Chapters 1 Accounting for Head Office and Branch

Accounting for Branch

The accounting work done at each branch depends upon the policy or
the accounting system of the enterprise which may provide for a
complete set of accounting records at each branch or keep all accounting
records in the home office.
A branch may, accordingly, maintain a complete set of accounting
records consisting of journals ledgers and chart of accounts similar to
those of an independent business enterprise, prepare financial
statements and periodically forward to the home office.
Transactions recorded by the branch should include all controllable
expenses and revenue for which the branch manager is responsible.
Expenses such as depreciation and branch plant assets are generally
maintained by the home office.
Reciprocal Accounts
The accounting records maintained by a branch include a Home Office
ledger account that is credited for all merchandise, cash, or other
resources provided by the home office; it is debited for all cash
merchandise or other asset sent to the home office or to other branches.
The Home Office account is a quasi-ownership equity account that shows
the net investment by the home office in the branch. At the end of the
accounting period when the branch closes its accounts, the Income
Summary account is closed to the Home Office account. A net income
increases the credit balance of the Home Office account; a net loss
decreases this balance.
In the home office accounting records, a reciprocal ledger account with a
title such as Investment in Branch is maintained. This non current asset
account is debited for cash, merchandise, and services provided to the
branch by the home office, and for net income reported by the branch. It
is credited for the cash or other assets received from the branch, and for

1
any net loss reported by the branch. Thus, the Investment in Branch
account reflects the equity method of accounting. A separate investment
account is generally maintained by the home office for each branch.
At the end of an accounting period, the balance of the Investment in
Branch X ledger account in the accounting records of the home office
may not agree with the balance of the Home Office account in the records
of Branch X, because certain transactions may have been recorded by
one office but not by the other. These balances of the reciprocal accounts
must be brought into agreement before combined financial statements
are prepared.
Expenses Incurred by Home Office and Allocated to Branches
Some business enterprises follow a policy of notifying each branch of
expenses incurred by the home office on behalf of the branch. When
such a policy is adopted, an expense incurred by the home office and
allocated to a branch is recorded by the home office by a debit to
Investment in Branch and credit to an appropriate expense account; the
branch debits an expense account and credits Home Office. Expenses
paid by the home office and allocable to branches may be insurance,
property and other taxes, depreciation, and advertising. Expenses of the
home office may also be allocated to branches especially if the home
office does not make sales and functions only as accounting and control
center. The head office may also charge each branch interest on the
capital invested there in. such expenses would not appear in the
combined income statement as they would be offset against interest
revenue recorded by the home office.
Billings of Merchandise to Branches
Three methods are available to the home office for billing merchandise
shipped to its branches:
 At cost
 At a percentage above cost
 At the retail selling price

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Billing at cost
 The simplest and widely used procedure
 Avoids complications of unrealized gross profits on inventories
 Attributes all gross profit to the branches even if some of the
merchandise may be manufactured by the home office
Billing at a percentage above cost
 Intended to allocate reasonable gross profit to the home office
 Under this method, the net income reported by the branch is
understated and the ending inventories are overstated for the
enterprise as a whole
 Adjustments must be made to eliminate intra company profits in
preparation of combined financial statements
Billing at Retail Selling Prices
 Based on a desire to strengthen internal control over inventories
 The home office record of shipments to a branch, when considered
along with sales reported with the branch, provide a perpetual
inventory stated at selling price
 Any difference with periodic physical count should be investigated
promptly
Illustrative Journal Entries of Operation of a Branch
Assume that S Company bills merchandise to Branch X at cost and the
branch maintains complete accounting records and prepares financial
statements.
Both the branch and home office use the perpetual inventory system.
Equipment used at the branch is carried in home office records.
Expenses such as advertising and insurance are incurred by the home
office and billed to the branch.

3
Summarized transactions of year 1
1. Cash of 1,000 was forwarded to Branch X
2. Merchandise with cost of 60,000 was shipped to Branch X
3. Equipment of 500 acquired by Branch X, to be carried in home
office records
4. Credit sales by Branch X amounted to 80,000; the cost of
merchandise sold was 45,000.
5. Collections of trade accounts receivable pf 62,000 made by Branch
X.
6. Payments for operating expenses by Branch X totaled 20,000
7. Cash of 37,500 remitted to home office by Branch X
8. Operating expenses charged to Branch X by home office totaled
3,000
Solution:
Branch
Home Office Cash 1,000
1. Investment in Br X 1,000 Home Office 1,000
Cash 1,000
Inventories 60,000
2. Investment in Br X 60,000 Home Office 60,000
Inventories 60,000
Home Office 500
3. Equipment: Br X 500 Cash 500
Investment in Br X 500 Trade A/R 80,000
CGS 45,000
4. None Sales 80,000
Inventories 45,000

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5. None
Cash 62,000
Trade A/R 62,000
6. None
Operating Exp 20,000
Cash 20,000
7. Cash 37,500
Inv. In Br X 37,500 Home Office 37,500
Cash 37,500
8. Inv in Br X 3,000
Operating Exp 3,000 Operating Exp 3,000
Cash 3,000

Adjusting and Closing Entries

None
Sales 80,000
CGS 45,000
Op. Exp 23,000
Income Sum 12,000
Investment in Br X 12,000
Income Br X 12,000 Income Summary 12,000
Home Office 12,000
Income Br X 12,000
Income Summary 12,000 None

