ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Chapter Three
Installment and Consignment contracts
3.1. Installment sales contract
3.1.1. Meaning of installment sales
Installment sale is a sale in which the buyer makes a series of payments instead of lump sum in
order to compensate the seller. It is also a sale of real or personal property or services which
provides for series of payments over a period of months or year. A down payment generally
required at the time of sale. Because the seller must wait for a considerable period of time to collect
the entire selling price, it is customer to provide for interest charged on unpaid balance.
3.1.2. Characteristics of installment sales contract
To protect themselves against the risk of non-collection, sellers of real or personal property select
a form of contract called a security agreement that repossess the property if the purchaser fails
to make payments.
In contractual sales agreement:
✓ Seller retains title to the property sold
✓ Buyer enjoys using the property during the payment period
✓ The contract term may be secured by mortgage notes. Thus, if the buyer defaults one or
more payments then the seller can repossess the items that were sold or other items of the
buyer held as a mortgage.
✓ The seller’s right to protect their security interest (uncollectable balance of sells contract)
and repossess the property varies by the type of industry, the form of contractual
arrangement and the statue relating to possessions.
✓ For service type enterprises repossession is not obviously available as a safeguard against
the failure to collect.
Problems of installment sales contract
✓ Greater risk of credit losses or uncollectible doubtful expenses
✓ Reposition of a highly damaged or substantially depreciated property
✓ Greater amount of collection costs
✓ Reconditioning or repairing accounting costs
✓ Substantial amount of working capital is tied up with receivables.
3.1.3. Realization of gross profit on installment sales
Accountants use the following three approaches for the recognition of gross profit on installment
sales:
I. The accrual base of accounting method
▪ The entire gross profit is recognized as realized at the time of installment sales.
II. Cost recovery method of accounting
▪ Under this method no profit is recognized until all cost of the merchandise sold
have been recorded, additional collections on the installment receivables are
recognized as revenues (gross profit on the sale and interest revenue).
III. Installment method of accounting
▪ Recognize gross profit in installments over the term of the contract as cash is
collected.

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

I. Installment Sales Accounting Method

The recognition of gross profit is based on the collection of cash rather than the completion of the
Sale. It is used in industries where collection is relatively uncertain. To accomplish this we use a
Separate set of accounts to record “Installment Receivables” and “Deferred Gross Profit.”
Year of Installment Sale:
(1) Record all transactions as follows:
Installment receivables ..............$XX, XXX
Inventory............................................... $X, XXX
Deferred gross profit, (current year)..........X, XXX
(To record installment sales and related deferred gross profit for the year)
(2) Calculate the gross profit percentage for all sales for the current year.
3) Record the collection of installment receivables and the recognition of gross profit as follows:
Cash.......................... $XX,XXX
Installment receivables..........$XX,XXX
(To record cash collected on installment receivables)
Deferred gross profit, (current year) ...........$X,XXX
Realized gross profit................................ $X,XXX
(To recognize gross profit on the collection of installment receivable)
Installment Collections on Prior Year Sales:
Apply each year’s gross profit percentage to the installment collections related to that year’s sales
as follows:
Cash ...............................$XX,XXX
Installment receivables, (year 1)............$XX,XXX
Installment receivables, (year 2)...............XX,XXX
(To record cash collected on installment receivables)
Deferred gross profit, (year 1) .............$X,XXX
Deferred gross profit, (year 2)................X,XXX
Realized gross profit ..................$XX,XXX
(To recognize gross profit on the collection of installment receivables)
II. Cost Recovery Method
The cost recovery method is use primarily in the real estate industry. It is used when the collection
of the selling price is uncertain. The same procedure is used as we demonstrated in the installment
method except that during the earlier periods no gross profit is recognized. We do not recognize
any gross profit until all of the costs have been recovered.

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Illustration: For installment method and cost recovery method.

On June 1, 2000, Booker production sells a large amount of unusual merchandise to a retailer. The
demand for the merchandise is unknown; Booker is questionable about financial strength of
retailer, and thus it is highly uncertain as to whether retailer 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 56,000 40%
Cash Collected in 2000 40,000
Cash collected in 2001 55,000
Cash collected in 2002 15,000
Total cash inflows 110,000
At December 31, 2002, it is determined that no more cash will be collected from this transaction.

