Chapter Three

Installment and Consignment Contracts

3.0. Introduction
The principle of revenue and expense recognition states that revenue will be recognized when earned
and expense when incurred. The point at which revenues are considered as earned is normally a point
at which the earning process is completed. It is also a case that this point for merchandising
businesses is a point at which the goods are handed over to the customers. However, in some
circumstances firms postpone the recognition of revenue beyond the point of sales. Hence, we will see
this circumstance in this chapter.
3.1. Installment Sales
An installment sale is a sale of real or personal property or services which provides for a service of
payments over a period of months or years.

3.1.1. Characteristics of Installment Sales

 Installment sales involve a financing agreement whereby the customer signs a contract,
makes a small down payment, and agrees to make periodic payments over an extended
period often several years.
 The customer accepts possession of the item when the contract is signed (thereby
enjoying its use during the payment period), while the seller retains legal title until the
payments are complete.
 Provides for a series of payments over a period of months or years.
 A down payment generally is required. Because the seller must wait a considerable
period of time to collect the entire selling price
 It is customary to provide for interest and carrying charges on the unpaid balance.
Today, installment sales contracts may still be used for merchandise. APB Opinion No. 10 found the
installment method of recognizing revenue for installment sales generally to be unacceptable. The
Board however did recognize that there are exceptional cases where receivables are collected over an
extended period and the probability of collection is not reasonably assured. In these exceptional
cases, the installment method is used. In addition, the installment method is still acceptable for income
tax purposes under certain circumstances.

It is important to distinguish between an “installment sale” as a legal contract involving a buyer

and a seller, and the “installment method” of revenue recognition. For example, for an installment
sale, a company may recognize revenue in full at the time of the sale if collectability is not issue.
In such a case, care must be taken to estimate the cost to be incurred in the future, such as costs
of collection and bad debts, so that appropriate matching occurs. Alternatively, a company may use the
installment method of revenue recognition for a sales transaction that is not an installment sale. In
summary, the installment method of revenue recognition is selected because the collectability of the
receivable from the sale is not reasonably assured, and this decision is independent of the legal form
of the contract.

3.1.2. Accounting for installment sales

There are some steps which are accepted as procedures to apply installment method of revenue
recognition as follows; -
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1. Total sales, cost of goods sold, and collections are recorded in the normal manner during the year.
2. At the end of the year, sales for which the installment method is to be used are identified. The
revenue and the related cost of goods sold that had been recorded during the year are “reversed,”
and the deferred gross profit is recognized.
3. At the end of the year, the gross profit rate recognized under the installment method for that year
is computed. The rate is calculated by dividing the deferred gross profit recognized by the related
installment sales for the year.
4. A portion of the deferred gross profit is recognized as gross profit for the year by multiplying the
cash collected on the sales recognized under the installment method during the year times the
gross profit rate calculated in step 3.
5. In future years the remaining deferred gross profit is reduced and the gross profit is recognized
based on the cash collected each year from the previous sales recognized under the installment
method times the gross profit rate for the year in which those sales were made.
Example of the Installment Method
To illustrate the installment method, consider the following information for Sheko Company in the
first two years of its operations:
1998 1999
Total credit sales Br.500,000 Br.600,000
Total cost of goods sold 390,000 430,000
Installment method sales* 100,000 150,000
Installment method cost of goods sold* 75,000 105,000
Gross profit rate on installment method sales 25% 30%
Cash receipts on installment method sales
1998 sales 20,000 30,000
1999 sales 40,000
Cash receipts on other credit sales 300,000 480,000

*Included in total credit sales and total cost of goods sold, respectively.
Assume that the company uses the perpetual inventory method and that, for simplicity, interest on the
installment receivables is ignored. The Sheko Company records the preceding events with the
following journal entries:
During 1998
Accounts Receivable ………………………………. 500,000
Sales …………………………………………………………… 500,000
Cost of Goods Sold ………………………………… 390,000
Inventory ………………………………………………………… 390,000
The total sales and cost of goods sold for the year are recorded in the normal manner. No
differentiation is made for the sales recognized under the installment method.
During 1998
Cash ……………………………………………... 320,000
Accounts Receivable……………………………………………. 320,000
Cash collections are recognized in the normal manner. Of these collections, Br.20,000 is for
installment sales and Br.300,000 for other credit sales.
December 31, 1998
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 Sales ……………………………………………… 100,000
Cost of Goods Sold …………………………………………… 75,000
Deferred Goods Profit, 1998 …………………………………... 25,000
The sales recognized under the installment method and the related cost of goods sold are identified
from the accounting records and “reversed,” and the deferred gross profit is recognized. The gross
profit rate for 1998 is computed to 25% (deferred gross profit of Br.25,000 divided by the sales of
Br.100,000).
December 31, 1998
Deferred Gross profit, 1998 …………………………5,000
Gross Profit Realized on Installment Method Sales ……… …. 5,000
The gross profit rate of 25% is used to recognize the gross profit on the cash collected. Since the
company collected Br.20, 000 on these sales for 1998, deferred gross profit is reduced and a gross
profit of Br.5, 000 =Br 20,000 X 25%) is recognized. The gross profit account is closed to Income
Summary along with the sales, cost of goods sold, and expense accounts (not illustrated). The
company reports the preceding events in its financial statements as shown below.

