Consignment refers to an arrangement where one party, called the consignor, sends goods to another party, known as the consignee, who agrees to sell them on behalf of the consignor. The ownership of goods remains with the consignor until the sale takes place. The consignee earns a commission for selling the goods and is responsible for safeguarding them until they are sold.
This system helps the consignor reach wider markets without having to establish a permanent presence. It also enables the consignee to generate income from sales without investing in inventory. The unique structure of this relationship requires specialized accounting treatments to accurately reflect the financial transactions between both parties.
Understanding the Role of Account Sale
A vital feature of the consignment process is the account sale. This document is periodically sent by the consignee to the consignor and contains a detailed summary of all activities related to the consignment. It reports financial transactions such as sales made, expenses incurred, commission due, and advances paid by the consignee. It also includes quantitative information like the quantity of goods sold, returned, or unsold.
The consignor relies on the account sale to record transactions in their books. This ensures transparency and helps track the performance of the consignment. It is an essential document for reconciliation and assessment of the effectiveness of the consignee’s sales efforts.
Commission and Its Variants
The consignee earns income through commission for the services rendered in selling the goods. There are different types of commissions based on the nature of the services and risks assumed by the consignee.
Regular Commission
The standard commission is paid as a percentage of sales proceeds. This compensates the consignee for handling and selling the goods, covering routine activities without any special risk involved.
Del-Credere Commission
When credit sales are involved, the risk of non-payment typically lies with the consignor. However, if the consignee agrees to bear the risk of bad debts, they receive an additional commission called del-credere commission. In this case, the consignee takes responsibility for any losses due to customer default.
This commission is usually calculated on total sales unless it is specifically agreed to calculate it only on credit sales. If bad debts occur under this arrangement, the consignee absorbs the loss and the consignor’s books remain unaffected by it.
Overriding Commission
In certain cases, the consignor may offer additional incentive to the consignee for extra effort. This additional commission, known as overriding commission, may be given for achieving higher sales prices, expanding market reach, or promoting a new product. It can also substitute reimbursement for administrative or selling expenses.
The basis and rate of overriding commission are typically pre-agreed and mentioned in the consignment agreement.
Handling Normal Loss
Normal loss refers to the reduction in quantity of goods due to unavoidable reasons such as evaporation, leakage, or breakage during transit or storage. This loss is considered inherent in the consignment process and does not require special treatment in the consignment account.
While the normal loss itself is not recorded separately, it affects the valuation of closing stock. The total expenses incurred for the consignment are spread over the net usable quantity, which is calculated by subtracting the normal loss from the total quantity sent.
This leads to a higher cost per unit for the remaining stock. If there is any scrap value realized from the normal loss, it should be credited to the consignment account.
Cost per unit = (Total cost – Scrap value of normal loss) ÷ Normal quantity Normal quantity = Total quantity sent – Normal loss
By distributing the cost over the normal quantity only, the financial records more accurately reflect the actual cost of usable stock.
Accounting for Abnormal Loss
Abnormal loss arises from unexpected events such as theft, fire, or accidents. Unlike normal loss, abnormal loss is not inherent to the business and needs to be recorded separately to prevent distortion of profitability.
The value of abnormal loss is calculated in the same way as closing stock, based on proportionate cost. To remove its impact from the consignment account, the following journal entry is made:
Abnormal Loss Account Dr.
To Consignment Account
If any part of the loss is recovered through insurance or salvage, it is credited to the abnormal loss account. The balance in this account, representing the net loss, is transferred to the profit and loss account.
This treatment ensures that the consignment account reflects only the regular outcomes of the consignment activities.
Documentation and Reporting
Proper documentation is critical in consignment transactions. The process typically involves several key documents:
- Proforma Invoice: Sent by the consignor to the consignee detailing the goods dispatched.
- Goods Received Note: Prepared by the consignee to confirm receipt of goods.
- Account Sale: Issued periodically by the consignee, summarizing sales, expenses, and commissions.