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Transaction between Branches
Efficient operation may on occasion require that assets be transferred
from one branch to another. A branch does not carry a reciprocal
account with another branch but records the transfer in the Home Office
account.
For example if Branch A transfers merchandise to Branch B, Branch A
debits Home Office and credits Inventories, while Branch B debits
Inventories and credit Home Office. The Home Office records the transfer
by debiting Investment in Branch B and crediting Investment in Branch
A.
The additional freight cost due to the indirect routing does not justify
increase in the carrying amount of inventories. Only freight costs of the
direct shipment from the home office are included in inventory costs.
Illustration: The home office shipped merchandise costing 6,000 to
Branch D and paid freight costs of 400. Subsequently, the home office
instructed Branch D to transfer this merchandise to Branch E. Branch D
paid 300 to carry out this order. The cost of direct shipment from home
office to E would have been 500. The journal entries in the three sets of
records would be:
Home Office
Investment in Branch D 6,400
Inventories 6,000
Cash 400
To record shipment of merchandise and payment of freight costs

Investment in Branch E 6,500

Excess Freight Expense- Interbranch Transfers 200
Investment in Branch D 6,700
To record transfer of merchandise from Branch D to Branch E under
instruction of the home office

Branch D

Freight in 400

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Inventories 6,000
Home Office 6,400
To record receipt of merchandise from home office with freight costs paid
in advance by home office

Home Office 6,700

Inventories 6,000
Freight in 400
Cash 300
To record transfer of merchandise to Branch E under instruction of home
office and payment of freight costs of 300

Branch E

Inventories 6,000
Freight in 500
Home Office 6,500
To record receipt of merchandise from Branch D transferred under
instruction of home office and normal freight billed by home office.

The excessive freight costs from such shipments generally result from
inefficient planning of original shipments and should not be included in
inventories. If branch managers are given authority to order transfer of
merchandise between branches, the excess freight costs should be
recorded as expenses attributable to the branches.

Combined Financial Statements

A balance sheet for distribution to external users the financial position of
the business enterprise as a single entity. A convenient starting point in
the preparation consists of the adjusted trial balances of the home office
and the branches.
The assets and liabilities of the branch are substituted for the
Investment in Branch ledger account included in the home office trial
balance. Similar accounts are combined to produce a single total amount
for cash, trade receivables, and other assets and liabilities of the
enterprise as a whole.

7
Reciprocal accounts are eliminated as they have no significance when the
branch and home office report as a single entity. The balance of the
Home Office account is offset against the balance of the Investment in
Branch account.
The operating results of the enterprise (the home office and the branches)
are shown by an income statement in which the revenue and expenses of
the branch are combined with the revenue and expenses of the home
office. Any intracompany profits or losses are eliminated.

Working Paper for Combined Financial Statements

A working paper for combined financial statements has three purposes:
 To combine ledger account balances like assets and liabilities
 To eliminate any intra company profits or looses
 To eliminate the reciprocal accounts
Illustration: the same data is going to be used. Assuming that all the
year end routine adjustments are made, the working paper is begun with
adjusted trial balances of the home office and Branch X.

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 S CORPORATION
Working Paper for Combined Financial Statements of Home Office and
Branch X
For the Year Ended December 31, Year 1
(Perpetual Inventory System: Billing at Cost)

Adjusted TB Elimination Combined

Home Off Br X
Income statement
Sales (400,000) (80,000) (480,000)
Cost of Goods Sold 235,000 45,000 280,000
Operating expenses 90,000 23,000 113,000
Net income 75,000 12,000 87,000
Total 0 0

Statement of RE
Retained E Jan 1 (70,000) (70,000)
Net income (75,000) (12,000) (87,000)
Dividends 40,000 40,000
Retained E Dec 31 117,000

Balance sheet
Cash 25,000 5,000 30,000
Trade A\R (net) 39,000 18,000 57,000
Inventories 45,000 15,000 60,000
Investment in Br X 26,000 a (26,000)
Equipment 150,000 150,000
Acc Dep. (10,000) (10,000)
Trade A\P (20,000) (20,000)
Home Office (26,000) b 26,000
Common Stock (150,000) (150,000)
Retained earnings (117,000)

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Total 0 0 0 0

In the elimination column, elimination (a) offsets the balance of

Investment in Branch X account against the balance of the Home Office
account. This elimination appears in the working paper only. Combined
financial statements of S Corporation prepared on the basis of the above
working paper are:
S Corporation
Income Statement
For the Year Ended Dec 31, Year 1
Sales 480,000
Cost of goods sold 280,000
Gross profit 200,000
Operating expenses 113,000
Net income 87,000
S Corporation
Statement of Retained Earnings
For the Year Ended Dec 31, Year 1

Retained earnings, beginning of year 70,000

Add: Net income 87,000
Subtotal 157,000
Less: Dividends (40,000)
Retained earnings, end of year 117,000
S Corporation
Balance Sheet
Dec 31, Year 1

Assets
Cash 30,000
Trade A/R (net) 57,000
Inventories 60,000
Equipment 150,000
Less: Accumulated Depreciation 10,000 140,000
Total assets 287,000

Liabilities and Stockholders Equity

Liabilities
Trade A/P 20,000

Stockholders’ equity
Common stock (10 par) 150,000

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 Retained earnings 117,000 267,000
Total liabilities and stockholders’ equity 287,000

Shipping Merchandise to Branches at Price above Cost

As explained earlier, some businesses bill merchandise shipped to
branches at cost plus a markup percentage or retail selling prices.
Because both methods involve similar modification of accounts, a single
example is used to illustrate the key points.
Change one assumption of the former example to: the home office bills
merchandise shipped to branches at 50% above cost. The merchandise
shipment in the previous example is thus billed at 90,000 (60,000+50%
mark up of 30,000) and are recorded as follows:
Home Office
Investment in Br X 90,000
Inventories 60,000
Overvaluation of inv: Br X 30,000
Use of the allowance account enables the home office to maintain record
of unrealized gross profit on shipments.

