CHAPTER 3 INSTALLMENT SALES AND CONSIGNMENT SALE

What is an Installment Sale?

An installment sale is an arrangement in which the seller allows the buyer to make payments
over an extended period of time. In an installment sale, the buyer receives the goods at the
beginning of the installment period and makes payments over the installment period. In other
words, revenue and expense are recognized at the time of cash collection and not at the time of
sale. The term installment sale refers to an accounting method that emphasizes the collection of
cash from customers rather than the sales transaction.  The installment sales method recognizes
income in the accounting periods it's collected, and not at the time of sale. Buy now pay later

Installment Sales Method of Revenue Recognition

The installment sales method of revenue recognition defers gross profit until cash from the sale
is received. Therefore, the installment sales method is a conservative method of revenue
recognition as revenue is not immediately recognized at the point of sale. The installment sales
method is only applied in situations where the risk and rewards of the good are not fully
transferred at the time of sale. In addition, the installment sales method is used when there is a
degree of uncertainty over the amount that will be collected (therefore, it would be inappropriate
to recognize all profits at the time of sale). The term installment refers to a sales approach that
allows customers to make periodic payments over an extended timeframe.  Installment sales are
oftentimes used by industries that manufacture furniture, automobiles, and heavy equipment. 
The risk of bad debt associated with uncollectible accounts increases for these companies, since
payment is received over a relatively long period of time. 
With the installment sales method, both the revenue and cost of goods sold is recognized in the
period of the sale, but the gross profit on the sale is delayed until the cash is collected from the
customer. 
 It is used when accrual accounting method is not appropriate, collection rather than sale.
 Both sales and cost of sales are deferred, but selling and administrative expenses are not
deferred.
 The method is also widely used for income tax purposes.
Example: Real estate sales.

Issues that should be considered in applying installment sales:-

 Gross profit on installment sales must be determinable.
 The amount of cash collected from installment accounts must be known.
 The cash collected from current years’ and prior years’ accounts must be known.
  Provision must be made for the carry forward of each year’s deferred gross profit.
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.
EXAMPLE ON INSTALLMENT SALES:
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

Prepare the journal entries to record the installment sales transactions to each year.
SOLUTION: Under Installment Sales Method
DUBE Company record (Journal entries for the year 2005, 2006 and 2007 using perpetual
inventory system).
Gross profit rate = 1000,000 – 700,000 = 30%
1000,000
Year Cash collected Gross profit rate Realized gross
(Birr) profit
2005 Br. 400,000 30% 120,000
2006 400,000 30% 120,000
2007 200,000 30% 60,000
Total Br. 1,000,000 Br 300,000

1) To record sales, cost and deferred gross profit during 2005.

Ledger accounts and explanations of 2005 2006 2007
transactions Dr. Cr. Dr. Cr. Dr. Cr.
Installment A/Receivable 1,000,000
Installment Sales 1,000,000 No entry
(To record installment sales)
Cost of Installment Sales 700,000
Inventory 700,000 No entry
(To record cost of installment sales)
Installment sales 1,000,000
Costs of Installment Sales 700,000 No entry
Deferred Gross Profit 300,000
(To record Sales, Cost and Deferred Gross
Profit in 2005)

2) To record cash collection from installment sales to customers during 2005, 2006 and
2007 when DUBE’s collected cash from installment customers of 400,000, 400,000 and
200,000 respectively.
Ledger accounts and 2005 2006 2007
explanations of transactions Dr. Cr. Dr. Cr. Dr. Cr.
Cash 400,000 400,000 200,000
Installment A/Receivable 400,000 400,000 200,000
(To record cash collection)
Deferred Gross Profit 120,000 120,000 60,000
Realized Gross Profit 120,000 120,000 60,000
(To record gross profit on sales)

As shown above, the entire amount of gross profit from Year 2005 sales is recognized as
deferred gross profit in that year.

When Birr 400,000 is collected, Birr 120,000 is recognized as realized gross profit. The
remaining balance of Birr 180,000, the balance in deferred gross profit is carried forward to Year
2006.