These records help maintain accountability and form the basis for accounting entries in both parties’ books. Accurate documentation ensures that both the consignor and consignee have a shared understanding of the transaction and reduces the possibility of disputes.
Entries in the Books of Consignor
To reflect the consignment arrangement accurately, the consignor records the following entries:
- On dispatch of goods: Consignment Account Dr.
To Goods Sent on Consignment Account - For expenses incurred by the consignor: Consignment Account Dr.
To Bank or Cash Account - On receiving the account sale: Consignee’s Account Dr.
To Consignment Account - For commission allowed to the consignee: Consignment Account Dr.
To Consignee’s Account - For unsold stock at the end of the period: Consignment Stock Account Dr.
To Consignment Account - When transferring profit: Consignment Account Dr.
To Profit and Loss Account
These entries provide a systematic way to track the performance of the consignment and ensure that the consignor’s financial records reflect the true state of affairs.
Advances and Security Deposits
The consignee may provide funds to the consignor either as an advance or as a security deposit. The treatment of each differs in accounting.
If the amount received is an advance, it is credited to the consignee’s account and adjusted later against sales proceeds. This is a simple transaction and requires no special handling.
However, if the payment is in the form of a security deposit, particularly when it is calculated as a percentage of the value of goods sent, it requires different treatment. The portion of the security deposit corresponding to the unsold goods at the end of the period should remain recorded as a liability, rather than being fully adjusted. This distinction is crucial for accurate reporting of obligations and receivables between the consignor and consignee.
Benefits of the Consignment Model
Consignment offers several advantages to both parties involved. For the consignor, it provides an opportunity to penetrate new markets without incurring the costs of establishing a sales outlet. For the consignee, it presents a low-risk business opportunity where income is generated through commission without the need for capital investment in inventory.
Moreover, consignment encourages better sales performance, as the consignee is incentivized through commissions. It also allows for real-time feedback from the market, enabling the consignor to adjust pricing or product offerings based on consumer behavior observed by the consignee.
Controls and Internal Checks
To maintain transparency and avoid misuse of resources, effective controls must be in place. These include periodic reconciliation of goods and sales records, verification of account sales, and regular audits. Both parties should ensure that their respective books reflect identical figures for quantities and amounts.
Internal checks, such as confirming the inventory held by the consignee and matching it with reported unsold stock, help prevent discrepancies. Clear agreements about commission rates, treatment of losses, and responsibilities ensure smooth functioning of the consignment arrangement. These measures provide confidence in the integrity of the system and foster trust between the consignor and consignee.
Introduction to Complexities in Consignment Accounting
While the foundational principles of consignment accounting cover the basic treatment of goods sent, sales, commissions, and losses, real-world scenarios often present more nuanced cases. These complexities arise due to variations in commission structures, handling of abnormal events, and specific arrangements between consignor and consignee.
Understanding how to navigate such intricacies is crucial for maintaining accurate and compliant accounting records. We explored in-depth concepts such as valuation under losses, the role of overriding commissions, adjustments for security deposits, and the relevance of inventory tracking in consignment arrangements.
In-depth Treatment of Del-Credere Commission
Del-credere commission not only compensates the consignee for the risk of bad debts but also alters the financial responsibility structure between the two parties. When this commission is paid, the consignee assumes liability for any unpaid credit sales.
For example, if a consignee sells goods worth a certain amount on credit and fails to recover the dues, they must absorb the resulting bad debt. In such cases, no entry for bad debts appears in the consignor’s books. The consignee adjusts the loss against their own accounts, ensuring that the consignor’s profit remains unaffected.
The determination of whether del-credere commission applies to total sales or only to credit sales depends on the terms of the agreement. In the absence of a clear specification, it is generally assumed to apply to total sales.
Implications of Overriding Commission
Overriding commission serves as an additional incentive beyond regular or del-credere commission. It is typically offered when the consignee performs tasks outside the scope of normal responsibilities. This includes selling above a benchmark price, introducing products to new markets, or bearing promotional costs.
