What is Consignment Inventory?
Consignment inventory refers to any stock that a company has the legal rights to but does not hold. Usually, another company, known as the consignee, keeps the stock. Although another company holds the goods, the risks and rewards associated with the inventory remain with the owner. The concept of consignment inventory is prevalent in some industries but may not apply to all.
A consignment inventory arrangement comes from an agreement. This agreement specifies that one party will hold another party’s inventory for a specific purpose. Usually, the objective is for the holder to sell the inventory. However, in case the purpose is not met or fulfilled, the owner receives their stock back. Similarly, the holder does not assume any responsibility for any damage to the inventory during the arrangement.
What are the parties involved in Consignment Inventory agreements?
Consignment inventory agreements involve two parties. These include a consigner and consignee. The consignor is the party the owns the stock, which they send over to the consignee. The consigner, in this agreement, holds the risks and rewards associated with the inventory. A consignor may usually have multiple consignment agreements with different consignees.
On the other hand, the consignee is the party that holds the inventory. As mentioned, the consignee does not assume any responsibility for the inventory. Usually, a consignee may also enter into agreements with various consignors. The consignee is often responsible for selling the goods. If they fail to do so, they can return the stock to the owner.
What is the Accounting for Consignment Inventory?
Consignment inventory agreements have several stages. The accounting treatment for each stage may differ based on the consignors’ accounting policies.
Initial Transfer
For the consignor, the consignment inventory accounting treatment depends on the risks and rewards associated with inventory. Since a consignment inventory agreement does not transfer these risks and rewards, the consignor cannot account for the physical transfer of goods. The consignor still owns the goods and must show them in its financial statements.
Some consignors may, however, transfer goods from one account to another account. It is usually to track any consignment inventory better. The transfer happens from one inventory account to another. Therefore, the overall classification does not change, but the presentation does. However, this transfer is not mandatory or required under accounting standards.
The accounting for consignment inventory for the consignee will be the same. The consignee does not get the risks and rewards associated with the stock. Therefore, they cannot record it as a purchase or asset in their accounts. That is because the definition of assets includes resources that companies own or control. In the case of consignment inventory, none of these is true.
Sale of Consignment Inventory
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. Similarly, it must record any commissions or fees paid to the consignee for selling the inventory.
For the consignee, the sale results in income from commission or fees received. Therefore, they must record income from the consignor for helping in the process. However, the consignee will not record any inventory transactions since they never get the risks and rewards that come with it.
Return on Consignment Inventory
The consignee also has the option to return the consignment inventory if it fails to sell it. The treatment for the return is similar to that of the initial transfer. For the consignor, the return does not specify any changes in risks and rewards. Therefore, it will not record the return from the consignee in its accounts. However, if the consignor has transferred the goods to another inventory account, they will revert the accounting treatment.
For the consignee, the process is the same. There is no change in the risks and rewards for the consignee. Therefore, they will not record the return on their books. Therefore, the only accounting treatment that is relevant to the consignee is when it sells the goods.
Example
A company, Orange Co., enters into a consignment inventory agreement with another company, Red Co. Orange Co., the consignor, transfers goods worth $100,000 to Red Co., the consignee. While not required by accounting standards, Orange Co. transfers the goods to a consignment inventory account. The accounting treatment for it is as follows.
| Account Name | Debit | Credit |
|---|---|---|
| Consignment Inventory | $100,000 | |
| Finished Goods | $100,000 |
Subsequently, Red Co. sells $80,000 worth of goods for Orange Co. However, it fails to sell the remaining $20,000 of goods. Eventually, Red Co. returns these goods to Orange Co. The accounting treatment for the sold goods for Orange Co. will be as follows.
| Account Name | Debit | Credit |
|---|---|---|
| Cost of Sales | $80,000 | |
| Consignment Inventory | $80,000 |
For the returned goods, Orange Co. will make the following double entries.
| Account Name | Debit | Credit |
|---|---|---|
| Finished Goods | $20,000 | |
| Consignment Inventory | $20,000 |
Conclusion
Consignment inventory includes goods that one company owns but are kept or kept by another company. The company that owns the goods is the consignor, while the company that holds them is the consignee. Usually, companies enter these agreements to sell their products through an intermediary. The accounting for consignment inventory differs according to the current stage in the agreement.
