Consigned inventory refers to stocks stored with its consignee or purchasing company and not with its consignor or selling company. The consignee then acts as an agent to sell the goods of the product owner (consignor). Each time the goods are sold, the consignee makes payment, and all unsold items are returned to the consignor.
When it comes to consignments, relationships are two-way as accounting for inventory is concerned. The goods translate as inventory in the consignor’s accounting records, though, and not in the consignees.
How does consigned inventory work?
With consigned inventory, the product owner usually approaches the agent/retailer to negotiate the terms of the consignment contract. The contract will then dictate the cost of the products, the shipping and handling fees, and return mechanics. It will also include information about inventory management, deposits, commissions, and what to do when products are damaged or lost.
After agreeing to the terms of the contract, the consignor will deliver the inventory to the consignee and earn money each time the consignee makes a sale. The consignee’s profit will depend on the price they set for a specific product or item.
Managing consigned inventory
Accurate consigned inventory management is paramount, as both the consignor and consignee will need to keep a close eye on the inventory. It can be challenging, for example, if a business sells both consigned and non-consigned items, as this may introduce complexity into inventory management.
For some businesses, relying on manual inventory tracking systems, like pen-and-paper or even spreadsheet-based ones, can prove both tedious and risky. Manual systems open businesses to vulnerability as they can be prone to human error and can thus cause mistakes in accounting for inventory.
Accounting for consigned inventory
Upon sending goods to the consignee, the consignor will need to record the change in location within their inventory management system. There is no need to create a related accounting entry regarding the physical movement of the goods but it is important to have visibility into inventory in different locations.
However, there are certain maintenance activities that they should take note of:
- Sending a statement regarding the inventory to the consignee periodically: This statement should be used by the consignee to carry out periodic reconciliations of the actual inventory amount on hand and match it with the record the consignor has.
- Requesting a statement of on-hand inventory from the consignee: The consignor should request a statement at the end of each accounting period during the consignor’s physical inventory count. The information will then be included in the consignor’s inventory records so both parties can arrive at a fully valued ending inventory balance.
When the consignee sells goods, the prearranged sale amount is paid to the consignor. The consignor then records the same with a debit to cash and credit to sales. This clears the related inventory amount from its records with a corresponding debit to the cost of goods sold and credit to inventory. Then, a profit or loss on the sale transaction will then come from these two entries.
Depending on the arrangement dictated in the contract, the consignor may also pay a commission to the consignee for every sale, in which case this will be reflected as a debit to commission expense and credit to accounts payable.