Required:
1. Show the entries to account for this transaction using the installment sales method.
2. Shaw the entries to account for this transaction using the cost recovery method
Solution:
June. 1. 2000 Installment Method Cost recovery method

Installment sales $140,000 $140,000

Cost of installment sales 84,000 84,000
Deferred gross margin 56,000 56,000
(To record installment sales)

Installment Method Cost recovery Method

Cash...................................................... 40,000 40,000
Installment sales receivable ......................40,000 40,000
Deferred gross margin (Br. 40,000 X 0.4).....16,000 no profit recognition
Realized gross margin............16,000
(To record cash collection and realization of gross profit)
Year 2001
Installment Method Cost recovery Method
Cash.............................................................. 55,000 55,000
Installment sales receivable ...........................55,000 55,000

Deferred gross margin (55,000x0.4).......................22,000 11,000*

Realized gross margin...............................................22,000 11,000

*11,000=40,000+55,000-84,000
(To record cash collection and realization of gross profit)

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Year 2002

Installment Method Cost recovery Method

Cash...............................................................15,000 15,000
Installment sales receivable ..................15,000 15,000

Deferred gross margin (15,000x0.4)........................6,000 15,000*

Realized gross margin........................................................6,000 15,000
(To record cash collection and realization of gross profit)

Installment Method Cost recovery Method

Deferred gross, margin (30,000x.4).........................12,000 30,000*
Loss on write –off of I. sale receivable (30,000x.6)..18,000 -0-
Installment sales receivable ................................................30,000 30,000
(To record write off of amount not expected to be collected)

Illustration 2 installment method of accounting

On December.31 year 1 ABC co. which maintains accounting records on calendar year base, sold
for birr 100,000 a parcel of land with carrying amount of Br 60,000.
Contract price ............................................................. 100,000 100%
Cost of land ...................................................................60,000 60%
Gross profit......................................................................40,000 40%
Additional information:
The contract of sale requires a down payment of Br 25,000 and promissory notes in the mount of
Br 75,000 with principal payments every six month for five years in the amount of Br 7,500 plus
interest at 10% on the unpaid principal amount of the notes.
Required: Make the necessary journal entries for ABC co. assuming that the purchaser made all
payments as required by the contract.
Solution
Year 1. a) Dec.31. year 1. To record events at the time of sales
Cash ..................................................25,000
Note receivable..................................75,000
Land............................................60,000
Differed gross profit on I. sales...40,000
b) Dec. 31.yeare 1. To record realized gain on Br 25,000 cash collected as down payment
Differed gain on installment sale of land..................................10,000
Realized gain on installment sale of land (25,000x.4)....................10,000

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Year 2. a) June 30. Year 2 to record semi-annual principal payment plus interest for six months.

Cash....................................11,250
Note receivable..............................7,500
Interest revenue (75,000x.1x1/2)......3,750
b) Dec. 31.yeare 2 to record semi-annual principal payment plus interest for six months.

Cash....................................10,875
Note receivable..............................7,500
Interest revenue (65,700x.1x1/2)......3,375
c) Dec. 31.yeare 2 to recognize realized gain
Differed gain on installment sale of land..................................6,000
Realized gain on installment sale of land (15,000x.4)....................6,000

Year 3 a) June 30. Year 3 to record semi-annual principal payment plus interest for six months.

Cash....................................10,500
Note receivable..............................7,500
Interest revenue (60,000x.1x1/2)......3,000
b) Dec. 31.yeare 3 to record semi-annual principal payment plus interest for six months.

Cash....................................10,125
Note receivable..............................7,500
Interest revenue (52,500x.1x1/2)......2,625
c) Dec. 31.yeare 3 to recognize realized gain
Differed gain on installment sale of land..................................6,000
Realized gain on installment sale of land (15,000x.4)....................6,000

Year 4 a) June 30. Year 4 to record semi-annual principal payment plus interest for six months.

Cash....................................9,750
Note receivable..............................7,500
Interest revenue (45,000x.1x1/2)......2,250
b) Dec. 31.yeare 4 to record semi-annual principal payment plus interest for six months.

Cash....................................9,375
Note receivable..............................7,500
Interest revenue (37,500x.1x1/2)......1,875
c) Dec. 31.yeare 4 to recognize realized gain
Differed gain on installment sale of land..................................6,000
Realized gain on installment sale of land (15,000x.4)....................6,000

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Year 5 a) June 30. Year 5 to record semi-annual principal payment plus interest for six months.
Cash....................................9,000
Note receivable..............................7,500
Interest revenue (32,000x.1x1/2)......1,500
b) Dec. 31.yeare 5 to record semi-annual principal payment plus interest for six months.

Cash....................................8,625
Note receivable..............................7,500
Interest revenue (22,500x.1x1/2)......1,125
c) Dec. 31.yeare 5 to recognize realized gain
Differed gain on installment sale of land..................................6,000
Realized gain on installment sale of land (15,000x.4)....................6,000

Year 6 a) June 30. Year 6 to record semi-annual principal payment plus interest for six months.