Branch
Inventories 90,000
Home Office 90,000
The two reciprocal accounts at branch and head office viz. Home Office
and Investment in Branch X accounts will have balances of 56,000
before the accounts are closed and net income or loss entered. This
amount is 30,000 larger than the balance in the previous illustration as
a result of change in billing method.
At the end of the period the branch will report its inventories at billed
prices of 22,500 (15,000*50%). In the records of the home office the
required balance of the Allowance for Overvaluation of Inventories:
Branch X account is 7,500 (22,500-15,000); thus, this account balance

11
must be reduced to 7,500 from the present amount of 30,000 to
represent the excess valuation contained in the ending inventories of the
branch.
Under the present assumption the branch reports a net loss of 10,500.
The adjustment of 22,500 is transferred as credit to Income: Branch X
account, because it represents additional gross profit over that reported
by the branch. Thus the actual net income for Branch X is 12,000, the
same as the previous illustration.
The following journal entries are passed in the home office records.
Income: Branch X 10,500
Investment in Branch X 10,500
To record net loss reported by branch
Allowance for Overvaluation of Inventories: Br X 22,500
Income: Branch X 22,500
To reduce allowance to amount by which ending inventories of branch
exceed cost
Income: Branch X 12,000
Income Summary 12,000
To close branch net income (as adjusted)

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Working Paper when Billing to Branches at Price above Cost

S CORPORATION
Working Paper for Combined Financial Statements of Home Office and
Branch X
For the Year Ended December 31, Year 1
(Perpetual Inventory System: Billing above Cost)

Adjusted TB Elimination Combined

Home Off Br X
Income statement
Sales (400,000) (80,000) (480,000)
Cost of Goods Sold 235,000 67,500 a (22,500) 280,000
Operating expenses 90,000 23,000 113,000
Net income 75,000 (10,500) b 22,500 87,000
Total 0 0
Statement of RE
Retained E Jan 1 (70,000) (70,000)
Net income (75,000) 10,500 b(22,500) (87,000)
Dividends 40,000 40,000
Retained E Dec 31 117,000
Balance sheet
Cash 25,000 5,000 30,000
Trade A\R (net) 39,000 18,000 57,000
Inventories 45,000 22,500 a(7,500) 60,000
Investment in Br X 56,000 c (56,000)
Allowance for over v (30,000) a 30,000
Equipment 150,000 150,000
Acc Dep. (10,000) (10,000)
Trade A\P (20,000) (20,000)
Home Office (56,000) b 56,000
Common Stock (150,000) (150,000)
Retained earnings (117,000)
Total 0 0 0 0

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 a) To reduce ending inventories and cost of goods sold of branch to cost, and
to eliminate balance in Allowance for Overvaluation of Inventories: Branch
X ledger account.
b) To increase net income of branch by portion of merchandise markup that
was realized.
c) To eliminate reciprocal ledger accounts .
Reconciliation of Reciprocal Accounts
In a previous section, the nature of reciprocal accounts and the necessity
for their reconciliation before the combined financial statements are
prepared was described. The situation is comparable to that of
reconciling the ledger account for Cash in Bank with the balance in the
monthly bank statement.
Illustration: Assume the home office and the branch accounting records
contain the following data and the balances of the Home Office account
and Investment in Branch accounts on Dec 31 are 41,500 Cr. and
49,500 Dr. respectively. Comparison of the two reciprocal accounts
discloses four reconciling items.
1. A debit of 8,000 in Investment in Branch account without a related
credit in Home Office account
Merchandise shipped to branch on Dec 29 but not received at year
end. Required journal in branch accounting records:
Inventories in Transit 8,000
Home Office 8,000
To record shipment of merchandise in transit from home office
The inventories in transit must be included in inventories in hand.
2. A credit of 1,000 in the Investment in Branch account without a
related debit in the Home Office account
The home office collected trade accounts receivable of the branch.
The journal entry required in the records of the branch on Dec 31:
Home Office 1,000
Trade A/R 1,000
To record collection of accounts receivable by home office

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 3. A debit of 3,000 in the Home Office ledger account without a
related credit in Investment in Branch account
The branch acquired equipment for 3,000 on Dec 28 and debited
Home Office as equipment used by branch is carried in records of
the home office. The journal entry required in the records of the
home office:
Equipment: Branch 3,000
Investment in Branch 3,000
To record equipment acquired by branch
4. A credit of 2,000 in the Home Office ledger account without a
related debit in the Investment in Branch account
Accounts receivable of the home office was collected on Dec 30 and
recorded as credit to Home Office. Journal entry required in the
records of the home office on Dec 31
Investment in Branch 2,000
Trade A/R 2,000
To record collection of receivable by branch
The effect of the foregoing end of year journal entries is to update the
reciprocal ledger accounts as shown below:
M COMPANY- HOME OFFICE AND A BRANCH
RECONCILIATION OF RECIPROCAL LEDGER ACCOUNTS
DEC 31, 19X9
Investment in Home Office
Branch
Balance before adjustment 49,500 Dr 41,500 Cr
Add: 1. Merchandise shipped 8,000
4. Home office A/R
collected by branch 2,000
Less: 2. Branch A/R
Colleted by H.O. (1,000)
3. Equipment acquired -
By branch (3,000)
Adjusted balances 48,500 48,500

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CHAPTER 2: INSTALLMENT SALES

INTRODUCTION

CREDIT SYSTEM
The introduction of credit, which involves buying and selling without requiring the
immediate payment of cash, has enabled to increase the volume and frequency of
transaction. Neither large volume of sales could have been obtained, nor could large
number of customers have been encouraged to participate in the business activity of the
world today without the extension of credit.

