Under this approach, the business is focused on producing the items for sale whereas its sales is managed by another business. This is done through a pre-defined arrangement where the items are sent on consignment to the seller and any sales is shared between them. The areas to consider when dealing with this scenario are: Inventory on Consignment; Sales and “Reverse” Invoice; and Returned Consignment Items.
INVENTORY ON CONSIGNMENT
For the Consignor, i.e. the business delivering the items, the quantity and unit cost of the items are captured under “Inventory – On Consignment”. This shall be based on the quantity produced from its manufacturing process, and the accumulated costs incurred in the said process. In the business system, the data will be triggered by “InventoryIn” process. The accounting entries to reflect this are as follows:
DR Inventory – On Consignment CR Inventory – Items
Note that inventory on consignment are physically not held by the business but held by the seller.
SALES AND “REVERSE” INVOICE
When a sale is made by the seller, the Consignor shall be notified of the remittance to be made by the seller. When the “Reverse Invoice” notice is issued, the Consignor will update the inventory balance of the affected consigned item in its system. This “InventoryOut” process will be reflected by the following accounting entries:
DR Sales Expenses – On Consignment CR Inventory – On Consignment
The reverse invoice representing sales revenue will also trigger the following entries:
DR Debtor – On Consignment
DR Sales Expense – Commission Charges CR Sales – On consignment
The sales transaction shall be closed upon receipt of the funds in the bank from the seller (“Debtor – On Consignment”). The gross profit earned by the business is the difference between sales and sales expense.
RETURNED CONSIGNMENT ITEMS
When the consigned items are returned, this will trigger an “InventoryIn” process. The accounting entries to reflect this situation are as follows:
DR Inventory – Items CR Inventory – On Consignment
If the inventory is obsolete or slow-moving item, a decision is required from the business on whether to maintain or write-off the inventory balance to the P&L account.