Accounting for Consignment Inventory

Definition:

Consignment inventory represents stock legally owned by one company or business but held by another. Usually, the risks and rewards associated with consignment inventory remain with the company that owns it.

Consignment inventory is common in industries where companies transfer their goods to the dealer, which distribute or sell them further. The dealer, in this case, is only responsible for its distribution or retail operations.

As mentioned, there are usually two parties involved in the consignment deal. The first party, the consignor, is the company that provides the goods. The other party, the consignee, is the company or business that holds the physical inventory.

The consignee also has the option to return any unsold or damaged goods to the consigner. Other names used for consignment inventory are consignment goods or consignment sales.

Accounting Treatment:

When it comes to the accounting treatment of consignment inventory, the standards are clear about it. Since the risks and rewards of the goods do not transfer due to the transfer, the consignor cannot record the inventory as sold.

However, some companies may still choose to convert inventory from one account to another to keep their records organized.

With consignment inventory, the consignor transfers the goods to the consignee, which sells the goods to customers. Once the consignee sells the goods, the risk and rewards related to the inventory get transferred.

The consignee also keeps a percentage of the sale proceeds and pays the consignor a predetermined sales amount.

Once the consignee sells the inventory, the consignor can record the sale amount. As with any other sale transaction, it consists of two double entries to the accounts.

The first double entry is to record the sale made through the consignee, while the second double entry is to record the decrease in inventory. Therefore, the consignor can only reduce its inventory account once it receives the sale proceeds.

On the other hand, if the consignee fails to sell all the goods transferred, they will return those goods to the consignor. In that case, the consignor doesn’t need to pass any double entry since the risks and rewards stay the same.

If the consignor had transferred the inventory into a different account, then they can convert the goods back to their finished goods account.

Journal Entry:

As mentioned, when the consignor transfer goods to the consignee, the risks and rewards still remain. Therefore, the consignor doesn’t need to pass a journal entry to the accounts.

However, some consignors may use the following double entry to transfer inventory into a different account, for organization.

DrConsignment inventoryx
CrFinished goodsx

Once the consignee sells the goods, it will repay the consignor the sale proceeds. It is when the risks and rewards transfer and the consignor can record the sale.

As mentioned, the consignor must use two double entries to record the transaction. The first journal entry used to record the sale proceeds is as follows.

EntryDescriptionAmount
DrCash or Bankx
CrSalesx

The next journal entry is to reduce the inventory. The treatment will differ according to whether the consignor has transferred the goods to a temporary consignment inventory account. The journal inventory is as follows.

EntryDescriptionAmount
DrCost of salesx
CrConsignment inventory / Finished goodsx

In case the consignee returns unsold goods, the consignor doesn’t need any accounting entries. However, if the consignor had transferred the goods to a temporary consignment inventory account, it must reverse the accounting treatment.

Example:

A company, ABC Co., transfers its goods to another company, XYZ Co., which further sells their goods to customers. At the start of the year, ABC Co. sends goods valued at $100,000 to XYZ Co. Subsequently, at the end of the year, XYZ Co. returns $20,000 worth of goods to ABC Co.

For the $80,000 goods sold, XYZ Co. gives ABC Co. $120,000 sale proceeds collected from its customers through a bank transfer.

Firstly, ABC Co. must record the sale proceeds for goods sold by XYZ Co. The accounting treatment will be as follows.

DrBank$120,000
CrSales$120,000

Similarly, ABC Co. must record the transfer of its inventory to customers, which marks a transfer of risks and rewards. The accounting treatment is as follows.

EntryDescriptionAmount
DrCost of sales$80,000
CrFinished goods$80,000

For the goods that XYZ Co. returned, ABC Co. does not need to pass any accounting entries.

Conclusion:

Consignment inventory refers to goods transferred from a company to another party while still holding its risks and rewards.

Therefore, there are two parties in a consignment inventory deal, the consignor and the consignee. The accounting treatment for consignment inventory depends on whether the consignee sells the goods or not.

Accounting for Goods in Transit

What Is Goods In Transit?

Goods in Transit indicates the stock that is bought from the purchaser and delivered through a dealer, nonetheless, the merchandise is in transit but still needs to arrive at the proposed buyer.

