Consignment is a business arrangement in which one person sends goods to another to sell them on behalf of the sender. The sender of the goods is known as the consignor, and the receiver is referred to as the consignee. Ownership of the goods remains with the consignor until they are sold to the final customer by the consignee. The consignee sells the goods at the best possible price and earns a commission for their services. The consignor records all transactions related to the consignment in the consignment account to determine the profit or loss on the consignment.
Features of Consignment
The essential features of consignment distinguish it from regular sale transactions. In a consignment arrangement, the goods are sent by the consignor to the consignee for sale, but the legal ownership remains with the consignor until the goods are sold to third parties. The consignee acts as an agent and is not responsible for any unsold goods unless otherwise agreed. The consignee does not record the goods as purchases; instead, they render an account of sales, expenses, and commission periodically. The consignor bears the risk of goods until they are sold. This also implies that any loss arising from unsold goods, theft, fire, or other unexpected events is the responsibility of the consignor unless it is proven that the consignee was negligent.
Objectives and Importance of Consignment Accounts
Consignment accounts help the consignor to track and record the detailed performance of each consignment transaction. It shows all expenses incurred, commissions payable, sales revenue, and valuation of closing stock or abnormal losses. This account helps in determining the profit or loss from the consignment activities. Since the consignee is acting on behalf of the consignor, it becomes important to maintain transparency through proper recording and communication of information. Consignment accounting ensures accurate profit determination, helps in taxation and compliance, and establishes accountability for both parties involved.
Account Sale
An account sale is a periodic statement sent by the consignee to the consignor that summarizes the sales and related transactions made on behalf of the consignor. This statement usually contains information such as the total quantity of goods sold, the selling price realized, expenses incurred by the consignee, commission earned, advances paid, if any, and the final balance due to or from the consignor. The consignor relies on the account sale to record necessary entries in their books. It serves as a crucial document for maintaining accurate consignment accounts and helps in reconciling records between the consignor and consignee. It is usually prepared and sent at regular intervals, depending on the terms agreed upon.
Commission and Its Types
Commission is the remuneration earned by the consignee for selling the goods on behalf of the consignor. It is usually expressed as a percentage of the gross sales. Different types of commissions can be agreed upon between the consignor and consignee. The main types include ordinary commission, del credere commission, and overriding commission.
Ordinary commission is the standard commission paid for making sales. Del credere commission is paid when the consignee agrees to take responsibility for bad debts arising from credit sales. In such cases, any losses due to non-payment by customers are borne by the consignee and not the consignor. Overriding commission is given for additional responsibilities such as selling goods above a specified price or entering new markets. These commissions are essential for motivating the consignee to put effort into achieving better sales results.
Del Credere Commission
Del credere commission is a special type of commission given to the consignee who agrees to bear the risk of bad debts arising from credit sales. Under normal conditions, the loss due to bad debts is borne by the consignor because the ownership of the goods lies with them. However, in certain cases, the consignee agrees to take on this risk in return for an extra commission known as a del credere commission.
This commission is usually calculated on the total sales unless specifically agreed to be calculated only on credit sales. It provides an incentive for the consignee to carefully evaluate the creditworthiness of customers. If the consignee receives del credere commission and a customer defaults on payment, the consignee is still required to pay the consignor the amount due from that customer. This commission shifts the risk of credit losses from the consignor to the consignee.
Overriding Commission
Overriding commission is an additional commission paid to the consignee over and above the normal commission. It is given in recognition of extra efforts made by the consignee. This could include achieving a higher sales price than the invoice price, entering new geographical markets, or promoting new products.
For example, if the consignor instructs the consignee to sell the goods at a fixed minimum price, and the consignee sells them at a higher price, the difference may be shared as overriding commission. Similarly, when the consignee incurs promotional or administrative expenses not otherwise reimbursed, they may be compensated with a higher commission rate. This kind of commission is beneficial in motivating the consignee to go beyond basic selling duties and secure higher profits or market share for the consignor.
Normal Loss in Consignment
Normal loss refers to the unavoidable and expected loss that occurs during transit or storage due to the inherent nature of the goods. Examples of normal loss include leakage, evaporation, drying, breakage, or spoilage. Since it is considered inevitable, no special accounting treatment is needed to record normal loss separately.