TYPES OF CREDIT
 Through open accounts
 Through promissory notes
 Through installment plan
The first two types of credits will not be discussed here as students would have been
already exposed to them in financial accounting transactions. Thus only third type of
credit will be dealt in the ensuing pages.

INSTALLMENT PLAN
Installment plan is a sale, which involves a down payment of a certain amount of money
from the agreed upon sale price, and then followed by series of payments spread over a
given period of time.

The purpose of installment sales plan is to afford sales of large scale operations, and
purchase of big and expensive items. For example, in today’s world, heavy agricultural
equipment like combined harvester, could not have been available at the disposal of
farmers, neither could computers be available at large to many individuals. Thus
installment sales enables individual to reach many customers through monthly payments,
and small income customers to have access to high priced, durable and desirable goods,
thereby achieving large volume of sales and production output.

Without installment scheme, it would even been difficult for many with middle class
income to buy durable goods such as radios-cassette sets, T.V. and cars.

In the industrialized world such installment sales have led to such slogans as “fly now
and pay later, or buy now and pay later”, and “Dollar down Dollar a month purchase”.
However, such schemes have not been without disadvantages and problems as they lead
to many abuses and risks too. The risk of default and the indulgence in credit beyond
ones means which leaves individuals at the mercy of so called “loan sharks” and court
litigation are some of the non-salutary social effects of it.

Under installment plan the consumer can buy the goods with an initial payment of the
portion of the sales price, and pay the balance usually with additional service charge. The
interest charged on the balance due depends on the number of installments involved and
the amount paid per installment.

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FOR AND AGAINST INSTALLMENT CREDIT

FOR:
Installment credit enables many customers to purchase goods which otherwise would
have been out of their reach. Installment plan increases trade and permits better standard
of living. People buying on installment plan will be induced to save. Thus overall it will
have impact on the national economy by increasing sales and production.

AGAINST:
The main argument is that the customer pays higher price than he would if he paid cash.
He also faces the risk of losing the goods he purchased and the amounts paid in case of
default. Other disadvantage is that installment sales arrangement encourages people to
easily indulge into credit, and live beyond their means.

CHARACTERISTICS OF INSTALLMENT SALES

Installment sales is characterized by a series of payments over a given period and usually
requires a down payment; provision of interest on unpaid balance and additional carrying
charges to listed price; provision of protection to the seller against risk of non-collection
from a customer-through security agreement which enables the seller to repossess the
merchandise sold; and the seller’s right to protection of security interest of uncollected
balance on the sales contract.

In installment plan ownership title does not immediately pass in many cases. The seller
tries to protect himself against non-collection of payments by various sales contract
agreements.

TRUST DEED AGREEMENT

Under this agreement title of ownership to the sold item passes to a trustee until full
payment is effected (or until the last installment is paid).

CONDITIONAL SALE
Under this agreement title of ownership does not pass to the buyer until he/she pays the
last installment.

MORTGAGE AGREEMENT
Under this agreement title passes to buyer since the buyer provides fixed property as lien
or mortgage for the unpaid property.

LEASE-OPTION PLAN
Under this plan, the title is retained by the seller, and the purchaser considers the
purchase as a rented item for certain period of time, at the end of which an option is given
to the buyer to purchase the item rented by settling the remaining balance in full. In this
case, the series of payments (rents) are considered as installment payments, while the
remaining amounts are considered as a down-payment for the purchase of the item.

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To minimize loss of non-payment of installment contracts receivable, the seller tries to
require:
- Sufficient down-payment to cover loss in value on repossession such as damage
from wear and tear and physical use;
- Periodic payments which is large enough to cover decline in value of article,
- Payment schedule that is spaced short in-between periods,
- Consideration for collection expenses and load factor for time value of money,
and waiting for collection, i.e., interest changes.

METHOD OF RECOGNITION OF PROFIT ON INSTALLMENT SALES

There are three approaches to accounting for installment sales:
i. Recognition gross profit at time of the installment sale
ii. Cost of recovery method recognizing gross profit from installment sales
iii. Installment method of recognition of gross profit from installments sales.

RECOGNITION OF INCOME AND GROSS PROFIT AT THE TIME OF SALE

This method treats installment sales as regular credit sales. Assume that merchandise is
passed over to the customer, receivables have been established, and the excess of contract
receivable over cost of merchandise is considered as a realized gross profit. The journal
entry will be:
Installment Contracts Receivable xxx
Installment Sales xxx

If a perpetual inventory system was maintained, there will be additional entry:

Cost of Merchandise Sold xxx

Merchandise Inventory xxx
The differences between the installment sales and cost of installment sales would be
considered as the realized gross profit. However, such treatment fails to take into
consideration the very characteristic of installment sales, that is, the fact that title is not
transferred and that sales is not completed. This method recognizes profit before it is
earned, and when default arises expenses are not matched to revenue.

COST OF RECOVERY METHOD

Under this method, no profit is recognized until all costs are recovered. When all costs
have been recovered and additional collection on installment receivables are then
recognized to be revenues. Thus all amounts received are first applied to recovery of cost
in full, only thereafter are receipts on installment recognized as revenue.

RECOGNITION OF GROSS PROFIT ON INSTALLMENT METHOD

This method tries to measure income and recognize gross profit on installment sales in
installments over the term of the contract on the basis of cash collection. Gross profit on
installment is then realized as cash is collected on receivables. Each cash collection is
regarded as including both return of cost and realization of profit in the ratio in which
costs and gross profit elements are contained in the selling price.