Towards the ending of an accounting time frame, such stock items permit exceptional consideration for accounting such merchandise are neither accessible at the dealer’s space nor at the buyer’s location.

Explanation

As a presumable possibility, these items can remain disregarded during the way toward representing overall stock as such products are not genuinely available at both the buyer’s or the vendor’s place.

The accounting of goods on the way demonstrates whether the dealer or the buyer of the products has the proprietorship and who has compensated for conveyance. Normally, there is an organization (dispatching terms) between the vendor and the purchaser with respect to who should record these items in the accounting records.

Goods in transit refer to stock and different sorts of stock that have left the transportation dock of the merchant, yet has not arrived at the receiving end of the purchaser. The idea is utilized to demonstrate whether the purchaser or dealer of products has collected the goods, and who is has to pay for transport.

Preferably, either the vendor or the purchaser should record products on the way in its accounting records. The standard for doing so depends on the delivery terms related to the goods, which are:

  • FOB shipping point. In case the shipment is assigned as freight on board (FOB) shipping point, proprietorship moves to the purchaser when the shipment departs the dealer.
  • FOB destination. In case of the shipment assigned as freight on board (FOB) destination, proprietorship moves to the purchaser when the shipment shows up at the purchaser.

Examples:

Example 1

ABC Inc. is the wholesaler and XYZ Inc. is the buyer. ABC Inc. ships stock worth $50,000 on March 15, 2020, and it still has to arrive at XYZ Inc. Figure out the organization that may record the merchandise on the way in the accounting books in case the conditions of the delivery freight on board (FOB) transporting point.

FOB delivering point implies that XYZ Inc. (buyer) will take responsibility for stock when it departs ABC Inc’s. transporting area. Thus, ABC Inc. will record a sales transaction on March 15, 2020, while XYZ Inc. may note it as transit inventory on a similar date.

Example 2

Here, ABC Inc. is the dealer and XYZ Inc. is the buyer, however, the terms of conveyance have been changed to FOB destination, and the shipment still has to arrive at XYZ Inc.’s. dock. The goods are required to be conveyed on April 5, 2020.

Figure out the organization that may note the goods in transit in their accounting books for such situation.

Under FOB destination, the buyer will note the sale contract on April 5, 2020, rather than March 15, 2020. Hence, for such a situation, XYZ Inc. will record the journal entry in the books of record on April 5, 2020.

Subsequently, there will be a contrast between the dealer and the buyer’s book attributable to the terms of shipment. While XYZ Inc. will note the exchange on April 5, 2020, however, ABC Inc. will record a similar exchange on March 15, 2020.

Goods In Transit Valuation

Recording stock relies upon the agreement with the vendor. Nevertheless, another concern is the goods in transit valuation, which should be perceived in the balance sheet. It is required to account for insurance, transport fees, freight in, shipping into the stock valuation. The issue is should the costs be accrued with goods in transit or wait until they show up.

This relies upon the arrangement of the capable individual over each cost. In case the purchaser is answerable for it, at that point he should assess the expense to make accrue costs as a component of the goods in transit. The purchaser will make accrue when we have a commitment to the provider, consequently not all the costs will be recorded simultaneously with goods in transit.

Treatment of Goods in Transit

The consolidated financial statement consolidates the parent and subsidiary balance sheet and income statement. In case there are goods in transit throughout the reporting date, it must be guaranteed that both parties account effectively for those goods.

The goods in transit actually have a place with the group (parent and subsidiary); hence, the balance must be in the consolidated balance sheet. Nonetheless, the goods should not be counted as double. This may occur if the parent doesn’t record the sale of products however subsidiary records stock and accounts payable.

The accounting treatment is outlined as follows:

When the forwarding specialist arranges the transportation archives, (for example, the bill of filling, receipt, or air waybill), at that time the journal entry can be:

DescriptionDrCr
Goods in transit recordXXXX 
Goods/ Invoice receipt record XXXX

At the point of the goods in transit but to get from the buyer client, then the journal entry can be:

DescriptionDrCr
Goods/ Invoice receipt recordXXXX 
Supplier recordXXXX

At the point the product is gotten by the buyer, then the journal entry can be:

DescriptionDrCr
Stock accountXXXX 
Goods in transit account XXXX

For goods in transit accounting, the foremost problem to answer is if a deal has occurred, bringing about the entry of title to the purchaser. If so, the dealer records a sale and a receivable or money and excludes the good in the ending stock.