Sheko Company
Partial Income Statement
For Year Ended December 31,1998

Sales Br.400,000a
Cost of goods sold (315,000) b
Gross profit Br. 85,000
Gross profit realized on installment method sales 5,000
Total gross profit Br. 90,000

Sheko Company
Partial Balance sheet
December 31,1998

Current Assets
Accounts receivable Br.100,000c
Installment accounts receivable Br. 80,000d
Less: Deferred gross profit (20,000)e 60,000

a. Br.500,000 – Br.100,000.
b. Br.390,000 – Br.75,000.
c. Br.500,000 – Br.320,000 – Br.80,000 (from footnote d).
d. Br.100,000 – Br.20,000.
e. Br.25,000 – Br.5,000.

Three aspects of the financial statements should be understood. First, in the income statement the gross
profit on the sales recognized under the installment method is shown separately from the profit on the

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other sales. Some companies, however, might combine the two amounts and disclose the gross profit
on these sales in the notes to the financial statements. Second, installment accounts receivable are
usually included in current assets on the balance sheet under the operating cycle concept. Finally, note
that the deferred gross profit is deducted from the installment accounts receivable on the balances
sheet.
 Some companies, however, include the deferred gross profit as a current liability rather than as
a contra asset.
 Such reporting is inconsistent with the concept of a liability, because no future cash outflow
will occur.
o Hence many practitioners and writers advocate the presentation as a contra asset
because, as discussed earlier in the chapter, accounts receivable is reduced from selling
price to cost.

In 1999 Sheko Company records the following journal entries:

During 1999
Accounts receivable 600,000
Sales 600,000
Cost of Goods Sold 430,000
Inventory 430,000
Cash 550,000
Accounts Receivable 550,000

Of these collections, Br.70, 000 is for installment sales and Br.480, 000 for other credit sales. Note that
the cash collections in the installment sales in 1999 include amounts from sales made in 1998 (Br.30,
000) and 1999 (Br.40, 000).
December 31, 1999
Sales 150,000
Cost of Goods Sold 105,000
Deferred Gross Profit, 1999 45,000
The sales recognized under the installment method and the related cost of goods sold for 1999 are
“reversed,” and the deferred gross profit for 1999 is recognized. The gross profit rate in 1999 is 30%
(Br.45,000) ÷ Br.150,000).
December 31, 1999
Deferred Gross Profit, 1998 7,500
Deferred Gross Profit, 1999 12,000
Gross Profit Realized on Installment Method Sales 19,500
During 1999 the company collected Br.30, 000 on is 1998 installment method sales, for which its
gross profit is 25%. As shown, the company reduces the deferred gross profit from 1998 and
recognized a gross profit of Br.7, 500 (Br.30, 000 x 25%). The company also collected Br.40,000 on
its 1999 installment method sales, for which its gross profit is 30%. In the entry the company reduces
the deferred gross profit for 1999 and recognizes a gross profit of Br.12, 000 (Br.40,000 x 30%) on
those collections. The combined gross profit for 1999 is Br19, 500, which is closed to Income
Summary.
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The Sheko Company includes the realized gross profit of Br.19,500 in its 1999 income statement, in
addition to the sales and the cost of goods sold from those sales on which revenue is recognized at the
time of sale. The installment accounts receivable of Br.160,000 (Br.100,000 – Br.20,000 + Br.150,000
– Br.30,000 – Br.40,000) and a deferred gross profit of Br.45,500 (Br.25,000 – Br.5,000 + Br.45,000 –
Br.7,500 – Br.12,000) are included on its December 31, 1999 balance sheet. Note that the balance in
the deferred gross profit account is the balance of the installment receivables multiplied by the gross
profit percentage.
Sales on Installment Plan: A sale of goods or services on the installment plan generally provides for
cash down payment and a series of additional monthly payments. Because payments extend over a
long period, the seller customarily charges interest and carrying charges on the unpaid balance of
installment receivables.