In Year 2006, when Birr 400,000 of the receivable is collected, an amount of Birr 120,000 is
realized as realized gross profit and,

In Year 2007, Birr 60,000 is recognized as gross profit (30% of Birr 200, 000).
2. Financial Statements
The installment accounts receivable and deferred gross profit accounts are reported on
December 31, 2005 balance sheet and income statement as follows.
DUBE COMPANY
Balance Sheet
For the Year Ended December 31, 2005
Installment Accounts Receivable (2005) Birr 600,000
Less: Deferred Gross Profit 180,000
Net Installment Accounts Receivable (2005) (70 % x 600,000) Birr 420,000
NB.
Installment Accounts Receivable (Beg. 2005)------------------------Birr 1,000,000
Less: Cash collections-------------------------------------------------------------400,000
Installment Accounts Receivable (End. 2005)---------------Birr 600,000
Deferred gross profit (Beg. 2005)------------------------------------------Birr 300,000
Less: Gross profit recognized in 2005------------------------------------------120,000
Deferred gross profit (End. 2005)------------------------------Birr 180,000
DUBE COMPANY
 Income Statement
For the Year Ended December 31, 2005
Installment Sales Birr 1,000,000
Less: Cost of installment 700,000
Deferred gross profit on sales Birr 300,000
Less: Deferred gross profit 180,000
Realized gross profit (30% X 400,000) Birr 120,000

Example 2 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
2010 Sales $ 85,000 $ 96,000 $ 45,000
2011 Sales 123,000 87,000
2012 Sales 147,000
Only the 2011 journal entries will be shown. The entries for 2010 and 2012 are the same,
but the entire set of entries for the installment method are demonstrated by the 2011 entries.
To record 2011 installment sales
Installment Accounts Receivable, 2011........................... 248,000
Installment Sales........................................................ 248,000
To record cash collected on installment receivables
Cash.................................................................................. 219,000
Installment Accounts Receivables, 2010................... 96,000
Installment Accounts Receivables, 2011................... 123,000

To record 2011 cost of goods sold on installment

Cost of Installment Sales................................................. 176,080
Inventory (or Purchases)............................................ 176,080
To close installment sales and cost of installment sales
Installment Sales.............................................................. 248,000
Cost of Installment Sales........................................... 176,080
Deferred Gross Profit, 2011....................................... 71,920
To record realized gross profit
Deferred Gross Profit, 2010............................................. 25,920 (a)
Deferred Gross Profit, 2011............................................. 35,670 (b)
Realized Gross Profit................................................. 61,590
(a) ($96,000 X .27)
(b) ($123,000 X .29)
EXAMPLE 3. 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

The journal entry associated with these transactions would be as follows.  To record the
installment sales for the current fiscal year:

Debit Credit
Installment Accounts Receivable $7,500,000  
Installment Sales   $7,500,000
The journal entry to record the collection of cash from customers:
  Debit Credit
Cash $3,000,000  
Installment Accounts Receivable   $3,000,000
The journal entry to record the cost of goods sold:
  Debit Credit
Cost of Installment Sales $6,000,000  
Inventory (Goods Sold on Installment)   $6,000,000
The journal entry to record the installment sales:
  Debit Credit
Installment Sales $7,500,000  
Cost of Installment Sales   $6,000,000
Deferred Gross Profit (Installment Sales)   $1,500,000
The journal entry to record the realized gross profit:
  Debit Credit
Deferred Gross Profit (Installment Sales) $600,000  
Realized Gross Profit (Installment Sales)   $600,000

EXERCISE ON INSTALLMENT SALES:

Given: 2003 2004 2005

Installment sales Br. 200,000 Br. 250,000 Br. 240,000
Cost of sales Br. 150,000 Br. 190,000 Br. 168,000
Gross Profit Br. 50,000 Br. 60,000 Br. 72,000
Cash received in:
From 2003 sales Br. 60,000 Br. 100,000 Br. 40,000
From 2004 sales -- 100,000 125,000
From 2005 sales -- -- 80,000
Required:
Determine the realized and deferred gross profit of each year.

What are Consignment Sales?

Consignment sales are a trade agreement in which one party (the consignor) provides goods to
another party (the consignee) to sell. However, the consignee owns the right to return unsold
goods back to the consigner. Consignment sales are also called goods on consignment.

