What is Consignment Accounting?
Consignment accounting is a type of business arrangement in which one person send goods to another person for sale on his behalf and the person who sends goods is called consignor and another person who receives the goods is called consignee, where consignee sells the goods on behalf of consignor on consideration of certain percentage on sale.
In Consignment, goods are left in the hands of an authorized third party called consignee to sale on behalf of the consignor, ownership of goods remains in the hands of the consignorThe ConsignorThe consignor is an independent owner who transfers goods to the consignee for sale on their behalf. The consignee acts as an agent or middleman, and the stock's ownership remains with the consignor until the goods are sold.. The agreement made between the consignor and consignee is for a smooth flow of transactions, with a clear understanding of the terms and conditions. Typical products sold through consignment include clothing, shoes, furniture, toys, music & other instruments, etc.
Below are some features:
- Two Parties: Consignment accounting mainly involves two party’s consignor and consignee.
- Transfer of Procession: Procession of goods transferred from consignor to consignee.
- Agreement: There is a pre-agreement between the consignor and consignee for terms and conditions of the consignment.
- No Transfer of Ownership: The ownership of goods remains in the hands of the consignor until the consignee sells it. The only procession of goods is transferred to a consignee.
- Re-Conciliation: At the end of the year or periodic intervals consignor sends Pro-forma invoice while consignee sends account sale details and both reconcile their accounts
- Separate Accounting: There is independent accounting done of consignment account in the books of consignor and consignee. Both prepare consignment account and record the journal entries of goods through consignment account only.
Example of Consignment Accounting
Let us understand with an example.
ABC sent goods costing $10,000 to XYZ on 01st Jan 2020 on a consignment basis. He spent $200 on its packaging. As per the term of consignment, XYZ is entitled to a 10% commission. On 3st Jan 2020, XYZ confirmed the receipt of the goods and sent a 50% amount as the advance. On the last day of the month, XYZ sends details of his sales, which showed that 3/4 of the goods were sold for $11,000, and XYZ remitted balance amount after deducting advance and commission. What will be the journal entries to record the transactions taking place?
Terms Used in Consignment Accounts
The following terms are used in consignment accounting:
- Consignor: It is the person that sends goods.
- Consignee: The person who receives the goods is called the consignee.
- Consignment: Consignment is a business arrangement through which the consignor sends goods to the consignee for sale.
- Consignment Agreement: It is legally written communication between the consignor and consignee, which defines the terms and conditions of the consignment.
- Pro-Forma Invoice: When the consignor sends goods to the consignee, he also forwards statements showing details of goods such as quantity, price, etc. and that statement is called the Pro-forma invoicePro-forma InvoicePro Forma Invoice is a document issued by the supplier to the buyer with delivery details of goods/services, including price, delivery charges, applicable taxes, and quantity or the total weight of the shipment..
- Non- Recurring Expenses: Expenses that are incurred by the consignor to dispatch the goods from his place to place of the consignee are called non-recurring expenses. These expenses are added to the cost of goods.
- Recurring Expenses: The consignee incurs these expenses after the goods reached his place. These expenses are of maintenance of goods type’s expenses.
- Commission: Commission is the reward/ consideration for the sale of goods on behalf of the consignor. It is as per the consignment agreement.
- Account Sale: It is the statement forwarded by the consignee to consignor showing details of goods sold, amounts received, expenses incurred, a commission charged, advance paymentAdvance PaymentAdvance payment is made by a buyer to the seller before the actual scheduled time of receiving the goods and services. It protects the seller from the risk of non-payment. Additionally, it helps sellers financially in the production of the goods or rendering of services. and balance due and stock in hand, etc.
How to Prepare a Consignment Account?
While preparation of the Consignment account:
#1 – Debit to Consignment Account:
- Cost of goods sent on consignment
- With expenses paid by the consignor
- Expenses paid by consignee by self or on behalf of the consignor
- Commission on consignment
#2 – Credit to Consignment Account
- Sale proceeds on consignment
- Cost of abnormal loss
- Value of closing stockValue Of Closing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level. and proportionate direct expenses
Balance of consignment account transferred to profit and loss account.
- Increase in Business Exposure: Due to consignment sales increase, thereby increase in business exposure. It is a cost-effective method to expand the business.
- Lower Inventory Cost: Less inventory holding costsInventory Holding CostsHolding cost refers to the cost that an entity incurs for handling and storing its unsold inventory during an accounting period. It is calculated as the sum total of storage cost, finance cost, insurance, and taxes as well as obsolescence and shrinkage cost. for the consignor;
- Incentives to Consignee: When consignee sells on behalf of the consignor, the former receives a commission and other incentives.
- Business Growth: Consignment benefits both consignor and consignee. Consignor gets lower inventory bearing cost, and consignee without investment earns the commission by selling on behalf of the consignor.
- Lower Profit Margin: Due to consignment, the consignor has to pay commission to the consignee, thereby resulting in a lower profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. in the hands of the consignor.
- Negligence by Consignee: Consignee’s negligence may create the problem.
- Risk of Goods Damaged: There is a high risk of goods damaged at the consignee’s place or during transport, especially perishable goods.
- High Charges: Sometimes, there are high maintenance charges of goods to be borne by consignee and high shipping or conveyance charges to be borne by consignor. This is the place of the consignee, and the consignor is far away from each other.
Consignment is the type of business arrangement in which the consignor sells goods to the consignee for exchange in return of the commission. There is separate accounting to be done of consignment accounting while sending goods consignor to send Pro-forma invoice for details of goods sold and consignee to send at the periodic intervals the account sale details to the consignor and both settle and reconcile their accounts.
Sometimes consignment is beneficial for both consignor and consignee as consignor gets business expansion and consignee gets commission and incentives without any investment. Hence consignment can be a good business expansion option.
This has been a guide to what is consignment accounting. Here we discuss features, an example with journal entries and terms used in consignment account along with its preparation. You may learn more about financing from the following articles –