3.1.3. Methods of recognition of profit on installment sales

Revenue from installment sales is recorded in the manner as from regular sales, unless the collection
of the installment receivables is not assured and there is no reasonable base for estimating the
probability of collection. If the accrual basis of accounting is not considered appropriate, an alternative
method of revenue recognition such as the installment method or the cost recovery method must be
used.
Thus, even though the completion of a sale has been widely accepted as a prerequisite to the
recognition of revenue, the preceding discussion indicates that “sale and delivery” and “revenue
recognition” are not necessarily synonymous. In some situations, accountants may record revenue at
other stages of the earning process, such as before or after delivery of the product. These and other
revenue recognition situations are discussed in the following sections.
 Revenue Recognition after Delivery
As stated in the preceding section, the most widely accepted evidence of revenue realization is the sale
and delivery of products or the performance of services. However, in the cash of product sales,
revenue recognition may be delayed until some stage in the earning process subsequent to sale and
delivery because the sale and delivery may not provide sufficient evidence of revenue realization. In
such instances revenue may be recorded under the installment method, the cost recovery method, or
other method based on cash collections. These methods are discussed in the following sections.

A. Installment Method
Business enterprises that sell goods on the installment plan may use the installment method of
accounting only when accrual accounting is not considered appropriate. The installment method is
widely used for income tax purposes because it postpones the payment of income taxes until
installment receivables are collected. However, the installment method is not acceptable for financial
accounting unless considerable doubt exists as to the collectability of the receivables and a reasonable
estimate of doubtful accounts expense cannot be made.
Under the installment method, the seller recognizes gross profit on sales in proportion to the cash
collected. If the rate of gross profit on installment sales is 40%, each Birr of cash collected on the
installment receivables represents 40 cents of gross profit and 60 cents of cost recovery.
For example, assume that Galeria Sales Company sold merchandise on the installment plan for
Br.400,000 in Year 1, and that the cost of the merchandise sold was Br.240,000, or 60% of selling
price. The terms of a typical sale required a down payment and 24 equal monthly payments. The cash
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collected, recovery of cost, and realized gross profit on these sales for Galeria Sales Company are
summarized below:
Analysis of Cash Collected on Installment Receivables

Cash Recovery Realized

Year Collected of cost, 60% Gross profit 40%
(A) (B) (A – B)
1 Br.180,000 Br.108,000 Br. 72,000
2 150,000 90,000 60,000
3 70,000 42,000 28,000
Galleria
Totals Br400,000 Br240,000 Br160,000
Sales
Company
used the perpetual inventory system, and adopted the installment method because it could not make a
reasonable estimate of the collectability of the installment receivables. Deferred interest and carrying
charges on the installment receivables are disregarded for purposes of this illustration, and we have
assumed that Galleria Sales eventually collected all receivables from these sales. The journal entries
during the three-year period for Galleria Sales Company under the installment method of accounting
are presented on next page.
Installment receivables from revenue transactions are included among current assets in the balance
sheet. The balance in the Deferred Gross Profit (Year 1 Installment Sales) ledger account may be
deducted from the receivables as a valuation account or included among current liabilities as a
deferred revenue item. Reporting the deterred gross profit as a valuation account is preferred by the
authors because it is more in concert with the reason for use of the installment method—absence of
reasonable assurance that the full amount of the receivables will be collected.
Under the procedures illustrated above, the entire revenue and cost of goods sold are included in the
income statement in the year installment sales are made, and the unrealized gross profit of Br.88, 000
(Br.220, 000 X 0.40 = Br.88,000) applicable to installment receivables outstanding at the end of Year
1 is deferred (deducted from total gross profit) and is recognized in Year 2 and Year 3 as the
receivables are collected. In the income statements for Year 2 and Year 3, the gross profit realized
from Year 1 installment sales is added to each year’ gross profit from regular sales.

GALLERIA SALES COMPANY

Journal Entries—Installment Method of Accounting
For years 1, 2, and 3
Leger accounts and Year 1 Year 2 Year 3
explanation of transactions Debit Credit Debit Credit Debit Credit

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 Installment Receivables…... 400,000
Cost of installment Sales….. 240,000
Installment Sales ……….. 400,000
Inventories ……………… 240,000
To record installment sales
and cost of installment sales.
Installment Sales………….. 400,000
Cost of installment Sales... 240,000
Deferred Gross Profit
(Year 1 installment Sales). 160,000
To record deferred gross profit
at end of Year 1.
Cash ………………………… 180,000
Installment Receivables……. 180,000 150,000 70,000
To record cash collections. 150,000 70,000
Deferred Gross Profit (Year 1
to 3 installment Seles) ……. 72,000
Realized Gross Profit on 72,000 60,000 28,000
installment Sales…………. 60,000 28,000
To record realized gross profit
on installment sales at 40%
of cash collections.