For instance, if the invoice price is fixed but the consignee manages to sell at a higher rate, they may receive a predetermined percentage of the additional amount as an overriding commission. This not only motivates higher sales performance but also rewards business development efforts. The overriding commission is recorded in the consignor’s books by debiting the consignment account and crediting the consignee’s account, just like other commission types. It is important that these additional commissions are explicitly outlined in the consignment agreement to avoid ambiguity.
Valuation of Closing Stock with Normal Loss
The presence of normal loss due to evaporation, shrinkage, or handling impacts the per-unit cost of the remaining inventory. When calculating the value of unsold stock, the total expenses incurred on the consignment must be spread over the net quantity, excluding the portion lost to normal loss.
This ensures that the remaining stock reflects the true cost of the usable inventory. The formula used is:
Cost per unit = (Total cost – Scrap value of normal loss) ÷ Normal quantity Normal quantity = Total quantity sent – Normal loss
If any scrap value is realized from the normal loss, it is credited to the consignment account to adjust the total cost accordingly.
Handling Abnormal Loss: A Detailed Look
Abnormal loss requires a different accounting approach because it is not part of the routine process. Events such as fire, theft, or accidental damage trigger such losses. Since these are not expected, they are recorded separately to maintain the accuracy of the consignment account.
Valuation of abnormal loss involves allocating a proportionate cost to the lost units, similar to how closing stock is valued. The relevant journal entry to record the loss is:
Abnormal Loss Account Dr.
To Consignment Account
If insurance compensation or salvage value is received, it is credited to the abnormal loss account. The final balance, representing unrecovered loss, is transferred to the profit and loss account. This treatment ensures that abnormal events do not distort the performance of the consignment.
Distinguishing Between Advance and Security Deposit
The consignee may pay a sum to the consignor at the beginning or during the consignment period. This payment can either be an advance or a security deposit, and its treatment varies accordingly.
An advance is a payment made in anticipation of future sales. It is credited to the consignee’s account and adjusted against the amount due from the sale of goods. This is a straightforward transaction that affects only the receivables and does not influence liability.
A security deposit, on the other hand, is held as collateral for the goods consigned. It is usually calculated as a fixed percentage of the consignment value. The distinctive feature of a security deposit is that it is not fully adjusted at the end of the period. Instead, the portion related to unsold goods remains unadjusted and is recorded as a liability in the books of the consignor. This distinction helps in proper classification of liabilities and ensures accurate representation of funds held on behalf of the consignee.
Importance of Inventory Reconciliation
In consignment arrangements, ownership of goods lies with the consignor. Therefore, it is essential to reconcile the inventory at the consignee’s premises with the consignor’s records. Regular verification ensures that the unsold stock reported matches the physical stock held.
The inventory reconciliation involves comparing the quantity of goods sent, goods sold, and goods remaining. Any discrepancies must be investigated promptly to prevent fraud, misstatement, or loss.
Such checks are typically carried out at the time of receiving the account sale or during periodic audits. Maintaining updated records of movement and sale of goods enhances transparency and supports accurate valuation.
Accounting Entries in Consignee’s Books
Though the consignee does not own the goods, they still maintain specific records to track the consignment. These records include:
- Goods received on consignment: No journal entry is passed, but the quantity is recorded in a memorandum book.
- Expenses incurred:
Consignor’s Account Dr.
To Bank or Cash Account - Sale of goods:
Bank or Debtors Account Dr.
To Consignor’s Account - Commission earned:
Consignor’s Account Dr.
To Commission Account - Advance or security deposit paid:
Consignor’s Account Dr.
To Bank Account
These entries allow the consignee to track their financial position regarding each consignment and ensure proper reporting to the consignor.
Effect of Discounts and Allowances
Sometimes, discounts are allowed to customers during the sale of consignment goods. These can be trade discounts, cash discounts, or special promotional reductions. The impact of each type varies:
- Trade discounts are deducted before invoicing and do not appear in the books.
