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Accounting for consigned goods

October 15, 2011

Accounting guide about consigned goods; definitions of consignment, consignee, consignor;


examples of consignment journal entries; consignment benefits, risks and controls.

1. Definition of consignor, consignee, and consigned inventory


Let us start with several definitions related to accounting for goods on consignment.
Consignor is a business or person who makes a consignment to consignee.
Consignee is a business or person that holds consignors goods for sale and acts as consignors agent in
selling the goods.
Consigned inventory includes goods shipped by a consignor to the consignee, who acts as an agent in
selling the goods.
Consigned inventory is the property of the consignor, not the consignee, until it is sold by the consignee.
In other words, goods on consignment are included in the inventory of the consignor (i.e., seller) while
they are excluded from the consignees (i.e., buyers) inventory. Consignee does not own the inventory
but agrees to exercise due diligence in holding and selling consigned merchandise.
The major differences between a sale and consignment are listed in the table below:
Sale
Ownership

Consignment

Transferred to the buyer along with the Property of the consignor (seller) until
transfer of goods.
consigned inventory is sold by the
consignee (reseller).

Goods sold on Buyer is a debtor of the seller.


credit
Debtor-creditor relationship.

Consignee is a debtor of the consignor.


Agent-principal relationship.

Return of
goods

Buyer cannot return goods unless they Can be returned to seller (consignor)
are defective or seller agrees to take because consigned inventory is property
them back.
of the consignor until it is sold by the
consignee.

Goods lost
after delivery

Buyers loss.

Sellers (consignors) loss.

2. Example of accounting for goods on consignment


Let us look at a simple example to understand the accounting for goods on consignment. Friends
Company, a manufacturer of valves, ships a consignment of gas valves to a retail store BestHome. In this
case, Friends Company is a consignor while BestHome is a consignee. Friends Company pays freight
costs while BestHome pays local advertising costs and credit card processing fees that are reimbursable
from Friends Company. By the end of the period, BestHome sells half of the consigned merchandise,

notifies Friends Company of the sales, retains a 15% commission, and remits cash due to Friends
Company.

Consignment Accounting
Consignment Overview
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 pre-arranged 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.

Accounting for consigned goods


2.1. Accounting for shipment of consigned merchandise
Friends Company ships gas valves costing $7,000 on consignment to BestHome.
Consignor: to record the shipment of consigned inventory, Friends Company makes the following journal
entry:
Consignor: shipment of consigned inventory
Account Titles
Debit
Credit
Inventory (Consignments)
$7,000
Finished Goods Inventory
$7,000
Consignee: BestHome does not make any journal entry. Mere receipt of the consigned goods does not
make the consignee a debtor of the consignor. In addition, the consignee does not record the
merchandise as an asset in its books as such merchandise is the property of the consignor until it is sold.

2.2. Accounting for payment of freight costs by consignor


Consignor: Friends Company shipped the gas valves to BestHome through a third-party shipping
company, which charged Friends Company $600 for shipping goods from the factory to the consignee
(i.e., BestHome). To record the shipping expense, Friends Company makes the following journal entry:
Consignor: payment of freight costs by consignor
Account Titles
Debit
Credit
Inventory (Consignments)
$600
Accounts Payable (or Cash)
Consignee: BestHome does not make any journal entry.

$600

2.3. Accounting of payment of advertising by consignee


Consignor: Friends Company does not make any journal entry until it is notified by the consignee (e.g.,
receives an Account Sales Report).
Consignee: usually a consignee is entitled to be reimbursed for expenses incurred in connection with the
consignment (i.e., it depends on the consignment agreement). Such expenses may include credit card
processing fees, storage and insurance costs, unloading charges, local advertising costs, etc. In our
example, BestHome paid $1,000 cash for local advertising costs. The consignee would make the
following journal entry:
Consignee: expenses incurred in connection with consignment
Account Titles
Debit
Credit
Receivable from Friends Company

$1,000

Account Titles
Cash

Debit

Credit
$1,000

Accounting for consigned goods


2.4. Accounting for sale of consigned merchandise
By the end of the period, BestHome sells 50% of the consigned gas valves for $8,000. According to the
consignment agreement, BestHom must receive a 15% commission on the sales (i.e., $1,200 = $8,000 x
0.15) and must be reimbursed for the 2% credit card processing fee (i.e., $160 = $8,000 x 0.02).
Consignor: Friends Company does not make any journal entry until it is notified by the consignee (e.g.,
receives an Account Sales Report).
Consignee: BestHome would make the following journal entry to record the sale of the consigned goods:
Consignee: sale of consigned merchandise
Account Titles
Debit
Credit
Cash
$8,000
Payable to Friends Company
$8,000
Consignee: expenses incurred in connection with consignment
Account Titles
Debit
Credit
Receivable from Friends Company
Cash