An alternative procedure suggested by some accountants is to record revenue and cost of goods sold
only as the installment receivables is collected. This approach would produce the following results for
Galleria Sales Company:

Year 1 Year 2 Year 3

Installment sales ………………… Br180,000 Br150,000 Br 70,000

Cost of goods sold (60%) ……… 108,000 90,000 42,000
Gross profit on sales (40%) ………… Br72,000 Br 60,000 Br 28,000

If this approach is used, no ledger account for deferred gross profit is required, because the difference
between the deferred portion of installment sales and the deferred cost of goods represents the amount
of gross profit deferred.
Application of the installment method is complicated by variations in the gross profit rates from year
to year, repossessions of goods sold on the installment plan, uncollectible installment receivables,
interest and carrying charges on the receivables, and trade-in allowances.
Cost Recovery and Deposit Methods: The cost recovery and deposit methods may be used to
account for revenue transactions when the terms of such transactions are ambiguous or the financial
position of customers is so unstable as to make it virtually impossible to evaluate the collectability of
the related receivables. Under the cost recovery method, no profit is recognized until the cost of the
products sold is fully recovered. In the period of sale, the cost of the products is deducted from sales
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(net of the deferred gross profit) in the income statement. The deferred gross profit also is deducted
from the related receivables in the balance sheet. Collections of principal reduce the receivable, and
any collections of interest are credited to the deferred gross profit ledger account. Deferred gross profit
subsequently recognized as earned is presented as a separate item or revenue in the income statement.
A situation in which the cost recovery method may be appropriate is in the sale of recreational land.
Such sales often are made to individuals who make only nominal down payments, have poor credit
standing, and are able to cancel the sale at any time without penalty, other than the loss of the
payments already made. It states a seller has no legal right to take any action against customers other
than to repossess the land. Because the seller has performed but the customer’s ability to carry out the
terms of the sale are very much in doubt in such cases, use of the cost recovery method of revenue
recognition would be appropriate. When a sales transaction is for any reason incomplete, performance
by either the seller or the purchaser has not taken place. Even though the parties fully intend to
consummate a sale, certain contingencies may have to be resolved before a sale is completed. Such
contingencies may include the obtaining of permits or financing.
Any cash received by the seller in such a “potential sale” is a deposit from customers rather than
revenue. Thus under the deposit method, cash received from customers is a liability (advances from
customers) until the sale is completed. On completion of the sale, the liability is transferred to a
revenue account, consistent with an appropriate revenue recognition method, for example, the accrual
method, the installment method, or the cost recovery method.
Additional Considerations for the installment method
Several additional factors that affect the accounting under the installment method are discussed in this
section.
 Alterative Accounting and Reporting
In the preceding example, it has been assumed that it is acceptable to report only the gross profit
amount in the income statement because the installment sales revenue was not material. If the
installment sales were considered to be material, then it would be necessary to report separately both
the installment sales and the cost of goods sold (a procedure that was used in the discussion of long-
term construction contracts earlier in the chapter). In this situation, the Sheko Company would prepare
an alternative journal entry as follows (using the amounts for 1998):
Deferred Gross Profit, 1998 5,000
Installment Cost of Goods Sold 15,000
Installment Sales 20,000
Under this alternative, when cash is received, the deferred gross profit is reduced as before. However,
an amount equal to the cash collected is recorded as the sales revenue and an appropriate amount of
cost of goods sold is recognized; in this case, 75% of the sales amount. Then, the company would
disclose the installment sales of Br.20,000 and deduct the installment cost of goods sold of Br.15,000
to report its gross profit of Br.5,000 for 1998.
Operating Expenses: As we have seen, the cost of goods sold is matched against the installment sales
and recognized in the same period as the sales. Operating expenses are not deferred and recognized in
the same manner. Instead, they are recognized in the normal way on an accrual basis. That is, they are
either recognized in the period incurred, such as general and administrative salaries, or by systematic
and rational allocation, such as depreciation on an office building.
Interest charges: The Company making an installment sale typically charges the buyer interest
because of the extended collection period. The interest charge usually is included as a component of
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the periodic payment specified in the sales contract. The normal practice is to make the installment
payment includes a smaller interest component and a larger principle payment. In other words, the
interest is treated in the same way as a loan.
When interest is included in an installment sale, the interest revenue is accounted for separately. Each
installment payment received is separated into two components interest revenue and a reduction in the
installment accounts receivable. The interest revenue is recorded on an accrual basis in the normal
manner (the period earned), and the gross profit is recognized as cash is received, as discussed earlier.
Uncollectible accounts: Installment sales contracts usually provide for repossession of the item if the
buyer defaults. If the experience of the company indicates that the price at which the repossessed item
can be sold will be sufficient to cover the remaining payment on the original installment sale, then a
provision for bad debts is not necessary. However, if past experience indicates that the expected resale
price will be insufficient to cover the payments, the recognition of debt expense and an allowance for
doubtful installment accounts receivable is appropriate.
Defaults and repossessions: When an item is repossessed, the inventory is recorded and the related
receivable and deferred gross profit written off. To illustrate, assume that the Sheko Company
repossesses an item it sold 1998 with a gross profit of 25%, and the fair value of the repossessed item
is Br.600. If Br.1,000 remained unpaid, the repossession is recorded as follows:
Repossessed Inventory 600
Deferred Gross profit 250
Allowance for Doubtful Installment Accounts Receivable 150
Accounts Receivable 1,000
The deferred gross profit (Br.1,000 x 25%) related to the remaining cash payments is eliminated and
the Br.150 “lost” on the recovery is debited to Allowance for Doubtful Installment Accounts
Receivable, which was established when the bad debt expense was recognized.