- Cash discounts are recorded as expenses in the consignee’s books if allowed.
- Promotional allowances, if borne by the consignor, are recorded in the consignment account.
It is important that such discounts are clearly categorized and agreed upon to avoid confusion during reconciliation.
Challenges in Consignment Accounting
Although consignment is a widely used method of selling goods, it presents certain challenges in accounting. These include:
- Determining the correct treatment of losses
- Proper valuation of closing stock
- Accurate calculation of commission types
- Reconciling consignor and consignee records
- Ensuring compliance with contractual terms
To overcome these challenges, both parties must maintain detailed documentation and establish clear communication. Regular training and audits also contribute to more efficient management of consignment transactions.
Use of Technology in Consignment Tracking
Modern accounting systems and inventory management tools simplify the process of handling consignments. These systems allow real-time tracking of stock levels, automate commission calculations, and generate account sales quickly. Integrated software reduces human error and improves accuracy in reporting.
By using barcoding, RFID, and cloud-based platforms, consignors and consignees can share information instantly, enhancing transparency and reducing delays. The digitalization of consignment records supports better control and analysis of business performance.
Reporting and Disclosure Requirements
Consignment transactions must be properly disclosed in financial statements. For the consignor, unsold goods held by the consignee are treated as part of inventory and shown under current assets. Any amount receivable from the consignee, including sales proceeds or security deposits, is recorded under receivables.
Consignees, while not recording the goods as assets, must disclose advances paid or liabilities for sales proceeds due to the consignor. Clear disclosures ensure compliance with accounting standards and improve the reliability of financial reports.
Building Effective Consignment Agreements
A well-drafted consignment agreement is the foundation of a successful consignment arrangement. The agreement should clearly define:
- Roles and responsibilities of each party
- Types and rates of commissions
- Risk-sharing arrangements, especially for credit sales
- Provisions for losses and insurance
- Terms for advances and security deposits
- Reporting frequency and format of account sales
Such clarity helps prevent disputes and provides a framework for consistent accounting and reporting.
Best Practices in Managing Consignment Transactions
To ensure efficiency and minimize errors, the following best practices are recommended:
- Maintain separate accounts for each consignment
- Regularly reconcile physical stock with accounting records
- Review account sales promptly upon receipt
- Verify all expenses and commissions claimed by the consignee
- Periodically review consignment agreements for relevance
These practices contribute to improved internal control, better decision-making, and enhanced profitability from consignment operations.
Accounting Entries in the Books of the Consignor
Consignment accounting begins with recording the initial transfer of goods. In the consignor’s books, since the goods are not sold but merely sent to the consignee, the transaction is not treated as a sale. Instead, it is recorded in a separate consignment account.
Goods Sent on Consignment
When goods are dispatched, the following entry is made:
Consignment Account Dr.
To Goods Sent on Consignment Account
This entry reflects the cost of goods sent and is not a revenue-generating transaction.
Expenses Incurred by the Consignor
All expenses directly related to sending the consignment, such as freight, insurance, and packaging, are debited to the consignment account:
Consignment Account Dr.
To Bank/Cash/Other Accounts
Expenses Incurred by the Consignee
When the consignee incurs expenses such as unloading, warehousing, or marketing, the consignor debits these to the consignment account:
Consignment Account Dr.
To Consignee’s Account
These expenses add to the cost of goods and affect the valuation of unsold inventory.
Sales Made by the Consignee
When the consignee sells the goods, the consignee’s account is credited, and the consignment account is debited:
Consignee’s Account Dr.
To Consignment Account
This entry shows the revenue generated from sales and increases the receivable from the consignee.
Commission Payable to Consignee
Commission is an expense to the consignor and is recorded as follows:
Consignment Account Dr.
To Consignee’s Account
This may include regular commission, del-credere commission, and overriding commission depending on the agreement.