Consignment occurs when goods are sent by their owner (the consignor) to an agent (the
consignee), who undertakes to sell the goods. The consignor continues to own the goods until
they are sold, so the goods appear as inventory in the accounting records of the consignor, not
the consignee. If the consignee is unable to sell all goods, they are able to return the goods to the
consignor (before a specified date). Therefore, the consignor bears the risks and rewards of
ownership while the consignee is not required to pay for the goods until they are sold.
A Consignment Agreement is a document between two parties, called the "Consignor" and the
"Consignee," where one party (the Consignee) agrees to sell goods on behalf of the other party
(the Consignor). The Consignor is the person to whom the goods belong. Often, this is just an
individual looking for an easy and quick way to sell goods. The Consignee is the person who is
permitted to sell the goods on behalf of the Consignor. Often, this is the storefront or business
that runs specifically for this reason - most are called Consignment Shops.
Consignment Agreements can be drafted for any sort of consignment sale between two parties.
They can be used to sell just one product or a series of products. In Consignment Agreements,
the Consignee agrees to sell the product under certain conditions (such as that delivery is made,
they get a specific fee, etc.) and the Consignor gives Consignee the right to sell under those same
conditions. For the Consignor, these agreements can be very effective because the Consignor
does not have to do the work of sale themselves.
In a Consignment Agreement, the most important details of the parties' relationship will be
entered: things such as a description of the product being offered for sale, as well as pricing
information, and how the fees will be split. A good Consignment Agreement will also have both
parties covered in case anything goes wrong: things such as dispute resolution and governing
law should be included.

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
Consignment Accounting - Initial Transfer of Goods

When the consignor sends goods to the consignee, there is no need to create an accounting entry
related to the physical movement of goods. It is usually sufficient to record the change in
location within the inventory record keeping system of the consignor. In addition, the consignor
should consider the following maintenance activities:
  Periodically send a statement to the consignee, stating the inventory that should be on the
consignee's premises. The consignee can use this statement to conduct a periodic
reconciliation of the actual amount on hand to the consignor's records.
 Request from the consignee a statement of on-hand inventory at the end of each
accounting period when the consignor is conducting a physical inventory count. The
consignor incorporates this information into its inventory records to arrive at a fully
valued ending inventory balance.
 It may also be useful to occasionally conduct an audit of the inventory reported by the
consignee.
From the consignee's perspective, there is no need to record the consigned inventory, since it is
owned by the consignor. It may be useful to keep a separate record of all consigned inventory,
for reconciliation and insurance purposes.
Consignment Accounting - Sale of Goods by Consignee
When the consignee eventually sells the consigned goods, it pays the consignor a pre-arranged
sale amount. The consignor records this prearranged amount with a debit to cash and a credit to
sales. It also purges the related amount of inventory from its records with a debit to cost of goods
sold and a credit to inventory. A profit or loss on the sale transaction will arise from these two
entries.
Depending upon the arrangement with the consignee, the consignor may pay a commission to the
consignee for making the sale. If so, this is a debit to commission expense and a credit to
accounts payable.
From the consignee's perspective, a sale transaction triggers a payment to the consignor for the
consigned goods that were sold. There will also be a sale transaction to record the sale of goods
to the third party, which is a debit to cash or accounts receivable and a credit to sales.
EXAMPLES
Suppose a consignor (owner) agrees to consign goods to a consignee (agent) to sell by
consignment. The consignor will purchase the goods and pay for them to the transported to the
consignee. The consignee in return for a commission of 10%, will arrange for the goods to be
distributed and sold. The consignor (owner) has the following transactions relating to the
purchase and transfer of the consignment goods:
 Purchase of goods – 3,000
 Carriage and freight expense – 350 and the consignee (agent) has similar transactions
relating to the collection and storage
  Import duty – 200
 Selling expenses – 300
 Revenue – 7,000
Goods Transferred by the Consignor
Normally the goods will have been purchased together with other purchases and form part of the
inventory of the consignor. The consignment accounting journal entry records the transfer of the
goods from inventory to a consignment inventory account to indicate that the goods have been
consigned to an agent.
Consignor Accounts – Goods transferred by consignor
consignee
Account Debit Credit
Consignment inventory 3,000

Inventory 3,000
The consignment inventory accounting journal represents the transfer of inventory from the
normal inventory account to a separate consignment inventory account. The inventory is still the
property of the consignor, and no entry is made by the consignee.
No entry is made by the consignee.
Consignor Pays Expenses
The consignor pays the carriage and freight expenses.
Consignor Accounts – Consignor pays expenses
Account Debit Credit

Consignment inventory account 350

Accounts payable 350
As the expenses relate to the consignment and are a cost of bringing the inventory to its present
location and condition, they are debited to the consignment inventory account. The credit entry
as usual is either to accounts payable or cash depending on the terms agreed with the supplier.
No entry is made by the consignee.
Consignee Pays Expenses
The consignee pays the import duty (200) and selling expenses (300) on behalf of the consignor.
Consignee Accounts – Consignee pays expenses on behalf of consignor
Account Debit Credit