B. Cost Recovery Method

If a company makes a sale in which there is a very high degree of uncertainty about the collectability
of the sales price, it is appropriate to defer the recognition of any profit until the cost of the entire sale
has been recovered. As with the installment method, APB Opinion No. 10 found the cost recovery
method of recognizing revenue generally to be unacceptable. The Board, however, did recognize that
there are exceptional cases where receivables are collected over an extended period and where the
terms of the transaction provide no reasonable basis for estimating the degree of collectability. In such
exceptional situations, the cost recovery method may be used. For example, a company may sell a
distressed division, thereby transferring the risks and benefits of ownership, but agree that the
purchaser will pay with the net operating cash inflows generated by the division.
Under the cost recovery method, sales, cost of goods sold, and collections are recorded during the year
in the usual manner (as with the installment method). In contrast to the installment method, however,
no gross profit is recognized under the cost recovery method until all the cost of the item sold has been
recovered. Once the cost has been recovered, gross profit is recorded at an amount equal to the cash
received in the period. To illustrate the cost recovery method, consider the following information for
the Patken Company:
Sale of property under cost recovery method Br.20,000
Cost of property sold (net) 12,000
Cash collections:
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 1998 5,000
1999 9,000
2000 6,000
It is assumed that the Patken Company has made no sales in previous periods for which it has used the
cost recovery method. The company records the preceding events using the cost recovery method as
follows:
During 1998
Accounts Receivable 20,000
Deferred Gross profit 8,000
Property (net) 12,000
Cash 5,000
Accounts Receivable 5,000
The transaction is recorded and the profit is deferred. No gross profit is recognized when the cash is
collected because the Br.12,000 cost of the property sold has not yet been fully recovered.
During 1999
Cash 9,000
Accounts Receivable 9,000
December 31, 1999
Deferred Gross profit 2,000
Gross profit Realized on Cost Recovery
Transactions 2,000
In 1998, Br.5,000 of the Br12,000 cost of the property sold was recovered. Therefore, the first
Br.7,000 collection in 1999 completes the recovery of the cost, and the remaining Br.2,000 collected
results in the recognition of a gross profit of Br.2,000.
During 2000
Cash 6,000
Accounts Receivable 6,000
December 31, 2000
Deferred Gross profit 6,000
Gross profit Realized on Cost Recovery
Transactions 6,000
Since the total cost was recovered in 1999, the Br.6,000 cash collected in 2000 results in an equal
amount of gross profit being recognized. The Sheko Company includes the gross profit in its income
statement each year. Accounts Receivable, less the balance in the Deferred Gross Profit account, is
included on the company’s balance sheet.

 Comparison of Installment and Cost Recovery methods

As discussed earlier, APB Opinion No.10 allows the use of either installment or cost recovery methods
in certain exceptional circumstances and makes no distinction between the situations in which each
should be applied. If collectability is not reasonably assured, revenue should not be recognized at the
time of sale. Instead, the installment method should be used. (Also, income tax rules allow the
installment method to be used in certain situations for the computation of taxable income.) Since the
cost recovery method is a more conservative revenue recognition method, it is used only when such

10
conservatism is appropriate. For example, if the collectability is extremely uncertain or there is no
reliable basis for estimating the collectability, then the cost recovery method is appropriate.
3.2. Consignment sales

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 sales agent
who has possession of the merchandise is called a consignee.
 The relationship between the consignor & the consignee is that of principal and agent.
 Consignees are responsible to consignors for the merchandise placed in their custody until it is
sold or returned.
As the title to merchandise is retained by the consignor, the consignees do neither include the
inventories in their records, nor include a trade accounts payable or other liability.
The only obligation of consignees is to give reasonable care to the consigned merchandise & to
account for it to consignor.
When the consigned merchandise is sold, the consignor records the sale, & the receivable is the
property of the consignor. As a result the consignor bears any credit losses, provided that the
consignee has exercised due care in granting credit & making collections.

