Accounting for Consignment Inventory
Consignment inventory is the way that consignor allows the consignee to sell the inventory without paying for it. The consignee will require to pay the consignor only when the goods are sold. The goods belong to the consignor who will take full ownership and responsibility for any damage.
Consignee: is the party who sells products (usually the retailer) on behalf of the consignor.
Consignor: is the party who owns the products (usually the vendor or wholesale) but allows the consignee to sell on behalf of them.
Consignment Inventory Example
For example, Mr. A is a new author who just releases some books into the market. It is very hard for him to sell the books to the bookstore as the seller may doubt the sales performance of the books. They require to invest some capital on the book which may not be sold, so they may invest in other books which highly likely to be sold in a short time.
In order to solve this problem, Mr. A allows the seller to keep put the books on their shelve without paying until they are sold.
Consignment Inventory Journal Entries
The journal entries for consignment inventory is different from normal sale and purchase. It follows the principal and agent relationship. The consignor allows the consignee to collect the revenue on their behalf. The consignor still owns the inventory and takes full responsibility for any risk of unsold or obsolete stock.
1. Inventory Transfer to Consignee
Consignor: need to separate the amount from a normal inventory which enables them to control the balance.
- Dr. Consignment Inventory
- Cr. Inventory
Consignee: The inventories’ ownership does not transfer to the consignee, so there no recording when the product send to the retailer. Any expenses incurred during the transfer paid by the consignor will not record too.
Note: Even we do not record any transaction into the financial statement, an accountant must maintain the proper listing which enables us to reconcile with the actual balance. In real practice, some companies may record into the consignment inventory and suspend accounts in order to control them. Both accounts will be eliminated from the financial statement at month-end. In this example, we will simplify by express only the accounting treatment.
2. Consignee sells the inventory
Consignee: need to record cash/accounts receivable with the accounts payable to the consignor. Moreover, the consignee also needs to record the commission income which depends on the term and condition.
- Dr. Cash/AR
- Cr. Consignor’s Account (Liability)
- Dr. Consignor’s Account
- Cr. Commission Income
Consignor: Do not record any transaction as they do not have any information. They have to wait till the month-end which the consignee will send the selling report and cash.
3. Consignee pay the consignor
Consignee: need to record cash vs accounts payable which are record in step 2.
- Dr. Consignor’s Account
- Cr. Cash
Consignor: first, they need to record sale revenue vs Cash receipt from consignee plus other expenses if any.
- Dr. Cash
- Dr. Commission Expenses
- Dr. Other Expenses
- Cr. Sale Revenue
Second, they need to record COGS and Consignment Inventory
- Dr. Cost of Goods Sold
- Cr. Consignment Inventory
Consignment Inventory Example
For example, Company A (consignor) has made an agreement with Company B (consignee). On 01 January 2020, Consignor has transferred an inventory of 10,000 units to the consignee, they cost $10 per unit and the selling price is $ 15 per unit. Company A agrees to pay the sale commission 10% on the sale made.
- During Transportation, Company A has paid $ 3,000 for the shipping
- During January, Company B has sold 1,000 units
- On 02 February, Company B has paid $ 13,500 (1,000 units * $ 15 * 90%) to Company A for the product sold.
Please prepare journal entries for both companies.
|01 January 2020|
|To separate the consignment inventory
To record shipping cost
|Do not record any transaction.|
|During January, Sell of inventory|
|Do not record any transaction||To recognize cash and liability to the consignor
To recognize commission income
|On 02 February 2020|
|To recognize revenue and cash
To recognize COGS
To recognize shipping cost
($ 300 = $ 3,000 * 1,000units/10,000units)
|To clear liability to the consignor
|Advantages of Consignment Inventory|
|It helps the new product to gain new market share. As the products are available on the shelve, they are highly likely to be seen and purchased by the customer.||It helps the retailer from investing in the new products which are not certain about the sale. They can allow the new products to sit on the shelve for sometime before making any deals with the vendor.|
|The vendor can get the products faster to customers. The products do not need to move from factory to warehouse and to the retailer. The vendor can negotiate and bring the product directly to the retailer.||To lower the risk: there is almost no risk for the retailer as they do not spend on inventory. If the products are not sold, the vendor will take them back.|
|They also are able to save some costs on marketing and advertising as the products already arrive in some popular stores already.||Improve cash flow: the retailer can manage the cash effectively as they will be invested somewhere else.|
|Disadvantages of Consignment Inventory|
|High inventory balance: the vendor will face with high inventory balance even they are already ship to the store.||Difficult to control: It is hard to control as the staff may not aware of the consigned products. It is even harder during the inventory count as we have to separate between normal stock and consigned stock.|
|Cash flow problem: the vendor will require more cash to invest in the company as there are delays in cash generating from the sale.||Additional work: it requires to have someone keep a record and reconcile between remaining inventory and sale.|
|Less profit: By selling products through retailers, we have to pay them the commission, so it will decrease our profit. We will be able to get a higher profit if we sell directly to end-users.||High holding cost: We need to pay for a huge holding cost if a large number of inventories are unsold.|