However, normal loss is taken into account when valuing the closing stock. The total cost incurred is distributed over the quantity remaining after deducting the normal loss. This effectively increases the cost per unit of the remaining goods. The idea is to spread the cost of the lost units over the good units that remain. If there is any scrap value recoverable from the normal loss, it should be credited to the consignment account, thereby reducing the overall cost.
Valuation of Stock After Normal Loss
The valuation of closing stock in consignment involves calculating the cost of the unsold goods that remain with the consignee at the end of the accounting period. When there is a normal loss, the total cost incurred, including direct expenses such as freight and insurance, is distributed over the net quantity after deducting the normal loss. This results in a higher cost per unit for the remaining goods.
For example, if 10,000 units are sent and there is a normal loss of 2 percent, then 200 units are considered lost. The cost of the remaining 9,800 units is calculated by dividing the total cost (less scrap value) by the normal quantity. This adjusted cost per unit is then used to value the closing stock. This method ensures that the cost of the lost units is absorbed by the good units and the inventory valuation reflects the true cost per unit.
Abnormal Loss in Consignment
Abnormal loss refers to the unexpected and avoidable loss that occurs due to unforeseen circumstances such as accidents, fire, theft, or negligence. Unlike normal loss, abnormal loss is not an inherent part of the consignment process and is therefore treated separately in the accounting records.
The valuation of abnormal loss is done in the same way as closing stock. The cost of the lost goods, along with a proportionate share of expenses, is calculated. This loss is excluded from the consignment account to ensure that the reported profit from the consignment is not distorted. An abnormal loss account is debited, and the consignment account is credited to remove the effect of the loss.
If any scrap value or insurance claim is received for the lost goods, it is credited to the abnormal loss account. The net amount is then transferred to the profit and loss account. This treatment ensures that the consignment profit is not understated due to unforeseen losses.
Advance and Security Deposits from Consignee
Sometimes the consignee may pay an advance amount to the consignor at the beginning or during the consignment period. If it is simply an advance against future sales, it is credited to the consignee’s account and adjusted later against the amount due from the sale proceeds. No special treatment is required for such advances beyond recording them as a liability until adjusted.
However, if the amount is received as a security deposit, the treatment differs. A security deposit is typically a percentage of the value of goods sent and is meant to be retained until the end of the consignment or adjusted only in part. In such cases, the portion of the deposit equivalent to the value of unsold goods should not be adjusted. The security deposit must continue to be shown as a liability to the consignee until the final settlement. This ensures that the consignor has a financial safeguard in case of damage, loss, or non-performance by the consignee.
Recording of Consignment Transactions
In the books of the consignor, a consignment account is opened for each separate consignment. All costs incurred by the consignor, including goods sent, freight, insurance, and other direct expenses, are debited to this account. Expenses incurred by the consignee and commissions due are also debited. The sales proceeds and closing stock value are credited to this account. The balance figure in the consignment account represents profit or loss and is transferred to the profit and loss account.
The consignee, on the other hand, does not maintain a consignment account but rather a personal account for the consignor. They record only the expenses incurred, commission earned, sales made, and any amount remitted to or received from the consignor. The consignee does not record goods received as purchases since they are not the owner of the goods.
Features of Consignment
In a consignment arrangement, the goods are sent by the consignor to the consignee for sale. The consignee does not become the owner of the goods but holds and sells them on behalf of the consignor. The ownership remains with the consignor until the goods are sold. The consignee is entitled to a commission for the services rendered. Unsold goods can be returned to the consignor. The consignee is responsible for remitting the sale proceeds after deducting expenses and commission. All risks and rewards associated with the goods lie with the consignor. The consignee must send regular reports of sales, expenses, and stock to the consignor. The consignor bears all losses unless otherwise agreed.
Accounting for Consignment
In the books of the consignor, a consignment account is maintained to record all transactions related to goods sent on consignment. The consignor records the goods sent, expenses incurred, consignee’s commission, sales made by the consignee, and the closing stock with the consignee. Any profit or loss is transferred to the profit and loss account. In the books of the consignee, only commission earned and expenses incurred are recorded. The consignee does not record the goods as their purchase since ownership does not transfer.
