How to Account for a Consignment
Consignment occurs when goods are sent by their owner (the consignor) to an agent (the consignee), who undertakes to sell the goods. The consignor continues to own the goods until they are sold, so the goods appear as inventory in the accounting records of the consignor, not the consignee.
Consignment Accounting - Initial Transfer of Goods
When the consignor sends goods to the consignee, there is no need to create an accounting entry related to the physical movement of goods. It is usually sufficient to record the change in location within the inventory record keeping system of the consignor. In addition, the consignor should consider the following maintenance activities:
Periodically send a statement to the consignee, stating the inventory that should be on the consignee's premises. The consignee can use this statement to conduct a periodic reconciliation of the actual amount on hand to the consignor's records.
Request from the consignee a statement of on-hand inventory at the end of each accounting period when the consignor is conducting a physical inventory count. The consignor incorporates this information into its inventory records to arrive at a fully valued ending inventory balance.
It may also be useful to occasionally conduct an audit of the inventory reported by the consignee.
From the consignee's perspective, there is no need to record the consigned inventory, since it is owned by the consignor. It may be useful to keep a separate record of all consigned inventory, for reconciliation and insurance purposes.
Consignment Accounting - Sale of Goods by Consignee
When the consignee eventually sells the consigned goods, it pays the consignor a prearranged sale amount. The consignor records this prearranged amount with a debit to cash and a credit to sales. It also purges the related amount of inventory from its records with a debit to cost of goods sold and a credit to inventory. A profit or loss on the sale transaction will arise from these two entries.
Depending upon the arrangement with the consignee, the consignor may pay a commission to the consignee for making the sale. If so, this is a debit to commission expense and a credit to accounts payable.
From the consignee's perspective, a sale transaction triggers a payment to the consignor for the consigned goods that were sold. There will also be a sale transaction to record the sale of goods to the third party, which is a debit to cash or accounts receivable and a credit to sales.
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Inventories are typically classified as current assets on the balance sheet. Managerial accounting courses cover the specifics of accounting for manufactured inventory. This book will focus on the general principles of inventory accounting that are applicable to most enterprises.
Goods to Include
Recall from the merchandising chapter the discussion of freight charges. In that chapter, F.O.B. terms were introduced, and the focus was on which party would bear the cost of freight. But, F.O.B. terms also determine when goods are (or are not) included in inventory. Technically, goods in transit belong to the party holding legal ownership. Ownership depends on the F.O.B. terms. Goods sold F.O.B. destination do not belong to the purchaser until they arrive at their final destination. Goods sold F.O.B. shipping point become property of the purchaser once shipped by the seller. Therefore, when determining the amount of inventory owned at year end, goods in transit must be considered in light of the F.O.B. terms. In the case of F.O.B. shipping point, for instance, a buyer would need to include as inventory the goods that are being transported but not yet received. In the diagram, the buyer or seller shown in green would “inventory” the goods in transit.Another inventory-related problem area pertains to goods on consignment. Consigned goods describe products that are in the physical custody of one party, but actually belong to another party. Thus, the party holding physical possession is not the legal owner. The person with physical possession is known as the consignee. The consignee is responsible for taking care of the goods and trying to sell them to an end customer.The consignor is the party holding legal ownership/title to the consigned goods. Consigned goods should be included in the inventory of the consignor.
Consignments arise when the owner desires to place inventory in the hands of a sales agent, but the sales agent does not want to pay for those goods unless resold to an end customer. For example, auto parts manufacturers produce many types of parts that are very specialized and expensive. A retail auto parts store may not be able to afford to stock every variety. In addition, there is the real risk of ending up with numerous obsolete units. But, the manufacturer desperately needs these units in the retail channel. As a result, the parts manufacturer may consign their inventory to auto parts retailers.
Conceptually, it is fairly simple to understand the accounting for consigned goods. Practically, there is a significant record keeping challenge. When examining a company’s inventory on hand, special care must be taken to identify both goods consigned out to others (which are to be included in inventory) and goods consigned in (which are not to be included in inventory). When the consignee sells consigned goods to an end user, the consignee would keep a portion of the sales price, and remit the balance to the consignor. All of this activity requires an accounting system capable of identifying consigned units, tracking their movement, and knowing when they are actually sold.
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How is significant amount of consignment inventory reported?
How is a significant amount of consignment inventory reported in the balance sheet? The inventory is reported separately on the consignor's balance sheet.
How do you record consignment inventory in accounting?
The only accounting treatment for consignment inventory occurs when the consignee sells the goods. In that case, the consignor can record the stock as sold. That is because the risks and rewards associated with the inventory get transferred to the customer. Therefore, the consignor can record the sale in its books.
At what value should inventory appear in a statement of financial position?
Generally, the financial statements of a U.S. company must report its inventory at its historical cost (not at its selling prices). Inventories are to be reported at less than the historical cost if the net realizable value of the inventories is lower than the cost.
Do you count inventory on consignment?
Consignment goods are stored in the warehouse of the retailer, but ownership of these goods is retained by the consignor. The responsibility for maintaining and selling them falls on the consignee. The consignor also counts these goods in their physical counts of inventory.