Cash....................................8,250
Note receivable..............................7,500
Interest revenue (15,000x.1x1/2)......750
b) Dec. 31.yeare 6 to record semi-annual principal payment plus interest for six months.

Cash....................................7,875
Note receivable..............................7,500
Interest revenue (7,500x.1x1/2)......375
c) Dec. 31.yeare 6 to recognize realized gain
Differed gain on installment sale of land..................................6,000
Realized gain on installment sale of land (15,000x.4)....................6,000

Installment note receivable Deferred gain

100,000 25,000------year 1-----------------10,000 40,000
15,000......year 2-----------------6,000
15,000......year 3-----------------6,000
15,000......year 4-----------------6,000
15,000-----year 5-----------------6,000
15,000-----year 6-----------------6,000
-0- -0- -0- -0-

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Illustration 3 installment method of accounting

XY corporation sales merchandise on the installment plan, and uses perpetual inventory system.
For an installment sale, its account is debited for the full amount of the selling price and it credit
with the amount of down payment. Thus, the installment ledger account provides a complete
record of the transaction. Assume that on Jan. 1 year 5 XY co. accounting records include the
following ledger account balance.
Installment receivables-year 3......................................Br 18,000(Dr)
Installment receivables-year 4....................................... 69,500(Dr)
Deferred gross profit from year 3 installment sale............4,500(Cr)
Deferred gross profit from year 4 installment sale............19,460(Cr)
Additional information
The gross profit rate on installment sale was 25% in year 3 and 28% in year 4. During year 5 the
following transactions and events were completed by XY co.
1. Installment sale
Installment sales......................................Br 200,000 100%
Cost of installment sale............................ 138,000 69%
Deferred gross profit.....................................62,000 31%
2. Cash collections on installment sales
Cash collection
From the installment sale of year 5 80,000
From the installment sale of year 4 44,500
From the installment sale of year 3 17,000
Total collection in year 5 141,500

Required: Make the necessary journal entries for the installment sales and record adjusting
entries on Dec. 31, year 5 for XY co.

Solution:
1. Installment sales receivable.................Br 200,000
Cost of installment sale........................Br138,000
Deferred gross profit.................................... 62,000
(To record installment I. sales of year 5)
2. Cash...............................................................Br 141,500
Installment receivable for year 3.........................Br 17,000
Installment receivable for year 4.............................44,500
Installment receivable for year 5.............................80,000
(For adjusting installment receivables)

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

3. Deferred gross profit from year 3 installment sale (17,000x.25)............4,250

Deferred gross profit from year 4 installment sale (44,500x.28)............12, 460
Deferred gross profit from year 3 installment sale (80,000x.31)............24, 800
Realized gross profit....................................................41,510
(For adjusting gross profit)
4. After the adjustment the ledger account of XY co. indicates the following:
Installment receivables-year 3 (18,000-17,000)......................................Br 1,000(Dr)
Installment receivables-year 4 (69,500-44,500)....................................... 25,000(Dr)
Installment receivables-year 5 (200,000-80,000)....................................... 120,000(Dr)
Deferred gross profit from year 3 installment sale (4,500-4,250).......................250(Cr)
Deferred gross profit from year 4 installment sale (19,460-12,460)...................7,000(Cr)
Deferred gross profit from year 5 installment sale (62,000-24,800)...................37,200(Cr)
Objections against the installment method
Although the income tax advantage of the installment method are readily apparent the theoretical
support for it in the financial accountants is less impressive.
The American Accounting Association (AAA), accounting study No.3 & APB opinion No. 10 is
against the installment method due to the following justifications:
▪ Income has accrued and should be recognized in the financial statements at the time
of sale.
▪ Major activity necessary for product and disposition of the goods is performed or
completed
▪ The postponement of recognition of revenue is not in accordance with the concept of
accrual base of accounting.
▪ Firm should provide for uncollectible instead of postponing the recognition of revenue
The circumstances in which the use of the installment method of accounting is permitted are:
a. If collection of installment receivables is not reasonably assured
b. If installment receivables are collectible over an extended period of time.
c. If there is no reasonable base for estimating degree of collectible of the installment
receivable.