Unsold Stock at the End of the Period
Closing stock represents unsold goods with the consignee and must be brought into the books:
Stock on Consignment Account Dr.
To Consignment Account
The valuation is done based on proportionate cost including expenses, adjusted for normal loss.
Profit or Loss on Consignment
The balance in the consignment account after all debits and credits is transferred to the profit and loss account:
If there is a profit:
Consignment Account Dr.
To Profit and Loss Account
If there is a loss:
Profit and Loss Account Dr.
To Consignment Account
Consignee’s Books
The consignee does not own the goods and therefore does not record them as inventory. Only transactions that affect their role as an agent are recorded.
Recording Expenses
Any expenses incurred are debited as recoverable from the consignor:
Consignor’s Account Dr.
To Bank/Cash/Other Accounts
Recording Sales
Sales proceeds belong to the consignor, so the amount received is credited to the consignor:
Bank/Cash/Other Accounts Dr.
To Consignor’s Account
Recording Commission
Commission earned by the consignee is their income:
Consignor’s Account Dr.
To Commission Income Account
This ensures clarity in the consignee’s earnings from the consignment arrangement.
Valuation of Unsold Stock
The valuation of closing stock at the consignee’s premises includes the cost of goods plus proportionate non-recurring expenses such as freight and insurance. It does not include selling or administrative expenses incurred after the goods arrived.
The formula used:
Closing Stock Value = (Cost of goods sent × Quantity unsold ÷ Total quantity sent) + Proportionate expenses
In cases of normal loss, this valuation applies to the net quantity, which raises the unit cost.
Treatment of Normal and Abnormal Loss
Normal Loss
It is an expected reduction in quantity due to inherent characteristics of goods. It is not recorded separately. However, while calculating closing stock, the cost is distributed over the reduced quantity.
Abnormal Loss
This loss arises from exceptional events and should be treated separately:
Abnormal Loss Account Dr.
To Consignment Account
The valuation is similar to unsold stock, and any insurance recovered is adjusted:
Bank/Insurance Company Dr.
To Abnormal Loss Account
The net loss is transferred to the profit and loss account:
Profit and Loss Account Dr.
To Abnormal Loss Account
Features of Consignment Accounting
No Transfer of Ownership
Ownership of goods remains with the consignor until the consignee sells them. Therefore, unsold goods appear in the consignor’s closing inventory.
Separate Consignment Account
Each consignment transaction is recorded in a separate account to calculate the profitability of each consignment individually.
Realization Basis of Revenue
Revenue is recognized only when the consignee sells the goods. Mere dispatch does not result in income.
Adjustment for Losses
Proper accounting ensures normal and abnormal losses are treated accurately to avoid distortions in profitability.
Agent-Principal Relationship
The consignee operates as an agent and not as a buyer, meaning no revenue is recorded for inventory unless sold.
Special Cases in Consignment
Goods Invoice at a Marked-Up Price
Sometimes goods are invoices to the consignee at a price higher than cost, often called invoice price. This includes a markup or loading for internal purposes.
The consignment account is maintained at invoice price but adjusted later:
To remove the loading:
Goods Sent on Consignment Account Dr.
To Consignment Account
Or
Consignment Account Dr.
To Stock Reserve Account
This adjustment ensures profit is not overstated.
Advance Against Consignment
If the consignee gives an advance, the amount is credited to their account and reduces the balance receivable. It is not income for the consignor.
Security Deposit
A refundable deposit held against consignment is treated as a liability unless the goods are sold. The portion related to unsold stock remains a liability and is not adjusted.
Control Accounts for Consignment
For organizations with multiple consignments or consignees, control accounts help summarize and track overall positions.
Examples include:
- Consignment Debtors Account
- Consignment Stock Account
- Consignment Profit or Loss Account
These control accounts support reporting and financial analysis by aggregating individual consignment transactions.