Proforma Invoice
A pro forma invoice is a statement sent by the consignor to the consignee with the goods. It details the quantity, description, and price of the goods consigned. It is not an invoice in the legal sense but serves to provide the consignee with information for reference and pricing. It helps in accounting and pricing the goods for sale. The pro forma invoice is useful for the consignee to fix the selling price and to inform customers.
Consignment Expenses
Expenses related to consignment are borne either by the consignor or the consignee. Expenses incurred by the consignor include packaging, freight, insurance, and forwarding charges. These are added to the cost of goods consigned. The consignee may also incur expenses such as unloading, storage, advertising, and selling expenses. Non-recurring expenses are those incurred to bring the goods to the consignee’s location and are included in the cost of goods. Recurring expenses like storage and advertising are treated as revenue expenses and are charged to the consignment account.
Commission
The consignee is entitled to a commission for selling goods. It is the reward for the services rendered. There are different types of commissions: Ordinary commission is a fixed percentage of the total sales made by the consignee. Del credere commission is an additional commission given to the consignee to bear the risk of bad debts. In this case, the consignee guarantees payment to the consignor and assumes responsibility for collecting from customers. Overriding commission is an extra commission for achieving sales targets or for promoting new products. All types of commissions are charged to the consignment account.
Accounting Treatment in the Books of the Consignor
The consignor debits the consignment account when goods are sent. Any expenses incurred by the consignor are also debited to the consignment account. When goods are sold, the consignee sends an account sales report detailing sales, expenses, and commission. The consignor then credits the consignee’s account for sales proceeds and debits the consignment account. Commission and expenses incurred by the consignee are also debited to the consignment account. Closing stock is valued and credited to the consignment account. Profit or loss is transferred to the profit and loss account.
Accounting Treatment in the Books of the Consignee
The consignee records only those transactions that affect their account directly. They do not record goods received, as ownership remains with the consignor. When sales are made, the consignee debits the buyer and credits the consignor. Commission earned is credited to the commission account and debited to the consignor. Expenses incurred by the consignee are also debited to the consignor. The balance payable to the consignor is shown as a liability in the consignee’s books.
Valuation of Closing Stock
At the end of the accounting period, the unsold goods with the consignee are valued and shown as closing stock. The closing stock is valued at cost or net realizable value, whichever is lower. It includes the proportionate cost of goods and non-recurring expenses. Recurring expenses are not added to the cost of closing stock. The closing stock is shown as an asset in the balance sheet of the consignor. In the consignment account, it is credited as “Stock on Consignment.”
Normal Loss
Normal loss refers to the unavoidable loss that occurs during transit or storage due to the nature of the goods, such as leakage, evaporation, or breakage. It is considered part of the cost and is not recorded separately. The cost of normal loss is absorbed by the remaining units. While valuing closing stock, the total cost and expenses are divided by the quantity remaining after deducting the normal loss. This inflates the cost per unit of the remaining stock.
Abnormal Loss
Abnormal loss is a loss beyond the normal level and is considered avoidable or accidental. It includes loss due to theft, fire, or mishandling. Abnormal loss is treated separately and not included in the cost of goods. It is calculated by taking the proportionate cost and expenses of the lost goods. The value of abnormal loss is debited to the abnormal loss account and credited to the consignment account. If the goods are insured, the insurance claim received is credited to the abnormal loss account. The net loss is transferred to the profit and loss account.
Journal Entries in the Books of the Consignor
To properly reflect consignment transactions, the consignor passes a series of journal entries:
- For goods sent on consignment:
Consignment Account Dr.
To Goods Sent on Consignment Account - For expenses incurred by consignor:
Consignment Account Dr.
To Bank/Cash Account - For goods sent on consignment being recorded at invoice price:
Goods Sent on Consignment Account Dr.
To Trading/Purchases Account - For adjustment of loading (if invoiced above cost):
Goods Sent on Consignment Account Dr.
To Consignment Account - For account sales received from consignee:
Consignee’s Account Dr.
