Chapter - 3

ACCOUNTING FOR INSTALLMENT AND CONSIGNMENT SALES

Real, Personal or inventory 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.
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 a goods on
consignment is not considered a
sales transaction.
However, both parties must
establish adequate procedures to
control and account for goods on
consignment.
Objectives
Identify the nature of installment
sales
Describe the methods for installment
sales and their impact on the
financial position and operating
results of the enterprises.
Prepare financial reports for the
installment sales transaction.
Objectives
Record the repossession of properties
sold transaction.
Record the repossession of properties
sold under installment sales.
Account for consignment.
Identify reporting process of the
Consignor (owner)and the Consignee
(Seller agent).
INSTALLMENT SALES
Although the concept of the installment sale
first was developed in the field of real
estate and for high-priced durable goods.
It has spread through nearly every sector of
the economy.
Almost all single-family residences are sold
on the installment plan. With monthly
payments extending as long as 25 to 30
years.
INSTALLMENT SALES
For many business enterprises,
installment sales have been a key
factor in achieving large- scale
operations.
The large amount of achieved by the
automobile industry has made
possible economies in tooling,
production and distribution that could
not have been achieved on a small
scale of operations.
Realizations of Gross Profit on Installment sales

The determination of net income on

installment sales is complicated by the fact
that the amounts of revenue and related
costs and expenses seldom are known in
the accounting period when sales are
made. Substantial expenses (as for
collection, accounting, repairs and
repossession) may be incurred in
subsequent accounting periods.
Realizations of Gross Profit on Installment sales

In recognition of the diverse business

conditions under which installment sales
are made, accountants use the following
three approaches for the recognition of
gross profit on installment sales:
1. The accrual basis of accounting
2. The cost recovery Method
3. The installment Method of accounting
1. Accrual basis of Accounting
To recognize the entire gross profit as at the
time of an installment sale is to say in effect
that installment sales are the same as regular
sales on credit.
The merchandise has been delivered to
customers, and accounts receivables of
definite amount have been acquired.
The excess of the accounts receivable over the
cost of merchandise sold is realized gross
profit in the traditional meaning of them.
Accrual basis of Accounting
The journal entry consists of a debit to
installment contracts receivable and a
credit to installment sales.
If the perpetual inventory system is used, a
second journal entry is needed to transfer
the cost of the merchandise from the
inventories account to the cost of
installment sales account.
2. Cost recovery Method
Under the cost recovery method, no
profit is recognized until all costs of
the merchandise sold have been
recovered. After all costs have been
recovered, additional collections on
the installment contracts receivable are
recorded as revenue.
The cost recovery method of accounting
rarely is used.
3. Installment Method of Accounting
This method measures income from
installment sales is to recognize gross
profit in installments over the term of
the contract as cash is collected.
Emphasis is shifted from the acquisition
of receivables to the collection of
receivables as the basis for realization
of gross profit.
In other words, A modified cash basis
of accounting is substituted for the
accrual basis of accounting. This
modified cash basis is known as the
Installment Method of Accounting
Install Method of Accounting
Under the install method of
accounting, each cash collection
on the contract is regarded as
including both a return of cost
and a realization of gross profit in
the ratio that these two elements
were included in the selling price.
For Example, Assume that a farm equipment
dealer sells for $ 10,000 a machine that
cost $ 7,000. the $ 3000 excess of the sales
price over cost is regarded as deferred
gross profit. Because Cost 70%, gross
profit 30% constituted on the sales price.
70:30 ratio is used to divide each
collection under they contract between the
recovery of cost and the realization of GP.
If $ 1,000 received as a down payment,
$ 300 of the deferred gross profit is
considered realized in the current
accounting period.
The method described is acceptable
under current income tax laws.
This method also may use to
computation of taxable income.
At a point of time AAA stated that, no
sound accounting reason for the use of
this method for financial statement
purposes in the case of closed
transaction.
Accounting research study stated that revenue
should be recognized in the accounting
period in which the major economic activity
necessary for the production and disposition
of goods is performed and rejected the use of
the installment method of accounting.
APB opinion No 10 almost virtually removed
this method of accounting from the body of
GAAP because it reaffirmed the general
concept the income is realized when a sale is
made.
The “circumstance” in which the use of
installment method of accounting is
permitted are.
1. Collection of installment receivables
is not reasonably assured.
2. Receivables are collectible over an
extended period of time.
2.There is no reasonable basis for
estimating the degree of collectability.
Single sale of Land on the Installment plan
Let us assume that on December 31, year 1.
Ahmad company, that maintains accounting
records on a calendar year basis, sold for $
1,00,000 a parcel of land acquired for $ 52,000.
commission and other expenses of sale in the
amount of $ 8,000 were charged to Ahmad in
the escrow statement. Because Ahmed was not
a dealer in real estate, these expenses are
considered as additional costs of the land rather
than expenses of the year in which the sale
took place.
Thus, the gain on the sale of the land is $
40,000 (1,00,000- (52,000+8,000)
And all collections of cash from the purchaser
are regarded as consisting of 60% cost
recovery and 40% realization of gain
(Profit).
The contract of sale called for a down
payment of $ 25,000 and promissory notes,
with principal payments every six months
for five years in the amount of
$7,500 plus interest at the annual rate of
10% on the unpaid principal balance
of the notes. A portion ($8,000) of the
down payment was applied in the
escrow statement to pay the
commission and other expenses of
sale.
Record journal entries on the sale of
land on December 31, year1, the
collections on the notes in year 2, and
the realization of portion of the
deferred gain in year 1 and 2.
Retail sale of Merchandise on the Installment plan