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

3.2. Consignment sales

3.2.1. Meaning of consignment
Consignment means the process of sending goods by one person to another, who is to sell goods
on behalf of the first person. It is also, transfer of possession of merchandise from the owner to
another person who acts as the sales agent of the owner. The legal relationship between these two
persons is that of principal and agent.
The person who sends the goods is known as consignor and the person whom the goods are sent
is known as consignee.
a. Consignor is the owner who retains the title to the merchandise.
b. Consignee is the sales agent who has physical possession to the merchandise.
Consignees are responsible to consignors for merchandise paced in their custody until
it is sold or returned. Because consignees did not acquire title to the merchandise, they
neither include it in inventories nor record an account payable or other liability. The
only obligation of the consignee is to give reasonable care to the consigned
merchandises to account for it to consignors.
When the merchandise is sold by consignee, the resulting A/R is the property of the
consignor. At this point the consignor records the sale.
Important terms in consignment
1. Pro forma invoice: when the consignor sends the goods to the consignee, he prepares only
a pro forma invoice and not an invoice. A pro forma invoice looks like an invoice but is
really not one. The objective of the pro forma invoice is only to convey information to the
consignee regarding particulars of goods sent and not to make him liable like a trade debtor.
2. Del-credere commission: Del-credere commission is an additional commission paid by the
consignor to the consignee for bearing the loss on account of bad debts, if any, arising out
of credit sale of consignment goods. Such commission may be allowed on credit sales or
total sales. However, in the absence of any such agreement, the consignor allows such
commission on total sales.
3. Account sale: An account sale is a statement sent by the consignee to the consignor
periodically. It contains the information the following information:
1. Sales made;
2. Expenses incurred on behalf of consignor;
3. Commission earned;
4. Advance money paid;
5. The balance of amount due to the consignor.
An account sale is different from sales account which gives the details of the sales made.

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Distinguish between consignment and sale

Some reason why a manufacturer or whole seller prefers to consign merchandise rather than to
make outright sale are:
➢ The consignor may be able to persuade dealers to stock the items on a consignment basis
where as they will not be willing to purchase the merchandise in regular sales.
➢ The consignor avoids the risk inherent in selling on credit to the debtors of financially
questionable.

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ODA BULTUM UNIVERSITY, COLLEGE OF BUSINESS AND ECONOMICS, DEPARTMENT OF ACCOUNTING AND FINANCE

Rights and duties of the consignee

The general rights and duties of the consignee are summarized as follows:

Rights consignee Duties consignee

1. To receive compensation for 1. To give reasonable care and protection
merchandise sold for the account of the in relation with the consigned
consignor. merchandise.
2. To receive reimbursement for 2. To keep the consigned merchandise
expenditures (such as freight and separate from owned inventories.
insurer ) made with the consignment 3. To use care in extending credit on sales
3. To sell consigned merchandise on of consigned merchandise &diligent in
credit if the consignor has not setting prices on consigned
forbidden credit sales. merchandise & in collecting the
4. To make the usual warranties as to the consignment receivable.
quality of consigned merchandise & to 4. To render complete report of sales of
bind the consignor to honor such consigned merchandise & to make
warranties. appropriate and timely payments to the
consignor.

3.2.2. Accounting for consignor and consignee

The consignor as well as the consignee should maintain separate record for the consigned goods
for their mutual benefit.
Example
Guna trading house shipped on consignment to Abebe Hagos 30 items of XL that cost birr 120
each. The selling price was set at birr 200 each the cost of packing was set at birr 75 and all costs
incurred in the packing department were debited by Guna to the packing expense ledger account.
Freight costs birr 202 by an independent truck line to deliver the merchandise to Abebe were paid
by Abebe. All 30 items of XL were sold by Abebe for birr 200 each. After deducting of the
commission of15% & freight costs of birr 202 Abebe sent to Guna a check for birr 4,898 along
with the account sales. The consignor uses perpetual inventory system.
Required: make the necessary journal entries on the book of consignor and consignee?

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Solution:

Entries on the book of consignor Entries on the book of consignee

Consignment- out (120x30)................3,600 Consignment- in

Date Explanation Dr Cr Balance

Inventory..............................................3,600
Received 30
(To record shipment of goods to consignee) items of XL to
be sold for Br
200 each at a
commission of
15% of selling
price

(to set a memorandum notation for the receipt

of goods)

Consignment- out ................75 No entry

Packing expense..................75
(To allocate packing expense to the cost of
consigned merchandise that was recorded in
the packing expense account)

No entry Consignment –in....................202

Cash........................................202
(to record payment of freight costs received in
consignment)

No entry Cash (30x200).........................6,000

Consignment in................................6,000
(To record the sale of cosigned goods)

No entry Consignment –in (6,000x.15)..............900

Commission
revenue.....................900
(To record the commission earned from
consigned goods)

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Cash.........................................4,898 Consignment- in..............4,898

Consignment –out.......................202 Cash.........................4,898
Commission expense...................900 (To record payment of cash to consignor)
Cost of consignment sale...........3,877
Consignment Sales.....................6,000
Consignment –out.....................3,877
(To record cost of consignment sale and
receipt of cash from the consignee)

Consignment-out-Abebe Hagos Consignment-in-Guna

3,600 202
75 900 6,000
202 3,877 4,898
-0- -0- -0- -0-

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