$160
$160

2.5. Accounting for notification of sales and expenses


BestHome notifies Friends Company of the sales and expenses by sending an Account Sales Report,
retains a 15% commission, and remits cash due to Friends Company.
Consignor: Friends Company makes the following journal entry:
Consignor: notification of sales and expenses and receipt of cash from consignee
Account Titles
Debit
Credit
Cash
$5,640
Advertising Expense
$1,000
Commission Expense
$1,200
Cost of Goods Sold
$160
Revenue from Consignment Sales
$8,000
Consignee: BestHome makes the following journal entry:
Consignee: notification of sales and expenses and remittance of cash to consignor
Account Titles
Debit
Credit
Payable to Friends Company
Receivable from Friends Company
Commission Revenue
Cash

$8,000
$1,160
$1,200
$5,640

2.6. Accounting for adjustment of inventory on consignment

Inventory on consignment should be adjusted for the cost of sales.


Consignor: to record the transfer of the inventory cost to the cost of goods sold, Friends Company
makes the following journal entry:
Consignor: recognize the cost of goods sold
Account Titles
Debit
Credit
Cost of Goods Sold [50% x ($7,000 + 600)]
Consignment Inventory

$3,800
$3,800

The cost of goods sold in this example includes not only 50% of the original inventory cost (i.e., $3,500 =
$7,000 x 0.50) but also 50% of the shipping expense (i.e., $300 = $600 x 0.50):
Consignee: BestHome does not make any journal entry.

Accounting for consigned goods


3. Consignment benefits and risks
It is important to analyze consignment arrangements to understand the rights and obligations of consignor
and consignee as well as the benefits and risks both parties are exposed to. When preparing or analyzing
a consignment agreement, examine the following issues:

When does ownership transfer (change)?

Who takes the risk associated with inventory storage?

Who takes the risk associated with inventory obsolescence?

Which tracking procedures are (will be) used?


Depending on the nature of a consignment arrangement, the following benefits and risks may arise for
consignor and consignee, respectively:
Consignor (Seller)
Benefits

Business expansion with


reduced initial and on-going costs
Reduced inventory holding

Consignee (Buyer)
Reduced investment in inventory
Operational savings

costs

Access to a wider range of inventory

Better understanding of user


demand and timing of production and
supply chain activities

Commission on sale

Operational savings
Risks

No inventory sales
Inventory lost after delivery

Risk to retain unsaleable or obsolete


inventory

Consignor (Seller)

Consignee (Buyer)
Extra inventory warehousing and
handling costs un-reimbursable by consignor

4. Consignees accounting controls for consigned inventory


It is important for a consignee to properly monitor and audit the consigned inventory. Three major
accounting controls for consigned merchandise include:

Identification: consigned inventory should be prominently labeled with an identification tag (e.g.,
colored tag) when such inventory is received. Separate colored receiving reports may be used. In the
computer system, consigned inventory should be recorded with a unique part number.

Segregation: consigned inventory should be physically segregated from other inventory. For
example, a part of a warehouse can be set aside for consigned inventory. Consigned merchandise
should be stored in a safe place protected from various hazards such as fire, theft, etc.

Monitoring: consigned inventory should be monitored by the materials review board in order to
determine whether the consigned inventory is obsolete.
In addition to the above-listed accounting controls, consignee could use the following consigned inventory
practices:

Hire independent audit firm for periodic audits of inventory and consigned inventory controls and
report the findings to the consignor.

Allow the consignor to inspect consigned inventory.

Set minimum and maximum levels for consigned merchandise.

Establish a maximum amount of time consigned inventory can be retained before it becomes
obsolete (should keep in mind shelf-life issues).
Finally, periodically the consignee must send an Account Sales Report to the consignor. The Accounts
Sales Report shows the merchandise received, merchandise sold, expenses chargeable (i.e.,
reimbursable) to the consignment, and the cash remitted. Then, revenue can be recognized by the
consignor.