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Example:
Assume a tractor (combined harvester) is sold by Ethno Co., for Birr 20,000, and its
factory cost was Birr 15,000. The excess of the sales price over costs which is Birr 5,000
is considered as Deferred Gross profit. In this case the sales price is composed of 75%
cost and 25% gross profit. Thus, the ratio of 75:25 is applied to each cash collection from
the installment contract receivable to recover cost and realize gross profit for the period.
If in our example Birr 2,000 were received as down-payment for the first period, then
Birr 500 or (25% of 2,000) of the deferred gross profit will be realized and taken into the
income of the current period. At the end of each accounting period, the Deferred Gross
profit account will contain 25% of the installment receivables that remain uncollected,
while the Realized Gross profit amount will show during each period an amount equal to
25% of cash collected during that period.

The Accounting Entry will thus be as follows:

Installment contracts Receivable 20,000
Tractor (Combined Harvester) 15,000
Deferred Gross Profit 5,000

To record sales of the tractor costing 15,000 Birr and to defer the gross profit of 25% of
the total price of 20,000 Birr.

Cash 2,000
Installment contract Receivable 2,000
To record receipt of cash of 2,000 Birr as a down-payment

Deferred Gross profit 500

Realized gross profit 500
To record realized gross profit of 25% on the 2,000 Birr down-payment.

If there were interest and carrying charges included in the installment payments, entries
will also be made separately to accrue and record collections of interests. If on the other
hand the installment plan involved a loss, then the entire loss should be recognized in the
year of sale.

SALES OF MERCHANDISE ON INSTALLMENT PLAN

In the previous example we dealt with a single sale of equipment (property) which does
not involve large amounts of merchandise and their accounting for merchandise
inventory. However, if it was a retailing enterprise with large volume of merchandise
inventory which uses installment method of accountancy there are several points that
must be noted and considered carefully in the accounting process.

i. Sales on installment plan must be distinguished from ordinary regular sales.

ii. Installment receivables are kept on contracts receivable bases, thus we need to
compute the average gross profit on all installment sales during the year. We
have on gross profit percentage applicable to all the contract receivable during
the fiscal year, and not several gross profits for individual installment sales.

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 iii. The average gross profit percentage of the period is to be applied to all cash
collections received on installment contracts net of interests and carrying
charges.
iv. We must note whether inventories are kept on perpetual inventory system. In
the perpetual inventory system the entries for sale of merchandise will be
debit to costs of sales and credit to merchandise inventory account.
Illustration 1
Assume the following information concerning ETHOF’s sales on installment during the
period of 2000:
 Installment Contracts Receivable from sales made during 1998 is 30,000 Birr
 Installment Contracts Receivable from sales made during 1999 is 95,000 Birr
 Installment Contracts Receivable from sales made during 2000 is 100,000 Birr
 Deferred interest and carrying charges on installment sales is 15% of the
installment price
 Gross profit rate on the installment sales made during 1998is 22%
 Gross profit rate on the installment sales made during 1999 is 25%
 Gross profit rate on the installment sales made during 2000 is 28%
The cash collections on installment contracts during 2000 are summarized below:

Total Cash Interest and

Collected Selling Price Carrying Charges
Installment Contracts 80,000 70,000 10,000
Receivable 2000
Installment contracts 47,000 34,000 13,000
Receivable 1999
Installment contracts 17,550 16,000 1,550
Receivable 1998
144,550 120,000 24,550

Entries to record the installment sales for the year 2000 and cash collections will be as
follows. Assume proper entries have been made for transactions that occurred during
1998 and 1999 and the accounts represent correct balance.

Installment Contracts Receivable 100,000

Installment Sales 86,957
Deferred interest and carrying charges on installment sales 13,043
 To record installment sales of the year 2000 and 15% interest and carrying charges
Cost of Installment sales 62,609
Inventory 62,609
 To record cost of installment sales separate from regular sales, assuming perpetual
inventory system.
Installment Sales 86,957
Cost of Installment sales 62,609
Deferred Gross profit 24,348
 To establish deferred gross profit on installment sales of 28% of the sales price of
86,957 Birr

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 Cash 144,550
Installment contracts receivable 2000 80,000
Installment contracts receivable 1999 47,000
Installment contracts receivable 1998 17,550
 To record cash collection in from installment sales contracts of 2000, 1999, and 1998.

Deferred gross profit 2000 installment sales 19,600

Deferred gross profit 1999 installment sales 8,500
Deferred gross profit 1998 installment sales 3,520
Realized gross profit 31,620
 To record realized gross profit computed as follows:

From 2000’s installment collection (70,000 x 28% = 19,600) plus

From 1999’s installment collection (34,000 x 25% = 8,500) plus
From 1998’s installment collection (16,000 x 22% = 3,520)

Deferred Interest and Carrying Charges 24,550

Revenue from interest and Carrying Charges 24,550
 To record interest and carrying charges earned in 2000 computed as follows:

On 2000’s installment contract receivable 10,000

On 1999’s installment contract receivable 13,000
On 1998’s installment contract receivable 1,550
Total 24,550

Illustration 2
Let us assume that in September 2000 ETHOF sold merchandise costing Birr 300,000 on
installment plan for Birr 550,000 including 50,000 interest and carrying charges. Assume
further that ETHOF received Birr 110,000 as a down-payment of which Birr 10,000 is for
interest on carrying charges and the company entered into contract with the customer for
the unpaid balance to be paid in four equal installments. In November 2001, ETHOF
received the first installment from its customer. Entries to record the above transaction
will be as follows:

September 2000: When the installment sales was made with the down-payment of
110,000 Birr.
Installment Contracts Receivables 550,000
Installment Sales 500,000
Deferred & Carrying changes 50,000
 To record installment sales and deferred interests and carrying charges on the
installment sales

Cost Installment Sales 300,000

Merchandise inventories 300,000
 To record cost of installment sales if the perpetual inventory system is under use.