Now we shall consider a large volume

of installment sales of merchandise
by a retailing enterprise that use the
Installment method of accounting
because the collectability of the
installment contracts receivable can
not be reasonable estimated.
A first requirement is to keep separate
all sales made on the installment plan
as distinguished from regular sale.
The accounting records for installment
receivables usually are maintained by
contract rather than by customer.
The average rate of gross profit on all installment
sales during a year generally is computed and
applied to all cash collections (net of interest
and carrying charges)on installment contracts
receivable originating in that year.

Assume that on January 1, year 5, Salma Co.

general Ledger included the following account
balances.
Illustration of Accounting for installment sales of
Merchandise.
Example:
Installment contracts Receivable- year 3 $ 200,000 Dr.
Installment contracts Receivable- year 4 $ 85,000 Dr.
Deferred interest and carrying charges on installment sales.
$17500 Cr.
Deferred gross profit- year 3 installment sales. $ 4,500 Cr.
Deferred gross profit- year 4 installment sales $ 19,460 Cr.
The gross profit rate on installment sales (excluding interest
and carrying charges) was 25% in year 3 and 28% in year
4. During year 5, the following transactions were
completed by Salma co:
1. Installment sales, cost of installment sales, and
deferred gross profit for year 5 are listed below:
Installment sales (excluding $ 30,000 deferred interest and
carrying charges)…………………………….. $ 200,000
Cost of installment sales…………… $ 138,000
Deferred gross profit- year 5 installment sales
($ 200,000 - $ 138,000). $ 62,000
Rate of gross profit on installment
($ 62,000 ÷ 200,000) 31%
2.Cash collections on installment contracts receivable
during year 5 are summarized below:
SP Int&carrying Total
Charges Cash collected
Inst contract receivable yr 5. 80,000 10,000 90,000
,, ,, ,, yr 4 44,500 12,500 57,000
,, ,, ,, yr 3 17,000 1,850 18,850
Totals 141,000 24,350 1,65,850

3. Customers who purchased merchandise in year 3 were

unable to pay the balance of their contracts. $ 1,150. the
contracts consisted of $ 1,000 sales price (1,000x 0.25= 250)
of deferred gross profit. The current fair (net realizable)
value of the merchandise repossessed was $ 650.
Defaults and Repossessions:
 If a customer defaults on an installment contract for
services and no further collection can be made.
 A similar situations exists for certain merchandise
that no significant resale value.
 The journal entry required in such cases is to write off
the uncollectible installment contract receivable,
cancel the deferred gross profit related to the
receivable, and debit uncollectible installment
contracts expense for the difference.
 In other words, the uncollectible installment contracts
expense is equal to the un recovered cost included in
the balance of the installment contract receivable.
Defaults and Repossessions:
However, in most cases a default by a
customer leads to repossession of
merchandise.