To Consignment Account - For commission payable to consignee:
Consignment Account Dr.
To Consignee’s Account - For expenses incurred by consignee:
Consignment Account Dr.
To Consignee’s Account - For closing stock valuation:
Stock on Consignment Account Dr.
To Consignment Account - For profit on consignment:
Consignment Account Dr.
To Profit and Loss Account
For loss:
Profit and Loss Account Dr.
To Consignment Account - For cash received from consignee:
Bank Account Dr.
To Consignee’s Account
Journal Entries in the Books of the Consignee
In the books of the consignee, the entries are limited since the consignee does not own the goods:
- For expenses incurred:
Consignor’s Account Dr.
To Bank/Cash Account - For sales made:
Customer Account Dr.
To Consignor’s Account - For commission earned:
Consignor’s Account Dr.
To Commission Account - For remittance of sale proceeds to consignor:
Consignor’s Account Dr.
To Bank Account
Treatment of Losses
In consignment, two types of losses are treated differently:
Normal Loss
This type of loss is inherent and unavoidable due to the nature of the goods or handling conditions. No separate journal entry is passed for normal loss. While valuing the closing stock, the cost is spread over the remaining units, increasing their per-unit cost.
Abnormal Loss
This loss arises due to unexpected events such as fire, theft, or accident. It is separately accounted for as:
Abnormal Loss Account Dr.
To Consignment Account
If any part of the loss is recovered through insurance:
Bank Account Dr. (for claim received)
Profit and Loss Account Dr. (for unrecovered amount)
To Abnormal Loss Account
Del Credere Commission and Bad Debts
When a consignee is paid a del credere commission, the risk of bad debts falls on them. In such a case, bad debts are not recorded by the consignor. However, if the consignee is not paid the del credere commission, bad debts are borne by the consignor and recorded as:
Bad Debts Account Dr.
To Consignee’s Account
Then,
Consignment Account Dr.
To Bad Debts Account
If a del credere commission is paid and bad debts occur, the consignee absorbs the loss, and no journal entry is passed in the consignor’s books.
Consignment vs Sale
Understanding the difference between consignment and outright sale is essential in accounting:
- In consignment, goods are sent to the consignee, who sells them on behalf of the consignor. In a sale, ownership transfers immediately.
- Risk in consignment remains with the consignor; in a sale, the buyer bears the risk after delivery.
- Revenue is not recognized on consignment until the consignee sells the goods. In a sale, revenue is recorded at the point of sale.
- The consignee earns a commission, while a buyer pays the purchase price.
- Unsold goods can be returned in consignment; in a sale, goods once sold generally cannot be returned unless agreed upon.
Treatment of Goods Invoiced Above Cost
Sometimes consignors send goods at a price higher than the cost (invoice price) to conceal the actual profit margin. In such cases, special care is needed:
- The consignment account is initially debited at invoice price.
- An entry is passed to remove the ‘loading’ or excess price over cost:
Goods Sent on Consignment Account Dr.
To Consignment Account - Similarly, stock on consignment is adjusted to reflect actual cost by deducting the loading included.
This ensures that profit or loss on consignment is accurately determined.
Stock Reserve
Stock reserve is created to adjust the profit element included in the value of unsold stock shown at invoice price. It is calculated as the difference between the invoice price and the cost price of the unsold goods. The entry passed is:
Profit and Loss Account Dr.
To Stock Reserve Account
This ensures that unrealized profit is not included in the period’s profit.
Account Sales
An account sales is a periodic statement sent by the consignee to the consignor. It details the quantity and value of goods sold, expenses incurred, commission charged, and the amount due to the consignor. The consignor relies on this statement to make journal entries in their books. Account sales serveas a key document for recording consignment transactions accurately.
Valuation of Closing Stock on Consignment
At the end of an accounting period, the consignor must value the unsold stock lying with the consignee. This stock is called Closing Stock on Consignment and is valued at cost or net realizable value, whichever is lower. The valuation includes:
- Cost of goods
- Proportionate non-recurring expenses (such as freight, insurance, octroi) incurred by both the consignor and consignee
Recurring expenses like godown rent, selling expenses, and salaries are not included. If the goods are sent at invoice price, the loading must be removed from the closing stock value to reflect the actual cost.