3.2.1. Distinguishing between a Consignment and a Sale

Although both consignment and sale involve shipment of inventories, they are not one and same.
Unlike the case with sales, the title for the consigned goods is retained by the consignor and the
consigned goods are carried as part of the inventories of the consignor.
Therefore, no revenue should be recognized at the time of the consignment shipment. But, not in sales.

Why Consignments (why not sale)?

From the consignor's side:
 It could be easier to persuade dealers to stock the items on a consignment basis (as the
dealers may not be willing to purchase the merchandise outright)
 The consignor avoids the risk inherent in selling on credit to dealers of questionable
financial strength.

From the consignee's side

 The acquisition of merchandise on consignment rather than by purchase requires less
capital investment
 Avoids the risk of loss if the merchandise cannot be sold.
Rights and Duties of the Consignee
Rights of Consignee
 To receive compensation for merchandise sold for the account of the consignor.
 To receive reimbursement for expenditures (such as freight and insurance) made in
connection with the consignment.
 To sell consigned merchandise on credit if the consignor has not forbidden credit sales.
 To make the usual warranties as to the quality of the consigned merchandise and to bind
the consignor to honor such warranties.
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Rights of Consignor
o To give care and protection reasonable in relation to the nature of the consigned
merchandise.
o 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 trade accounts receivable from other receivables.
o To use care in extending credit on the sales of consigned merchandise and to be diligent in
setting prices on consigned merchandise and in collecting consignment trade accounts
receivable.
o To render complete reports of sales of consigned merchandise and to make appropriate and
timely payment to the consignor.

The Account Sales

The report rendered by the consignee is called an account sales; it include the quantity of merchandise
received and sold, expenditures made, advances made, and amounts owed or remitted. Payments may
be made as portions of the consigned merchandise are sold or may not be required until the
merchandise either has been sold or has been returned to the consignor.
3.2.2. Accounting for Consignees
The consignment of the shipment of merchandise may be recorded by the consignee in any of several
ways. The objective is to create a memorandum record of the consigned merchandise; no purchase has
been made and no liability exists. The receipt of consignment could be recorded;
 By a memorandum notation in the general journal,
 By an entry in a separate ledger of consignment shipments, or
 By a memorandum entry in a general ledger account entitled Consignment In - followed by
name of consignor (this approach is used in this section).
In the later approach, only memorandum entry is required in the general ledger account –
Consignment In. This account will be debited for transactions such as payment of freight costs made
by consignee on shipment from consignor, commission on consignment sales, and remittance or
advance to Consignor. The account will be credited for transactions like sales of consigned goods (at
the total selling price).

Illustration
Assume that Debrework Co ships on consignment to Aman Co. 10 television sets to be sold at Br. 400
each. Aman Co. is to be reimbursed for freight costs of Br. 135 and is to receive a commission of 20%
of the stipulated selling price. After selling all the cosigned merchandise, Aman sends Debrework Co.
an account sale similar to the one below, accompanied by a check for the amount due:

Aman Co.

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 Bench Maji, Ethiopia
Account sales
Aug. 31, 1999
Sales for account and risk of:
Debrework Co. Bench Maji, Ethiopia
Sales; 10 TV sets @ Br. 400 Br. 4,000
Charges:
Freight costs Br. 135
Commission (4,000 x 0.20) Br.800 Br.935
Balance (remittance to consignor) Br. 3,065
Consigned TV sets on hand None

Under this method (the later approach discussed above), the ledger account appears as follows;
The journal entries for the consignee to record the payment of freight costs on this shipment and the
sale of the television sets are as follows;

Consignment In - Debrework Co. ……..Br 135

Cash ……………………………………135
To record payment of freight costs on shipment from consignor

Cash …………………………………..Br 4,000

Consignment In - Debrework Co. ……………..Br 4,000
To record sale of 10 TV sets at Br 400 each

The journal entry to record the 20% commission charged by the consignee consists of a debit to the
Consignment In ledger account and a credit to a revenue account, as follows;

Consignment In - Debrework Co. …………………Br 800

Commission Revenue ……………………………………….Br 800
To record commission of 20% earned on TV sets sold

The payment of the consignee of the full amount owed is recorded by a debit to the Consignment In
ledger account and results in closing that account. The journal entry is as follows:

Consignment In - Debrework Co. ……………………..Br. 3,065

Cash …………………………………………………3,065
To record payment in full to consignor

After the posting of this journal entry, the ledger account for the consignment appears as follows in the
consignee's accounting records:
Consignment In - Debrework Co
Date Explanation Debit Credit Balance
Received 10 TV sets to be sold for Br. 400

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 each at a commission of 20% of selling price
Freight costs Br 135 Br 135 Dr
Sales (10 x Br. 400) 4,000 3,865 Cr
Commission (Br. 4,000 x 0.20) 800 3,065 Cr
Payment to consignor Br 3,065 -0-

On the other hand, if the consignee doesn't measure profits from consignment sales separately from
regular sales, the sale of the consigned merchandise is credited to the regular Sales ledger account.
Concurrently, a journal entry is made debiting Cost of Goods Sold (or purchases) and crediting the
consignment In ledger 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 Consignment In
ledger account and credit 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 purchase). The Consignment In ledger account is closed by a debit for the payment
made to the consignor in settlement.