The uncollectible installment contracts

expense is reduced by the current fair value
of the merchandise repossessed, and it is
possible for the repossession to result in a
gain.
Defaults and Repossessions:
Salma company.
1. It eliminates the default installment contracts
receivable of $ 1,000 X 0.25= $250 and the deferred
interest and carrying charges of $ 150 applicable to
the default installment contracts receivable.
2. It recognizes an asset equal to the $650 current fair
value of the repossessed merchandise.
3. It recognizes uncollectible installment contracts
expense of $ 100, the difference between the un
recovered cost in the defaulted installment contracts
receivable ($ 750) and the current fair value of the
repossessed merchandise ($650)
Defaults and Repossessions:
When the installment method of accounting is
used, no loss or expense is recognized with
respect to the deferred gross profit and
interest and carrying charges contained in the
defaulted installment contract receivable,
because these amounts had not been
recognized previously as realized revenue.
Other Accounting Issues Relating to Installment
sales:
Special accounting issues arise in connection
with
1. The acceptance of used property as a trade-in.
2. The computation of interest on installment
contracts receivable.
3. The use of the installment method of
accounting solely for income tax purposes.
4. Retail land sales.
1. Trade- ins
A familiar example of the use of trade-ins is
the acceptance by a dealer of a used car as
partial payment for a new car.
An accounting problem exists only if the
dealer grates an over allowance on the used
car taken in trade.
An over allowance on trade-ins is significant
because it represents a reduction in the stated
selling price of the new merchandise.
1. Trade- ins
The stated selling price must be reduced by the
amount of the over allowance to compute the
net selling price. The gross profit on the sale
of the new merchandise is the difference
between the net selling price and cost.
Assume that merchandise with a cost of $
2,400 is sold on the installment plan for $
3,300. used merchandise is accepted as a
trade-in at a ‘value’ of $ 1,100, but the dealer
expects to spend $50 in reconditioning the
1. Trade- ins
Used merchandise before reselling it for only
$1,000. Assume that the customary gross
profit percentage on used merchandise of this
type is 15%, an amount that will cover the
selling and overhead costs, and also provide
a normal gross profit on the resale. Compute
the current fair value of the trade-in and the
amount of the over allowance:
Computation of over allowance:
Trade-in allowance given to customer……. 1,100
Deduct current fair value of trade-in:
Estimated resale value of merchandise trade in ..1,000
Less: Reconditioning cost expected
to be incurred……………………... 50
Gross Profit($1,000X 0.15)……150 200
Current fair value of merchandise traded in…….800
Over all allowance on trade-in……………… 300
Assuming that a perpetual inventory system is used,
the journal entry to record the installment sale and
the trade-in appears below:

Inventories (Trade-ins)…………..........800
Installment contract Receivable(3,300-1,100) 2,200
Cost of installment sales…………………… 2,400
Installment sales (3,300-300) 3,000
Inventories (New) 2,400
(To record sale to merchandise for $ 3,000, consisting of gross
sales price of $ 3,300 minus a $ 300 over allowance on the
trade-in)
Cost of the new article was $ 2,400;Therefore, the
deferred gross profit on the installment sale of $
3,000 amounts to $600. the GP percentage is 20% ($
600/3,000= 0.20).

This percentage will be applied in the computation of

realized GP on the basis of cash collections. The
current fair value of the merchandise accepted as a
trade in $ 800, is considered equivalent to a cash for
this purpose .
2.Interest on Installment contracts receivable:
Installment contracts usually provide for
interest and carrying charges to be paid
concurrently with cash installment payment.

