allocated to one unit 840
The Consignment-Out account provides a summary of the consignment transactions that have
occurred during the period. After the transactions reflected in the account sales report have been
posted, the balance in the account must be adjusted to recognize the cost of consigned units sold.
The balance remaining in the account after this adjustment is posted represents the cost to be
deferred as an asset on the unsold units.

3.12 Allocating Costs on Partial Sales

In order to determine the profit from sales in this period and the cost to be deferred, it is necessary
to allocate the total cost identified with the goods on consignment between the units sold in this
period (to be matched against consignment sales in this period) and the units still on hand at the
end of the period (to be reported as inventory on the consignor’s balance sheet). The allocation of
costs and the amount of the consignment profit were determined as follows:
Costs associated with
Total Consignment Sales-9 Ending
Costs units Inventory
Consignment sales 10,800
Cost of 10 video recorders Br. 7,500 Br. 6,750 Br. 750
Packing expense 400 360 40
Freight expense 500 450 50
Repairs expense-on unit sold 60 60 -
Advertising expense 80 80 -
Commission expense 2,160 2,160 -
Total Br. 10,700 Br. 9,860 Br. 840
Consignment profit Br. 940
When this allocation is made, costs are classified as either inventoriable or noninventoriable.
Inventoriable costs (product costs) are those considered necessary to acquire the product, get it to
the location of sale, and prepare it for sale. Inventoriable costs are said to attach to the inventory
and become a part of the total cost, or total valuation, of the inventory. In this illustration the cost
of the goods, the packing, and the freight expenditures were considered costs necessary to get the
goods to a location for sale and in a salable condition. Such costs are deducted from (matched
against) consignment revenues in the accounting period in which the individual units are sold.
Other costs incurred by the consignee and consignor do not add to the utility of the goods and are
considered noninventoriable or period costs. Period costs are expensed in the accounting period in
which the expense is incurred. Costs such as commissions earned by the consignee and the cost of
repairing two of the units sold did not add to the value of the unsold units and were expensed
currently. Advertising is considered a period expense, even though there may be some future
benefit. Freight on shipments to the consignee is considered an inventoriable cost to the extent that
it does not exceed the normal costs of direct shipment for the consignor. Excessive freight on

20
 consignments should not be included in the value of the unsold units, but should be expensed
currently as a period charge.
Other inventoriable costs may be incurred by the consignor when unsold units are returned by the
consignee. The amount restored to the inventory account (that is, a credit is made to Consignment-
Out) should not exceed the original cost of the inventory, and in some situations may be less if the
goods have a lower value. After this entry, the balance remaining in Consignment-Out is expensed
in the current period. Failure to do so would result in an overstated value for the retained goods.
In addition, cost incurred to restore the inventory to a salable condition should be accounted for as
a period expense.
The journal entries when the regular accounts are used to record the consignment transactions are
self-explanatory and are based on the allocation of costs discussed before. It should be noted that
the increase in net income of Br. 940 and the deferred cost of Br. 840 (Br. 750+Br. 90) are the
same for both alternatives.
Only minor changes are needed in the foregoing journal entries if the consignor maintains a
periodic inventory system. If consignment transactions are kept in separate accounts, the entry to
record the shipment of goods [entry (1)] becomes:
Consignment-Out-XYZ Co……………7,500
Consignment Shipments……………….7,500
The consignment shipments account is viewed as a reduction in the costs of goods available for
sale in order to determine the cost of goods available for regular sales. This account is, of course,
closed at the end of the period. The remainder of the entries are the same as those in the first set
of columns.
If consignment transactions are recorded in the regular accounts, a memorandum entry may be
made in the journal to create a record of the goods shipped on consignment. This entry is in the
form presented in the preceding paragraph, except that the two accounts are considered
memorandum accounts. Memorandum accounts are accounts with equal but opposite balances that
offset each other and, accordingly, are not reported on the financial statements. This entry would
be reversed for the cost of goods sold (Br. 750 X 9 units) by the consignee. The ending balance of
Br. 750 in consignment-Out. In other words, these accounts are simply memorandum accounts
used to provide a record of goods still on consignment. The balances in the accounts will not be
reported in the financial statements of the consignor. All other entries are once again the same,
except that one additional entry is necessary to record a deferred inventory cost equal to the original
purchase price of the one unsold unit of Br. 750.

3.13 Financial Statement Presentation of Consignment Sales

Balance Sheet Presentation of Consignment-Out:

