Consignment Accounting: Definition & Format
One of the largest parts of a business is accounting. Your books have to be properly taken care of to ensure that everything will run smoothly. However, accounting isn’t the same for all businesses. That’s because not all businesses operate in the same fashion.
One of the major issues that some people have is accounting for consignment inventory. If your business operates using a consignment model, have no fear. We’re going to cover all of the basics of consignment accounting in this article.
Here’s What We’ll Cover:
Defining the Term: Consignment
When people hear the word consignment, they tend to think of consignment shops. Consignment items are brought to a place of business and sold on behalf of a person. However, consignment shops are not the only businesses that operate under this model. In fact, many businesses use consignment without even knowing it.
The Consignment Process
When you’re talking accounting and business, consignment refers to the consignment sale process. This process is specialized, and it requires its own accounting method. In the consignment process, goods are left with a third-party by a manufacturer or provider.
The individual selling the goods is the consignee, while the provider of the goods is the consignor. The two parties make a consignment agreement, stating that the consignee will sell the goods for consignor. The consignee will take a fee for this, while the consignor will retain ownership of the goods while they are unsold. Normally, there is a specific consignment period that is established. This period of time is how long the consignee will attempt to sell the goods for the consignor.
In most cases, consignment shops are the sole user of this business model. People sell toys, furniture, shoes, and clothes on consignment frequently.
The 3 Basic Steps of the Consignment Process
The consignment process adheres to 3 basic steps, in most cases:
- Transfer of Goods. The consignor transfers goods to the consignee.
- Agreement. The consignor agrees that ownership remains with the consignee. The consignee agrees to the sales commission expense proposed by the consignor.
- Sales and Transfer of Funds. When a sales transaction takes place, the consignee transfers funds to the consignor, minus the commission fee.
Understanding Consignment Accounting
You may be wondering how consignment accounting differs from traditional accounting. To understand consignment accounting, you’ll need to know a few specific terms.
- Pro-Forma Invoice: Provided to the consignee by the consignor. It provides information about the goods being received, like quantity and price.
- Non-Recurring Expenses: Expenses incurred by the consignor. These are expenses related to sending the goods to the consignee. They are added to the cost of the goods.
- Recurring Expenses: Incurred by the consignee once goods are received. These are considered a business expense for maintaining the goods.
- Commission: The basis of revenue for the consignee. Commission revenue is the money charged by the consignee to the consignor for the sale of the goods.
- Account Sale: Provided periodically to the consignor by the consignee. It provides information about the goods sold, and the commission expenses held by the consignee.
Recording Journal Entries for a Consignment Account
When practicing consignment accounting, the process begins when the consignee receives goods. The consignor will make a journal entry for the goods received. The journal entry for the consignment accounting will have a credit and a debit. It is recorded as a debit for the consignment inventory, and a credit for the store’s inventory. The consignee does not make an entry.
Then, the consignor will pay expenses for the goods to be shipped. In double-entry accounting, the shipping charges are accounted as a debit, while a credit is placed for accounts payable.
Now, the consignee (the business) begins making entries. In their books, the double-entry will have a debit entry for the consignor’s account. A credit is created for the consignee’s accounts payable.
When the consignee sells the goods, they’ll give the consignor’s account a credit. The money received is recorded as a debit.
Another entry is made when the goods are sold, as well. The consignee creates an entry documenting the commission that they make. It is recorded as a debit on the consignor’s account, and a credit for the consignee.
The consignee then provides an account sale to the consignor. This details revenue and expenses incurred on the sale of the goods.
The consignee then records the funds that are transferred to the consignor, less the commission fees.
As you can see, using double-entry accounting is the easiest way to record these transactions. When you’re looking to do this in the easiest way possible, make sure that you use reliable accounting software. It can help you track all of every part of the consignment accounting process.
Advantages of Consignment
The accounting process for the consignment business model seems to be difficult. However, the process itself comes with many advantages. Take a look at them below.
- Reduced Costs: When you run a consignment business, you have lower costs. Inventory can be one of the most expensive parts of business. Consignment eliminates the need to spend money on inventory.
- Exposure: Consignment provides a great deal of exposure to your business. People and businesses like to work with consignment businesses. It makes selling their items easier.
- Growth: When you spend less money on inventory, you can afford to grow your business more quickly.
Drawbacks of Consignment
There are some drawbacks associated with consignment, as well. The two most notable are listed below.
- Lower Profit Margins: When you only charge commission, you reduce your profits. This can make it harder to make money.
- Higher Risk: If goods are damaged in your store, you’re liable for their costs. This can make consignment a risky business.
Consignment businesses are one of the easiest businesses to start. They require little capital to get started. However, the consignment accounting process can become difficult if you don’t know what you’re doing. By reviewing this guide and investing in good accounting software, you can make consignment accounting easy! If you want more information like this, check out our resource hub! It has plenty of information just like this.