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 Installment Sales 500,000
Cost of Installment Sales 300,000
Deferred Gross profit 200,000
 To establish deferred gross profit as 40% of installment sales price of 500,000 Birr

Cash 110,000
Installment contracts receivable 110,000
 To record down-payment on sales
Deferred Gross profit 40,000
Realized Gross profit 40,000
 To record realized gross profit of 40% of the cash collection from the down-payment
of 100,000 Birr.
Deferred Interest and Carrying charges 10,000
Revenue from Interest and Carrying charges 10,000
 To record interest and carrying charges earned during the year as a result of cash
collection.
November 2001: When the first installment was collected, the following journal entries
would be made.
Cash 110,000
Installment Contracts 110,000
 To record cash collected from the first installment.

Deferred gross profit 40,000

Realized gross profit 40,000
 To record realized gross profit of 40% of 100,000 Birr collected as the first
installment.

Deferred Interest and Carrying charges 10,000

Revenue from Interest and Carrying Charges 10,000
 To record interest and carrying charges earned as on the date of the collection of the
first installment.
DEFAULT AND REPOSSESSION OF ASSETS SOLD
Assume that a customer who purchased merchandise in 1998 was unable to pay the
balance of a contract receivable of Birr 1,380 of which 180 was interest and carrying
charges, and 1,200 Birr is sales price. The deferred gross profit on this defaulted contract
receivable is Birr 264.00 (1,200X22%), and the fair value of the repossessed merchandise
is found to be Birr 750. The entry to record the repossession of merchandise and
cancellation of the receivable and related deferred gross profits would be as follow:

Inventory Repossessed 750

Deferred gross profit 1998 264
Deferred interest and carrying Changes 180
Loss on repossession of doubtful expense accounts 186
Installment contracts receivable 1998 1,380
To record the repossessed merchandise at its fair market value and revoke related
deferred gross profit.

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VALUE OF REPOSSESSED ITEMS COULD BE ESTABLISHED AT:
a) Book value of un-cleared indebtedness (that is uncollected balance
of installment accounts receivables reduced by the amount of
deferred gross profit related thereto)

b) Zero value- no value being recognized for the repossessed item- rather
a loss is recognized for the amount of book value of indebtedness.
When the item is sold later the entire sale proceed is considered as
periodic revenue.

c) Fair market value of the item on the date of repossession. This is

considered to be the most appropriate. Used goods replacement cost
value is used for inventory valuation.
The bases for differences in view between doubtful expense accounts and loss on
repossession can be easily recognized in the above cases.

For example, assume an item sold for Birr 1,500 is defaulted, and the gross profit on the
sale was 20%. The following journal entries are made under the above three methods of
establishing value for the repossessed items:

a) Book Value: As indicated earlier the book value is the excess of the installment
contract receivable over the unrealized (deferred) gross profit. The journal entry at the
time of repossession is:

Inventory repossessed 1,200

Deferred Gross profit 300
Installment Contracts receivable 1,500

If later on, the repossessed item is sold for 700 Birr, the journal entry to record the
repossession is:
Cash 700
Loss 500
Inventory repossessed 1,200

b) Zero Book Value: As explained earlier, under this method the repossessed inventory
is not recorded at all. Hence the book value of the contract receivable treated as a loss on
repossession. The journal entry made at the time of the repossession is:

Loss on default (on repossession) 1,200

Deferred Gross Profit 300
Installment Contracts Receivable 1,500
When the repossessed item is sold for Birr 700 later on, the total collection is recorded as
other income.

Cash 700
Other income 700

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C) Fair Market value: Under this method, the repossessed item is recorded at its current
fair value which is the replacement cost of the asset repossessed. If the repossessed item
has the current fair value of 700 Birr for instance, the following journal entry will be
made.

Inventory Repossessed 700

Deferred Gross Profit 500
Loss on Repossession 300
Installment Contracts Receivable 1,500
If the repossessed item is sold for 900 birr some time after repossession, the following
journal entry will be made.

Cash. 900
Inventory Repossessed 700
Gain on sale of Repossessed item 200

ACCEPTANCE OF USED ASSET AS DOWN-PAYMENT

When sales on installment plan involves the acceptance of a used asset in partial payment
of the new asset, special accounting issues arise because (i) the dealer may give an over
allowance on the used asset accepted as a down-payment. The over allowance is the
excess of the trade-in allowance over the current fair value of the used item, after
considering its potentiality for fetching a price which will recover all direct costs and a
normal gross profit; (ii) Over allowance on trade-in represents a reduction in stated
selling price of the new asset. It is this net selling price, which gives the gross profit on
the sale of the new item. Therefore, in accounting for installment sales, which include
trade-in, the accountant (a) must compute the over allowance and (b) determine the gross
profit based on the net selling price- stated selling price of the new item less the over
allowance, (c) determine the deferred as well as the realized gross profit (gross profit is
realized to the extent of the current fair value of the accepted used asset. The current fair
value of the merchandise accepted as a trade-in is considered as equivalent to cash
collection.