Only the portion of the payment that is

applied to reduce the principal of the
contracts is considered in the measurement
of realized gross profit under the installment
method of accounting.
2.Installment Method for income tax purposes:
The installment method of accounting is widely
used for income tax purposes because it post
pones the payment of income taxes.
Example: Assume that New Life Company
retailing enterprise, uses the accrual basis of
accounting for financial accounting purposes.
The pre-tax accounting income for year 10 is
$200,000, as indicated by the following
condensed partial income statement (revenue
from interest and carrying charges is ignored in
this example).
 New Life Company
Condensed partial income statement for year 10

Sales…………………………..$ 800,000
Cost of Goods sold……............$ 500,000
Gross profit on sales…………..$ 300,000
Operating expenses……...........$ 100,000
Income before income tax…….$ 200,000
Assume that the deferred gross profit on installment sales
was $ 55,000 at the beginning of year 10 and $ 105,000 at
the end of year 10, and that New Life Company uses the
installment Method of accounting for income tax purposes.
The taxable income for year 10 is determined as follows:
Taxable income for year 10
Pre tax accounting income for year 10 …..$ 200,000
Add: Deferred gross profit on installment
sales, beginning of year 10………………..$ 55,000
Less: Deferred gross profit on installment
sales, end of year 10……………….. $ 105,000
Taxable income for yr 10 (IMA)……….. $ 150,000
Income taxes fro yr 10 would be recorded as follows,
assuming that the income tax rate for New Life
company is 45% of taxable income:
Journal entry to record income taxes for year 10:
Income Taxes Expense……..90,000
Income Taxes Payable………….67,500
Deferred income Tax Liability…22,500
To record income taxes for year 10, determined
as follows:
Income Taxes Expense 200,000X 0.45= $90,000
Income Taxes Payable 150,000X0.45= $67,500
Deferred income Tax Liability 50,000X 0.45= 22,500
Practice problems:
1. Abdikani sold a piece of land to khader for
$500,000. the land originally cost $350,000.
Khader made a down payment of $ 50,000 and
signed an installment contract calling for annual
payments of $25,000 and 10% interest on the
outstanding balance. What is the percentage of
Gross profit, and record necessary journal
entries for the same year.

2. On January 1, 2015 Kim sold to Rick a machine

that cost her $50,000 for a down payment of
$35,000 and three annual payments of $ 18,000.
payments begin December 31, 2015. how much
profit Kim reports in 2015 if she use Installment
Method accounting.