At the end of the accounting period when financial statements are prepared, some Consignment In
accounts in the subsidiary consignment ledger may have debit balances and other may have credit
balances. A debit balance will exist in a Consignment In account if the total of expenditures,
commission, and advance to the consignor is larger than the proceeds of sale of that particular lot of
consigned merchandise; a credit balance will exist if the proceeds of sales are in excess of the
expenditures, commission, and advance to the consignor. The total of the Consignment In account
with debit balances is included among the current assets in the balance sheet; the total of the
Consignment In accounts with credit balances is included among current liability.
Accounting for Consignors When a consignor ship merchandise to consignees, it is essential to have a
record of the location of this portion of inventories. Therefore, the consignor may establish in the
general ledger a Consignment Out account for every consignee (or every shipment on consignment).
The Consignment Out ledger account represents special category of inventories.

Separate Measurement of Gross Profit

Separate measurement of gross profit on consignment sales is not same as separate measurement of net
income on consignment sales. Separate measurement of net income from consignment sales is not
justifiable, as it requires arbitrary allocation of many operating expenses. However, the measurement
of gross profits from consignment sales as distinguished from gross profits on regular sales is much
simpler, because it is based on the identification of direct costs associated with consignment sales.

The choice of accounting method by a consignor depends on whether (1) consignment gross profits are
measured 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
The choice of accounting methods by a consignor depends on whether (1) consignment gross profits
are measured 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.
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The journal entries required under these alternative methods of accounting for consignment shipment
now are illustrated, first under the assumption that gross profits on consignment sales are measured
separately, and second without a separate measurement of gross profits. The assumed transactions for
these illustrations already have been described from the consignee's view point, but now are restated to
include the data relating to the consignor. In all remaining illustrations, assume that the consignor uses
the perpetual inventory system.
Debrework Co. (the consignor) shipped on consignment to Aman Co. (the consignee) 10 TV sets
that cost Br. 250 each. The selling price was set at Br. 400 each. The cost of packing was Br. 30; all
costs incurred in the packing department were debited by Debrework Co. to the Packing Expense
ledger account. Freight costs of Br. 135 by an independent truck line to deliver the merchandise to
Aman Co. were paid by Aman. All 10 sets were sold by Aman for Br. 400 each. After deducting
the commission of 20% and the freight costs of Br. 135, Aman sent Debrework Co. a check for Br.
3,065, along with the account sales illustrated previously.
The journal entries for the consignor, assuming that gross profits on consignment sales are determined
separately, and gross profits on consignment sales are not determined separately, are summarized as
shown in the next page.
If the consigned merchandise is sold on credit, the consignee may send the consignor an account sales
but no check. In this case the consignor's debit would be to Trade accounts receivable rather than to
the Cash ledger account. When sales are reported by the consignee and gross profits are not measured
separately by the consignor, the account credited is Sales rather than Consignment Sales, because there
is no intent to separate regular sales from consignment sales. Similarly, the commission paid to
consignees is combined with other commission expenses, and freight costs applicable to sales on
consignment are recorded in the Freight out Expense ledger account.

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 Debrework Co.
Journal entries, ledger account, an income statement presentation for a completed consignment
Explanations Gross profits determined separately Gross profits not determined
separately
(1) Shipments of merchandise costing Br. 2,500 on Consignment Out - Aman Co. ….2,500 Consignment Out - Aman Co. 2,500
consignment; consigned merchandise is transferred to a Inventories ……………….2,500 Inventories 2,500
separate inventories ledger account.
Consignor uses the perpetual inventory system.
(2) Packing expense of Br. 30 allocated to consigned Consignment Out - Aman Co. …… 30 No journal entry required; total packing
merchandise; this expense previously was recorded in Packing expense ……………30 expense is reported among operating
the Packing expense ledger account. expenses.

