What is a Consignment Inventory?
Consignment inventory refers to an inventory arrangement that results from an agreement. This agreement mostly specifies that one party must hold inventory for another party for a specific purpose.
In this regard, the main objective of the holder is to sell the inventory on the behalf of the initial owner of the inventory.
The owner will receive the stock back if the inventory is left unsold. The holder of the inventory (the reseller) mostly does not undertake any responsibility for the damage that might be incurred to the inventory during the stock arrangement.
Parties involved in Consignment Inventory
Consignment Inventory mostly consists of two parties: the consigner and the consignee.
As far as the consigner is concerned, it is defined as the party that takes ownership of the stock. In other words, they are the initial owners of the inventory that is meant for resale.
Since the stock ownership lies with the consigner, the consigner does not undertake any responsibility associated with the inventory.
A consignee might also enter into agreements with various consignees. In the case where consignees fail to deliver the goods, the stock is returned back to the consigner.
On the other hand, the consignee simply undertakes the responsibility of selling the goods owned by the consigner, in exchange for a certain cut.
It is important to realize the fact that the consignee is supposed to return the goods back to the consignee, in case any agreement clauses are not met, and if the consignee is unsuccessful in selling the goods.
Accounting Method for Consignment Inventory
In order to account for consignment inventory, a number of different steps are undertaken by the accountants. These steps are divided into stages, and are mentioned below:
Initial Transfer of Goods
As far as the Initial Transfer of Goods, accountants do not need to record the physical movement of the goods on the behalf of the consigner.
This is because there is no change in ownership, as far as the initial transfer is concerned. However, it is preferable to record a change in location of the inventory, in order to ensure that it is properly recorded.
Additionally, the consigner is also required to consider the following maintenance activities that are related to the initial transfer of goods. They include the following:
- Periodically sending out statements to consignees, acting as a reminder of the presence of the inventory on the premises of the consignee. The consignee can further use this statement in order to reconcile the inventory records, to make sure that there is no discrepancy involved.
- Periodically requesting statements from consignees, pertaining to the inventory they have on hand, and the sale made until a particular date.
Sale of Goods by the Consignee
In the case where the consignee sells the goods, the consigner can then record it as a sale made in the financial statements. In other words, inventory that is initially sent out to the consignee is only recorded as a sale, once the consignee sells the inventory.
When recording the sale of inventory, the consigner is also required to record the commission or fees that is paid to the consignee for selling these goods and services.
From the perspective of the consignee, the sale primarily results from the income or the commission that is received. Therefore, it is important to accurately calculate the income and the commission earned on the consignee’s behalf.
However, since the consignee never really ‘owns’ the inventory, they are not required to record any inventory-related transactions in the company’s financial statements.
Hence, inventory always continues to be recorded in the financial statements of the consigner, whereas the consignee is not supposed to record any inventory-related transactions.
Return on Consignment Inventory
In the instance where the consignee fails to sell the goods sent by the consigner, the consignee has the option to return the goods. The treatment of the return of the goods is similar to the treatment that is required when the goods are first sent to the consignee.
Since the amount is not recorded as a sale by the consigner, the consigner does not need to record the return of the goods as a ‘Sales Return’.
In fact, only the location of the inventory will be changed back to the premises of the consigner.
Journal Entries for Consignment Inventory
Since Consignment Inventory goes through a number of stages before a sale is recognized, different journal entries are created across each step.
When the goods are initially transferred to the consignee, the following journal entries are created:
|Finished Goods Inventory||xxx|
Even though these goods are still owned and possessed by the consigner, it is considered good practice to create a separate account to record all the inventory movements in the company.
This requires transferring the goods from the Finished Goods account to the Consignment Inventory account.
When the sale is made, an additional change needs to be made, pertaining to the inventory treatment. In this regard, the following transactions are carried out:
|Cost of Sales (Commission and Fees)||xxx|
Lastly, in case of any returns that are made by the consignee back to the consigner, the following transactions are required:
The journal entries above are recorded in order to show the receipt of goods back to the consignee since they were unable to be sold by the consignee.
Example of Consignment Inventory
Biggs Inc. manufactures healthy snacks, which are eventually passed on to specialty food shops on a consignment basis. For the month of December 2019, they transferred goods equivalent to $5,000 to the consignee.
Out of these goods, the consignee could sell food products equivalent to $3,500. This included their commission equivalent to $500. The remaining inventory was sent back to Biggs Inc.
In order to record the transactions mentioned above, it can be seen that a different treatment is required for the transfer of inventory, the sale of inventory, and the return of the inventory.
To reflect this scenario, the following journal entries are required:
|Finished Goods Inventory||$5,000|
The journal entry above shows the inventory transfer from Biggs Co. to the consignee. Although it is not yet recorded as a sale, the transfer of inventory is recorded in the books as a consignment inventory.
|Cost of Sales (Commission and Fees)||$500|
Since the sale of the goods was equivalent to an amount of $3500 (including commission), the transaction can then be recorded as a sale in the books of Biggs Inc.
Subsequently, since Biggs Inc. no longer owns the inventory, it needs to credit the inventory account to show the purchase.
After the month’s closing, the unsold goods were returned back to the consigner (Biggs Inc.). Therefore, there is a need to record the inventory receipt by crediting the Consignment Inventory Account and debiting the Finished Goods Inventory Account.