Consignor Personal Account 500

Accounts payable 500
The consignee pays expenses on behalf of the consignor so the debit entry is made to the
personal account of the consignor representing monies due by the consignor to the consignee.
The credit entry as usual is either to accounts payable or cash depending on the terms agreed
with the supplier.
No entry is made by the consignor.
Consignee Sells the Goods
The consignee sells the goods on behalf of the consignor. In this example, we will assume for
simplicity the goods are sold for cash.
Consignee Accounts – Consignee sells the goods on behalf of consignor
Account Debit Credit
Cash 7,000
Sale/ Consignor personal account 7,000
The agent has sold the goods for cash. The credit entry is to the personal account of the
consignor and represents an amount due by the consignee to the consignor as the goods were
sold on their behalf.
No entry is made by the consignor.

Consignee Records Commission

Under the consignment contract agreement the consignee is entitled to a commission of 700
(7,000 x 10%), and makes the following consignment accounting journal entry.
Consignee Accounts – Consignee records commission
Account Debit Credit
Consignor personal account 700
Commission income/A/R 700
The credit entry to the commission income account represents the income earned by the
consignee on the consignment sales. The amount is due from the consignor and is therefore
posted as a debit to the personal account of the consignor.
No entry is made by the consignor.
Consignee Accounts to the Consignor
The consignee now provides a summary to the consignor of all transactions it has made relating
to the consignment. This report is referred to as an Account Sales Report.
Consignment Accounting – Sales Report
Revenue 7,000
Import Duty 200
Selling expenses 300
Commission 700
Net income 5,800
The consignee now pays the balance on the personal account of the consignee (5,800) to the
consignor and clears the account with the following journal entry
Consignee Accounts – Consignee pays the consignor
Account Debit Credit
Consignor personal account 5,800
Cash 5,800
No entry is made by the consignor
Consignor Records the Consignment Sales and Expenses
On receipt of the Account Sales Report from the consignee, the consignor completes the
consignment accounting by accounting for the sales and expenses with the following
bookkeeping entry.
Consignor Accounts – Consignor records details from the account sales report
Account Debit Credit
Consignment inventory (import duty) 200
Selling expenses 300
Commission 700
Cash 5,800
Revenue 7,000
It is important to note that the import duty of 200 is debited to the consignment inventory
account as it is a cost of bringing the inventory to its current location and condition relating to
the entire consignment, and needs to be taken into account when calculating the cost of goods
sold in the next step.

The selling and commission expenses relate only to goods which have been sold and can be
taken direct to the appropriate expense account.

In this simple example the debit entry to cash represents the remittance from the consignee with
the account sales report, had the consignee not sent cash at the same time, the debit entry would
have gone to the personal account of the consignee representing monies due (accounts
receivable) from the consignee.
No entry is made by the consignee.
Consignor Records the Consignment Cost of Goods Sold
The consignor must now transfer the cost of goods sold from the consignment inventory account
to the cost of goods sold account.
Consignor Accounts – Consignor records cost
of goods sold
Account Debit Credit
Cost of goods sold 3,550
Consignment inventory account 3,550
In this example, as all the inventory has been sold, the total on the consignment inventory
account (3,000 inventory, 350 carriage and freight and 200 import duty) is transferred to the cost
of goods sold account. Had the entire inventory not been sold, then only a proportion of the
inventory would be transferred and the balance would represent inventory still held by the
consignee.
No entry is made by the consignee.

The net effect of these postings is summarized in the memorandum income statement below.
Consignment Accounting Memorandum Income Statement
Revenue 7,000
Purchases 3,000
Import duty 200
Freight and carriage 350
Cost of goods sold 3,550
Gross margin 3,450
Selling expenses 300
Commission 700
Total Operating expenses 1,000
Net income 2,450
The 2,450 reflects the profit made by the consignor on this consignment.
EXAMPLE OF CONSIGNMENT SALES
On January 1, Company A sends 100,000 copies of its magazines to retailers to sell on
consignment. The company also specifies that the deadline to return unsold goods is January 31.
In this scenario, Company A is the consignor while the retailers are the consignee.

The retail price per magazine is $10 and the price charged by Company A selling to the retailers
is $5. Throughout the month of January, the retailers manage to sell 50,000 copies (the retailers
notify Company A on January 30). Therefore, there were unsold magazines of 50,000 to which
the retailers returned to Company A on January 31. Additionally, each magazine costs Company
A $1 to make.

Required Pass a necessary journal entry