(3) Consignment sales of Br. 4,000 reported by consignee Cash ………………………………..3,065 Cash …………………..3,065
and payment of Br. 3,065 received. Charges by Consignment Out - Aman Co. ………135 Freight Out expense ……135
consignee; freight costs, Br. 135; commission, Br. Commission Exp. -Consignment sales..800 Commission Expense …..800
800. Consignment Sales …………..4,000 Sales ……………...4,000

(4) Cost of consignment sales recorded, Br. 2,665 (=2,500 Cost of Consignment sales ………2,665 Cost of goods sold 2,500
+ 30 + 135) Consignment Out - Aman Co. ……..2,665 Consignment Out - Aman Co. 2,500

(5) Summary of Consignment Out ledger account: Consignment Out - Aman Co. Consignment Out - Aman Co.
2,500 2,665 2,500 2,665
30
135
2,665 2,665

(6) Presentation in the income statement: Consignment sales ………………….Br. 4,000 Included in total sales Br. 4,000
Less: Cost of consignment sales..2,665 Included in cot of all goods sold 2,500
Commission ………………..800 3,465 Included in total packing expense 30
Gross profit on consignment sales ……Br. 535 Included in total freight-out expense

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135
Included in total commission exp. 800

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Accounting for Partial Sale of Consigned Merchandise

In the preceding example, the assumption was that the consignor received an account sales showing
that all the merchandise shipped on consignment had been sold by the consignee. The account sales
was accompanied by remittance in full, and the consignor's journal entries were designed to recognize
the gross profit from the completed consignment. However, it is possible for the consignee to sell only
some of the consigned goods and remit the partial amount collected from partial sales.

Assume that only four of the ten TV sets (instead of all ten) consigned by Debrework Co. to Aman
Co. had been sold by the end of the accounting period. To prepare financial statements, the consignor
must determine the amount of gross profit realized on the four units sold and the inventory value of the
six unsold units. The account sales received by Debrework Co. at the end of the current period
include the following information:
Aman Co.
Account sales to Debrework Co.
Sales: 4 TV sets @ Br. 400 Br. 1,600
Charges: Freight costs 135
Commission (1,600 x 0.2) 320 455
Total payable to consignor Br. 1,145
Less: Check enclosed 500
Balance payable to consignor Br. 645
Consigned merchandise on hand 6 TV sets

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19
 Debrework Co.
Journal entries, ledger account, a Balance Sheet presentation for a partial sale of Consigned merchandise
Explanations Gross profits determined separately Gross profits not determined separately
(1) Shipments of merchandise costing Br. 2,500 on Consignment Out - Aman Co. 2,500 Consignment Out - Aman Co. 2,500
consignment; consigned merchandise is transferred to a Inventories 2,500 Inventories 2,500
separate inventories ledger account.
Consignor uses the perpetual inventory system.

(2) Packing expense of Br. 30 allocated to consigned Consignment Out - Aman Co. 30 No journal entry required; total packing
merchandise; this expense previously was recorded in Packing expense 30 expense is reported among operating
the Packing expense ledger account. expenses.

(3) Consignment sales of Br. 1,600 reported by consignee Cash ……………………………500 Cash …………………..500
and payment of Br. 500 received. Charges by Trade A/R ………………………645 Trade A/R …………….645
consignee; freight costs, Br. 135; commission, Br. 320. Consignment Out - Aman Co...135 Freight Out expense …..135
Commission Exp. -Consignment sales... Commission Expense …320
320 Sales ………………………….1,600
Consignment Sales ………….1,600
(4) Cost of consignment sales recorded, [(Br. 250 +Br. 3 + Cost of goods sold 1,000
Br. 13.5) x 4 = Br. 1,066; Br. 250 x 4 = Br. 1,000] Cost of consignment sales 1,066 Consignment Out - Aman Co. 1,000
Consignment out -Aman Co. 1,066
(5) Direct costs relating to unsold merchandise held by Consignment Out - Aman Co. …99
consignee deferred when profits are not determined No journal entry required Packing expense ……..……………….18
separately; Freight out expense …………………..81
Parking costs (Br. 3x6) Br. 18
Freight costs (13.5 x 6) 81
Total ………………..Br. 99 Consignment Out - Aman Co.
(6) Summary of Consignment Out ledger account: 2,500 1,000
Consignment Out - Aman Co. 99 1,599
2,500 1,066 2,599 2,599

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 30
135 Bal. 1,599
2,665 2,665 Balance 1,599
(7) Presentation in the balance sheet: Current assets:
Balance 1,599 Inventories on consignment Br. 1,599
Current assets:
Inventories on consignment Br. 1,599

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Return of Unsold Merchandise by Consignee
When the consignee returns merchandise to the consignor, the place utility originally created by the
costs (such as packing and freight costs) is lost. As a result all the packing and freight cost incurred to
get the merchandise in the consignee's premises should be considered as expense of the current
accounting period. The same is true for the costs incurred by the consignor on the return shipments,
including any repair costs necessary to place the merchandise in a salable condition.
Advances from Consignees
Although cash advance from a consignee sometimes are credited to the Consignment Out ledger
account, a better practice is to credit a liability account- Advance from consignees.
Nature of the Consignment Out ledger Account
This account belongs in the asset category- current asset.
This 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.

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