Accounting Standards Impacting Consignment
Accounting standards dealing with inventory and revenue recognition influence consignment accounting. These standards ensure that inventory held by third parties is correctly disclosed and revenue is not prematurely recognized.
Key concepts include:
- Inventory recognition for unsold stock
- Proper revenue timing
- Expense matching
Internal Controls in Consignment
Consignment arrangements require tight control mechanisms to avoid misstatements or fraud.
Suggested controls include:
- Periodic account sales reconciliation
- Physical stock verification at consignee’s location
- Segregation of duties between sales and accounting
- Proper documentation and consignment agreements
These ensure transparency and accuracy in reporting.
Legal Considerations in Consignment
The legal structure of consignment agreements determines risk allocation and accounting treatment.
Important aspects:
- Title retention clauses
- Risk of loss terms
- Duties and responsibilities of consignee
- Commission and incentive clauses
Properly drafted agreements prevent disputes and support consistent accounting.
Consignment in International Trade
When consignment occurs across borders, additional complexities arise:
- Customs documentation and duties
- Currency conversion
- Tax implications
- Time lags between dispatch and sale
International consignments often require detailed tracking and reconciliation to manage compliance and profitability.
Real-World Applications
Retail Consignments
Common in fashion and electronics where the consignor supplies goods to retailers who pay after sale.
Industrial Consignments
Used in machinery parts where availability at the point of use is critical but ownership remains with the supplier.
Agricultural Produce
Farmers send produce to commission agents who sell at local markets and remit proceeds after deducting expenses.
Each of these applications may involve different expense structures, risk levels, and documentation needs.
Use of Technology in Consignment Accounting
Modern accounting software allows for better management of consignment transactions:
- Automated journal entries based on account sale data
- Real-time inventory tracking with consignee inputs
- Alerts for aging stock or delayed settlements
- Consolidated reporting for multiple consignments
Technology ensures consistency and efficiency, particularly for businesses managing large-scale consignment operations.
Integration with ERP Systems
Businesses using enterprise resource planning systems often integrate consignment modules with inventory, accounting, and sales modules. This creates a seamless flow of data, enabling better decision-making.
Features include:
- Batch-wise tracking of consignments
- Valuation reports for unsold stock
- Expense allocation logic
- Commission calculations based on dynamic parameters
ERP integration also aids in compliance and audit readiness.
Conclusion
Consignment accounts form an essential part of accounting practices where goods are sent by one party to another for sale without transferring ownership. This system plays a vital role in industries involving widespread distribution networks or product launches in unfamiliar markets. Through the detailed exploration of account sale, types of commissions, and the treatment of various forms of losses and advances, it becomes evident that the consignment mechanism requires careful and consistent accounting treatment to present an accurate financial picture.
The account sale sent by the consignee is pivotal for the consignor’s record-keeping, ensuring transparency in the revenue generated and expenses incurred. Understanding different types of commissions like ordinary, del-credere, and overriding commissions helps clarify the consignee’s role, responsibilities, and reward structure. These commissions are not just incentives but are reflective of additional risks or performance-based incentives that impact how transactions are recorded and how liabilities and incomes are distributed.
Losses in consignment must be distinctly categorized. Normal losses, being inherent and unavoidable, affect the valuation of unsold stock and should be factored into cost per unit. In contrast, abnormal losses require separate accounting treatment to maintain the integrity of reported profits. Recognizing these differences helps ensure the accounts reflect only true operational outcomes and not distortions caused by unforeseen events.
Equally important is distinguishing between advances and security deposits from the consignee. Advances are temporary and directly linked to sale proceeds, while security deposits are held until the unsold inventory is dealt with, especially in cases where risks or performance guarantees are involved. Accurate classification of these inflows preserves the credibility of both current assets and liabilities.
Overall, consignment accounting demands diligence, transparency, and a firm understanding of the relationship dynamics between the consignor and consignee. When applied correctly, these accounting treatments safeguard financial reporting accuracy and provide valuable insights into business performance in consignment arrangements.