A consignee may advance a portion of the anticipated sales price to the consignor or may remit
more than the amount due based on the consignment transactions up to the end of the period. The
amount of these advances or excess remittances should be credited to a liability account rather than
the Consignment-Out account. Conversely, a receivable from the consignee should be established
if the consignee remits less than the amount disclosed by the account sales report.
Example: if XYZ Company reports the sale of 9 units but remits only Br. 4,000, an entry would
be made as follows:
Cash……………………………………....4,000
Accounts Receivable-XYZ Co…………...4,000
Consignment Out-XYZ Co……………...2,800
21 Consignment Sales………………………..10,800
 The receipt of cash at a later date would be recorded by a debit to Cash and a credit to Accounts
Receivable-XYZ Co. The inclusion of these balances in Consignment-Out would be contrary to
the purpose of this account, which is to report the inventoriable costs of goods held on
consignment. The balance of Consignment-Out and other deferred costs related to consignment
sales, if reported in a separate account, should be reported with the inventory of the consignor. The
balance in the consignment-out account is reported on the balance sheet as a separate inventory
item that is added to the merchandise on hand, as follows:
Inventories:
Merchandise on hand……………………………………Br. xxx
Merchandise on consignment………………………………. 840 Br. xxx
Income Statement Presentation of Consignment Sales
The income statement may take various forms, depending on the degree of detail that is desired in
the disclosure of consignment sales. This, of course, should be influenced by the significance of
consignment sales to the consignor. Two possible forms are presented in the following illustration.
The amounts reported for the non-consignment transactions are assumed; the amounts reported for
the consignment sales are based on the preceding illustration.
• Alternative 1
ABC Company
Income Statement
For the Year Ended June, 2002
Consignment Sales Regular Sales Total
Sales Br. 10,800 Br. 60,000 Br. 70,800
Cost of Goods Sold 7,560 40,000 47,560
Gross Profit 3,240 20,000 23,240
Operating Expenses
Selling Expenses 2,240 6,000 8,240
Other Expenses 60 7,000 7,060
Total 2,300 13,000 15,300
Net Income Br. 940 Br. 7,000 Br. 7,940

• Alternative 2
ABC Company
Income Statement
For the Year Ended June, 2002
Sales Br. 60,000
Cost of Goods Sold 40,000
Gross Profit on Regular Sales 20,000
Gross Profit on Consignment Sales 3,240
Total Gross Profit 23,240
Selling Expenses 8,240
Other Expenses 7,060
Total Expenses 15,300
Net Income Br. 7,940

It should be pointed out that in the first alternative, the net income from the consignment sales is
overstated, since none of the administrative costs have been allocated to consignment sales, but
are charged totally against regular sales. Although it may be desirable to derive a more accurate
measurement of net income on consignment sales, it is neither practical nor feasible to allocate

22
administrative costs because of the arbitrary nature of such allocation and the additional cost that
would be incurred in doing so.
 3.14 Consignment Reshipments
In the previous example, freight charges, whether incurred by consignor or consignee, were costs
of bringing goods to the point of the sale and hence were properly viewed as acquisition costs and
assignable to the inventory. When consigned goods are returned to a consignor, expenditures
identified with the original shipment of goods as well as with return should be recognized as an
expense. The reshipment of goods to a consignee calls for charges that are no more than those
which would normally apply to such transfer. Expenditures for the repair of defective units retuned
should similarly be regarded as an expense, with subsequent transfer of such units to a consignee
calling for charges that are no more than normal costs. Shipping charges to customers that are
necessary in completing sales, when paid by the consignor or when chargeable to the consignor
require recognition as expenses of the period.
Before closing this section, it should be emphasized that there is wide variation in practice in
accounting for and reporting on consignment transactions. The procedures illustrated in this unit
can be modified to satisfy the particular needs of the consignee and consignor. Any variation
adopted, of course, must report assets, liabilities, revenue, and expenses in a way that is supported
by sound logic and accounting theory and that satisfies all legal requirements.

3.15 Other issues in Consignment Contracts

3.15.1 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.

3.15.2 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.

3.15.3 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

23 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 groups 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.
INDIVISUAL ASSIGNMENT
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
2. 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.)
3. DUBE Company made sales Birr 1,000,000 in 2005 that qualified for the installment sales
method of accounting. The items sold have a cost to DUBE’s of Birr 700,000.
The following table shows the amount of receivable collected in 2005, 2006, and 2007; the
portion of cost recovered and gross profit realized when collections are made.
Year Cash collected (Birr)
2005 Br. 400,000
2006 400,000
2007 200,000
Total Br. 1,000,000
Required: Prepare the journal entries to record the installment sales transactions to each year.
4. To illustrate the installment sales method of accounting assume the following facts:
2010 2011 2012
Installment sales $226,000 $248,000 $261,000
Cost of installment sales 164,980 176,080 195,750
Gross profit $ 61,020 $ 71,920 $ 65,250
Rate of Gross Profit 27% 29% 25%
Cash Receipts

24 2010 Sales $ 85,000 $ 96,000 $ 45,000

 2011 Sales 123,000 87,000
2012 Sales 147,000
Required: Record the necessary journal entries for 2010, 2011 and 2012?
5. Company A recorded $7,500,000 in installment sales in the current fiscal year. The cost of
goods sold associated with these sales was $6,000,000. Company A was also able to collect
$3,000,000 from customers through their scheduled installment payments. The determination
of gross profit to record in the current fiscal period would be as follows:
Installment Sales $7,500,000
Cost of Goods Sold $6,000,000
Gross Profit $1,500,000
Gross Profit Margin ($1,500,000 / $7,500,00) 20%
Cash Receipts $3,000,000
Realized Gross Profit ($3,000,000 x 20%) $600,000
Deferred Gross Profit ($1,500,000 - $600,000) $900,000
Required: record the necessary journal entries?
6. 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.
7. 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 sale.
Required: Record the necessary transaction?
8. 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:
a. Gross profit on consignment sales is determined separately; and
b. Gross profits on consignment sales are not determined separately

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