Journal entry for closing stock is:
Stock on Consignment Account Dr.
To Consignment Account
Proforma Invoice
A forma invoice is a document sent by the consignor to the consignee along with the goods. It resembles a sales invoice but does not signify an actual sale. It contains:
- Description of goods
- Quantity and quality
- Invoice price
- Expenses incurred
- Terms of consignment
It is not recorded in the books of account but serves as a basis for the consignee to verify receipt and maintain records.
Important Points to Remember in Consignment Accounting
- Consignment is not a sale; ownership remains with the consignor until goods are sold by the consignee.
- Goods sent on consignment are recorded separately and not included in sales or cost of goods sold.
- The consignee is only an agent and earns commission for their services.
- Profit or loss on consignment is calculated after accounting for all expenses, commission, and adjustments such as stock reserve and abnormal loss.
- Goods may be sent at cost or invoice price; if at invoice price, adjustments for loading are essential.
- Closing stock must include proportionate non-recurring expenses but exclude any loading if invoice pricing is used.
- The Del Credere Commission alters the responsibility for bad debts.
- Journal entries differ between consignor and consignee because the transaction is agent-based rather than buyer-seller.
Numerical Example of Consignment Accounting
Let’s understand consignment accounting with a simplified example:
Scenario
A consignor sends goods costing $50,000 to a consignee. The goods are invoiced at 20% above cost. The consignor incurs $2,000 on freight and insurance. The consignee incurs $1,500 on clearing and $1,000 on storage. The consignee sells 80% of the goods for $60,000 and is entitled to a 5% commission. Closing stock remains unsold.
Step-by-Step Accounting in the Books of Consignor
- Goods sent on consignment at invoice price:
Invoice price = $50,000 + 20% = $60,000
Consignment Account Dr. $60,000
To Goods Sent on Consignment Account $60,000 - Expenses by consignor:
Consignment Account Dr. $2,000
To Bank Account $2,000 - Loading adjustment:
Goods Sent on Consignment Account Dr. $10,000
To Consignment Account $10,000 - Expenses by consignee:
Consignment Account Dr. $2,500
To Consignee’s Account $2,500 - Sales by consignee:
Consignee’s Account Dr. $60,000
To Consignment Account $60,000 - Commission to consignee (5% of $60,000 = $3,000):
Consignment Account Dr. $3,000
To Consignee’s Account $3,000 - Closing Stock valuation:
Cost of goods = $50,000
Unsold stock = 20% of goods = $10,000
Add proportionate non-recurring expenses:- Consignor’s $2,000 × 20% = $400
- Consignee’s clearing expense $1,500 × 20% = $300
Total = $10,000 + $400 + $300 = $10,700
Stock on Consignment Account Dr. $10,700
To Consignment Account $10,700
- Profit on Consignment:
Total debits to consignment account:- Goods (at cost): $50,000
- Expenses (Consignor + Consignee): $2,000 + $2,500 = $4,500
- Commission: $3,000
Total = $57,500
Total credit: - Sales = $60,000
- Closing stock = $10,700
Total = $70,700
Profit = $70,700 – $57,500 = $13,200
Consignment Account Dr. $13,200
To Profit and Loss Account $13,200
Consignment Accounting in GST Framework (if applicable)
Under the Goods and Services Tax (GST) framework, special rules apply to consignment:
- Transfer of goods to a consignee located in a different state may be considered a supply and may attract GST, even if ownership has not transferred.
- Intra-state consignment may not attract GST unless the consignee makes a sale.
- The consignor must generate an e-way bill when sending goods.
- GST registration may be required for both consignor and consignee, depending on state rules.
- Input Tax Credit (ITC) may be claimed on expenses if GST-compliant invoices are available.
Conclusion
Consignment accounting, while closely related to inventory and sales accounting, has distinct principles rooted in agency relationships and conditional ownership. Both theoretical understanding and practical application are critical for accurately maintaining records and ensuring compliance with financial and tax regulations. Proper treatment of consignment transactions, including expenses, commissions, losses, and stock valuation, ensures a true and fair view of the consignor’s financial performance.