3. An automobile dealer lists a new model costing $

5,000 at $8,000. A customer trades in an old
model for an allowance of $2,000: the balance of
$6,000 plus interest is payable $ 1,800 after
reconditioning it at a cost of $300. Normal gross
profit on used automobiles is 10%. Record the
journal for the sale of new model.
ACCOUNTING FOR CONSIGNMENTS
The term Consignment means a transfer
of possession of merchandise from the
owner to another person who acts as
the sales agent of the owner. Title to the
merchandise remains with the owner,
who is called a Consignor, the sale
agent who has possession of the
merchandise is called a Consignee.
Rights of Consignee
1. To receive compensation for merchandise
sold for the account of consignor.
2. To receive reimbursement for expenditure
(Such as freight and insurance) made it
concession with the consignment.
3. To sell consignor has not forbidden credit
sales.
4. To make the usual warranties as to the
quality of the consigned merchandise and to
bind the consignor to honor such warranties.
Duties of the Consignee
1. To give care and protection reasonable in
relation to the nature of the consigned
merchandise.
2. To keep the consigned merchandise
separate from owned inventories or be
able to identify the consigned
merchandise. Similarly, the consignee
must identify and segregate the
consignment receivable from other
receivables.
Duties of the Consignee
3. To use care in extending credit on the
sale of consigned merchandise and to
be diligent in setting prices on
consigned merchandise an collecting
consignment receivable.
4. To render complete reports of sales of
consigned merchandise and to make
appropriate and timely payments to the
consignor.
Accounting for consignor
The choice of accounting methods by the
consignor depends on:
1. Consignment gross profits are determined
separately from gross profits on regular
sales.
OR
2. Sales on consignment are combined with
regular sales without any effort to measure
gross profits separately for the two
categories of sales.
Illustration:
Example: Abdifitah company shipped on
consignment to Ramdan company 10
Television sets that cost $250 each. The
selling price was set at $ 400 each, the cost of
packing was $ 30; all costs incurred in the
packing department were debited by Abdifitah
to packing expense account. Freight costs of
$135 by an independent truck line to deliver
the shipment to Ramdan trading were paid by
the consignee. All 10 sets were sold by the
 Consignee for $400 each. After deducting
the commission of 20% and the freight
costs of $135, Ramdan trading sent
Abdifitah company a check for $ 3,065,
along with the account sales.
The journal entries for the consignor,
assuming that gross profits on
consignment sales are determined
separately, for the completed consignment,
are summarized below:
 Abdifitah Company (Consignor)
Journal entries
1. Shipment of merchandise Costing $ 2,500 on
consignment consigned merchandise is transferred
to a separate inventories account. Consignor uses
the perpetual inventory system.
Gross profits determined separately
Consignment out- Ramdan trading..2,500
Inventories 2,500
Gross profits not determined separately
Consignment out- Ramdan trading..2,500
Inventories 2,500
2. Packing expense of $ 30 allocated to
consigned merchandise; this expense
previously was recorded in the packing
expense account.
Gross profits determined separately
Consignment out- Ramdan Trading……30
Packing Expense………………………..30
Gross profits not determined separately
No journal entry required: Total packing
expense is reported among operating
expenses.
3. Consignment sales of $.4,000 reported by consignee
and payment of $ 3,065 received. Charges by
consignee: freight costs, $ 135; commission $ 800
Gross profits determined separately
Cash………………………………….3,065
Consignment out- Ramdan Trading……135
Commission Expense- consignment sale.800
Consignment sales…………………..4,000
Gross profits not determined separately
Cash………………………………….3,065
Freight Expense………………………..135
Commission Expense………………….800
Sales………………………….……..4,000
4. Cost of consignment sales recorded. $ 2,665
($ 2,500+ $ 30+ $ 135=$ 2,665).
Gross profits determined separately
Cost of Consignment sale……..2,665
Consignment out- Ramdan Trading....2,665
Gross profits not determined separately
Cost of Goods sold……………..2,500
Consignment out- Ramdan Trading....2,500
5. Summary of consignment out account.

Gross profits determined separately

Consignment out- Ramadan Trading
2,500 2,665
30
135
2,665 2,665
5. Summary of consignment out account.

Gross profits not determined separately

Consignment out- Ramadan Trading

2,500 2,500
Presentation in the income Statement:
Gross Profits determined separately
Consignment Sales……………………………4,000
Less: Cost of Consignment
Sales………………………..2,665
Commission……………….. 800 3,465
Gross Profit on Consignment sale.. $535
Presentation in the income Statement:
Gross Profits not determined separately
Included in total Sales…………………………4,000
Included in Cost of all merchandise sold……...2,500
Included in total packing expense…………………30
Included in total freight expense…………………135
Included in total commission expense……..........800
Accounting for partial sale of Consigned Merchandise
Assume that only four of the ten TV sets
consigned by Abdifitah company to
Ramadan Trading had been sold by the end
of the accounting period. To prepare
financial statement on four units sold and
the inventory value of the six unsold units.
The account sales received by Abdifitah
company at the end of the current period
includes the following:
Accounting for partial sale of Consigned Merchandise
Sales’4 TV sets at $ 400…………..1,600
Charge: freight costs…………135
Commission ($1,600X0.20)…320 455
Total payable to consignor ……….1,145
Check enclosed…………………. 500
balance payable to consignor…….$ 645
Consigned merchandise on hand 6 TV sets
Pass journal entries for the consignor account for
his uncompleted consignment.