Illustration
Assume a refrigerator costing Birr 650 is being sold at Birr 1,000 and a used one is
accepted with a trade-in allowance of Birr 300. The re-sale value of the old refrigerator
after reconditioning it with a cost of Birr 300 is estimated to be Birr.250. The expected
gross profit from the sale of the old refrigerator is 20%. The current fair value of the item
traded-in would thus be computed as follows:

Trade-in allowance given to the old 300

Current fair value of trade in:
Estimated re-sale value 250
Less Reconditioning Cost 30
Expected gross profit 20%x 250 50 80
Current fair value of article Traded-in 170
Over-allowance 130

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Accordingly the price of the new refrigerator would be Birr 870 or 1,000 Birr less the 130
Birr over allowance given on the trade-in. The value of the item traded-in is taken for
inventory at Birr 170, and the gross profit percentage on the sale of this new item with a
trade-in is 220, which is 870 less 650 or 25.2% in terms of percentage.

The journal entry would thus be follows:

Inventory (Trade-in) 170

Over allowance over Trade-in 130
Installment Contract Receivable 700
Installment Sales 1,000
To record installment contract receivable and related trade-in, and over allowance as
computed, (see above).

Cost of Installment Sales 650

Inventory new 650
To record cost of the installment sales

Installment Sales 1,000

Cost of Installment Sales 650
Over allowance over 130
Deferred Gross Profit 220
To record deferred gross profit

The above entries could be combined as follows:

Inventory (Trade-in) 170

Installment Contract Receivable (1,000 –300) 700
Installment sale (1,000- 130) 870
To record sale of merchandise for 870 consisting of sales price of 1,000 les 130 over
allowance on traded-in

Cost of Installment 650

Inventory 650
To establish cost of installment sales

Installment sales 870

Cost of Installment sales 650
Deferred Gross profit 220
To record deferred gross profit on the installment sales

Deferred Gross profit 42.84

Realized Gross Profit 42.84
To record realized gross profit on current fair value of trade-in of 170, as 25.2% gross
profits.

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FINANCIAL STATEMENT PRESENTATION OF ACCOUNTS ON
INSTALLMENT SALES

Income Statements
There are two alternative proposals concerning the presentation of accounts on
installment sales in the income statement.

1. Report separately all details of installment sales, cost of installment sales,

deferred gross profit, and realized gross profits and realized gross profits and
related expense and revenues from interests and carrying charges in a supporting
schedule. The final net figure of the realized profits on installment sales is
included into the income statement together with regular sales operations.
2. Show both details of regular sales and installment sales together in one income
statement containing columns for installments sales, regular sales, and combined
totals.

3.
INSTALLMENT REGULAR
Sales Sales Combined
Sales xxx xxx xxx
Cost of goods sold xxx xxx xxx
Gross Profits
Less deferred Gross profits on xxx xxx
Installment Sales
Realized Gross profit xxx xxx xxx

Balance Sheet
Installment contract receivables and deferred interest and carrying charges are classified
as current assets. The treatment of deferred gross profits, however, is based on different
approaches each with arguments for and against.

1. Deferred credit or (deferred revenue) at the end of a liability section or present

separately by itself between liability and proprietorship section. Argument against
this is that there is no specific evidence giving rise to liability.

2. Deductions from installment contracts receivables or asset valuation account.

The main point of this argument is to use it as a way of hedging against the overvaluation
of the contracts receivable accounts in case of uncollectibility. If so, however, valuation
should not be established only through the amount of the gross profit.

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CONSIGNMENTS

MEANING AND RELATED TERMS

Consignment means transfer of merchandise from owner to another person who acts as
a sales agent. Consignor is the owner of the goods with who the title of ownership to the
goods remain. He/she is the transferor. Consignee is the sales agent who has physical
possession of the goods, but has no title of ownership on them. He/she is, most of the
time, referred to as commission agent. Consignment-out is a term used by the consignor
referred to goods or merchandise shipment on consignment. Consignment in is a term
used by consignee referring to goods or merchandise shipment on consignment.

AGENCY AND PRINCIPAL

Relationship between consignor and consignee is governed by agency law, which
determines the contractual obligations and rights and duties of each. This is because of
the fact that the consignee is the agent for the consignor who is the principal.

RIGHTS AND DUTIES OF THE CONSIGNEE

There should be a formal written contract between consignor and consignee concerning
the rights, and duties of the consignee. Usually the following general rights and duties of
the consignee are recognized.

RIGHTS OF CONSIGNEE
- To receive compensation for merchandise sold on behalf of the consignor.

- To receive re-imbursements for expenses incurred in connection which the

consignment.

- To sell consigned merchandise on credit, unless the consignor specifically

prohibits him/her.

- To make usual warrants as to the quality of the consigned merchandise and

obligate the consignor to such warrants.

THE DUTIES OF THE CONSIGNEE

- To give reasonable care and protection to the consigned merchandise.

- To maintain the consignee marchioness separate from other inventories, and be

able to identify and segregate consignment receivables from other receivables.

- To exercise care in extending credit on sale of consigned goods, and be diligent

on setting up selling prices, and collecting consignment receivables.

- To render complete reports intermittently on sales of consigned goods and make

appropriate and timely payments to consignor.

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DISTINGUISHING A CONSIGNMENT FROM A SALE
In consignment, title does not pass when merchandise is shipped to consignee. The goods
are carried on the consignor’s books and included in his inventory even thought the goods
are physically in the possession of the consignee. The consignor has also right to
repossess any unsold consigned good. The consignee does not have title to these goods
and is not a creditor either, and if the goods are unsold he is obliged to return them.

The advantage of consigning goods to the consigned instead of making outright sales, is
that the consigner is easily able to convince dealers to handle his products without
purchase especially if products are new. It also permits the consignor to have a sales
outlet without trying to do is own marketing.

For the consignee the acquisition of merchandise on consignment permits him to have
goods for sale without purchase and saves him capital investment. If the goods are unsold
the consignee does not have to bear risk of loss from non-salability of merchandise, as the
unsold goods will be returned to the consignor.

ACCOUNT SALES REPORT

The consignee intermittently is required to render repost to the consignor which accounts
for the merchandise sold, expenses incurred and money owed to him and remittances
made or to be made by him. Following is a sample format of a consignor’s report.

Illustrative example 1:
Assume that the Toshiba Co. shipped 100 radio cassette-sets on consignment to ETHOF
to be sold at 300 Birr each. The consignee [ETHOF] is to receive reimbursements for
freight costs of Birr 1,300 and commission or 25% of the authorized sales price. Having
sold all the goods, the consignee sent the following sales report together with a bank draft
for the amounts due.

ETHOF- Addis Ababa

Account Sales
Date: September 30, 2004

Account Sales Report for

Toshiba
New Delhi, India

Sales: 100 Radio Cassette Sets @ Birr 300 Birr 30,000.00

Freight cost 1,300.00

Commission 25% of 30,000 7,500.00
Bank service charges 230.00 (9,030.00)
Balance [Amount to be remitted] 20,970

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ACCOUNTING METHOD FOR CONSIGNEE
Accounting method for consignee will depend on whether the consignee wants to
determine profits from consignment sales separately or not.

The following is the illustrative example to the accounting me followed by the consignee
if s/he wants to determine profit from the installment sales separately.
Considering the previous example for ETHOF and Toshiba, the following journal entries
can be made on the book of the consignee.

Transaction Entries
Receipts of goods by consignee (ETHOF) Only memorandum entry is made
“Received 100 radio-cassette sets for sale
at Birr 300 each at 25% sales commission”
Payment of Freight charges by consignee Consignment In-Toshiba 1,300
(ETHOF) on behave of TOSHIBA Cash 1,300
Sales of 100 Radio Cassette at Birr 300 Cash 30,000
each Consignment In-Toshiba 30,000
Payment of Bank charges Consignment In-Toshiba 230
Cash 230
Commission Revenue Consignment In-Toshiba 7,500
Commission income 7,500
Remittance to consignor Consignment In-Toshiba 21,970
Cash 21,970
Example 2:
Sherri Company shipped on consignment contract to Robert Company 10 TVs that cost
25,000 dollars. The selling prices were set at 4,000 dollars each. The cost of packing was
300 dollars, and all costs incurred in packing were debited by Sherri Company to the
packing expense account. Freight cost of 1,350 dollars by an independent truck line to
deliver the items to Robert was paid by the consignee. All the 10 TVs were sold by the
consignee @ authorized selling price. The commission expense is amounted 20 % of
sales.
Required: 1. How much is the amount of draft check balance sent.
2. Present all the necessary journal entries on the book of the consignor to
record all the foregoing transactions.
Solution:
1. Draft check balance
Accounts sales report
Sales 10 x 4,000 $40,000
(-) freight cost 1,350
Commission 8,000 (9,350)
Draft check balance $30,650

2. Entry on the book of the consignor

A. To record the transfer of inventory to the consignee
Consignment out - Robert 25,000
Inventories 25,000

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 B. To allocate the packing expense of $ 300 to the consigned merchandise which was
already recorded as a debit to the packing expense
Consignment out - Robert 300
Cash 300
C. To record the consignment sales of 40,000 dollars reported by Robert company & the
receipt of cash balance of 30,650 dollars after the deduction of the freight charges &
sales commission from the proceed

Cash 30,650
Commission expense 8,000
Consignment out – Robert 1,350
Consignment sales 40,000
D. To record cost of consignment sales
i.e. Cost of consignment sales = 25,000 + 300 + 1,350 = $ 26,650
Cost of consignment sales 26,650
Consignment out- Robert 26,650
E. Income statement
Consignment sales 40,000
(-) Cost of consignment sales (26,650)
Gross profit 13,350
(-) Operating expense
Commission exp. (8,000)
Operating income 5,350
ACCOUNTING FOR PARTIAL SALES OF MERCHANDISES
Let us now change our conditions by assuming that Robert, the consignee, sold only four
of the ten TVs consigned by Sherri Company during the accounting period.
Required: A. Show the sales account report prepared by the consignee at the end of the
accounting period.
B. Record all the necessary journal entries on the books of the consignor.
C. Prepare partial financial statement of balance sheet & income statement.
Solution:
Robert Company [Consignee]
Sales Account Report
For Sherri Company

Sales: 4 TVs @4,000dollars 16,000

Charges:
Freight costs 1,350
Commission expense 3,200 4550
Total payable to the Consignor 11,450

The following journal entries are made to record the partial sales by the consignee on the
book of the consignor are:
1. To record the shipment of merchandise to the consignee
Consignment out 25,000
Inventories 25,000

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2. To allocate the packing expense of 300 dollars to the consigned merchandise which
was already recorded as a debit to the packing expense
Consignment out 300
Cash 300
3. To record the consignment sales & the receipt of cash & the deduction of the freight &
commission charges from the sales proceeds is:
Cash 11,450
Commission exp. 3,200
Consignment out – Robert 1,350
Consignment sale 16,000
4. To record the cost of the consignment sales
Cost of consignment sales 10,660
Consignment out- Robert 10,660
i.e. Cost of consignment sales for 10 items= 26,650 for 4 items= 26,650 x 4 = 10,660
10
C. Balance sheet
Asset
Cash xx
A/R xx
Merchandise inventory xx
Consignment out 15,990 .i.e. 26,650-10,660
Income statement
Sales 16,000
(-) Cost of consignment out (10,660)
GP 5,350
(-) Commission exp. (3,200)
Operating income 2,140

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