The buyer records the payable or the installment of money, the purchase, and takes account of the item for the completion stock. Alternately, if the title has not changed or transferred, no purchase or sale has occurred, and consequently, the inventory is included for the seller’s ending inventory.

Conclusion

In short, goods in transit indicate at the time when the label of possession and threat goes from the vender to the purchaser.

What is inventories profit

Businesses that deal with physical products will have inventory at some point during their operations if not always. Inventory is a term used to describe all tangible materials that businesses use to manufacture products for sale.

For businesses, it is one of the most important assets as it is the main reason for the revenues and profits that they generate, which also translates to an increase in the wealth of owners.

There are different methods to value inventory. The first method that businesses use is known as the First-In, First-Out (FIFO) method. In this method, they value inventory based on the cost of the earliest purchases.

Businesses can also value inventory using the weighted average method using the average cost of purchases. Finally, they can also use the Last-In, First-Out (LIFO) method of inventory valuation, where they value inventory based on the cost of the latest purchase. However, using the LIFO method may be prohibited under some accounting laws.

Types of Inventory

Businesses can categorize inventory into three main types. The first type is raw material. The raw material of a business consists of unprocessed material. These are materials that it further uses in the production process to make finished goods.

Examples of raw material include wood for furniture makers, crude oil for refineries, chemicals for pharmaceutical companies, etc.

The next categorization of inventory is work-in-progress. Work-in-progress is a term used to describe inventory that has entered the production process of business but has not left it.

In other words, work-in-progress is the inventory that is partially finished and still needs work to convert into finished goods. Examples of work-in-progress include molten aluminum for steel manufacturers, which still needs further work to become sellable.

The last categorization of inventory is finished goods. Finished goods consist of goods that are in their finished form and readily available for sale. These are goods obtained after raw materials go through the work-in-progress phase. Examples of finished goods include any products that consumers buy from a business.

The types of inventories that businesses use will depend on their nature. All businesses that deal with physical products will have finished goods but may not have raw materials or work-in-progress inventory. For instance, retailers purchase products and do not need to process them further to sell them.

Therefore, for them, raw material and work-in-progress inventory may not exist. Similarly, the type of inventory will also be different for different types of businesses. For example, the finished goods of one business may be raw materials for another.

Inventory Profit

A concept that applies to inventory is inventory profit. Inventory profit is the increase or appreciation in the value of an item classified in inventory for some time. Regardless of which type of inventory it is or the inventory valuation method used, inventory may be subject to an appreciation in value.

For example, a business holds inventory that cost $50, the market value of which has risen to $75. The $25 difference in the cost of the inventory and its market value is known as inventory profit.

Inventory profit can generate due to two main reasons. The first reason for it is inflation. Inflation occurs when the value of the currency in a country decreases, thus, decreasing the purchasing power of the currency.

When the purchasing power of currency declines, the prices of products in the country goes up. Inventory profit due to inflation mainly occurs when a business uses the FIFO valuation of inventory. In FIFO valuation, the cost of the oldest inventory will be the lowest and will encounter a higher profit due to inflation.

The second reason for inventory profit is appreciation in the value of inventory. Appreciation mainly occurs due to factors other than inflation, for example, market speculation. Businesses that hold a high amount of inventory commonly experience appreciation of inventory.

Some businesses base their operations around inventory profit due to appreciation in value, buying inventory when it is at a lower price, and selling it when its value appreciates.

For a well-managed inventory system, inventory profit is rare because inventory turnover should be fairly regular. When a business can regularly turn over its inventory, it will not experience any inventory profit. Inventory profit mostly occurs for businesses with lower inventory turnover.

However, as mentioned above, some businesses can still profit due to it. Similarly, for businesses that face the risk of obsolescence of inventory, inventory loss due to impairment will be more common, the longer they hold on to it. Overall, inventory profit is very rare, and only specific industries may experience it.

Businesses do not record inventory profit in their books of accounts when it occurs. That is because accounting rules do not permit businesses to record inventory profit. Instead, when a business sells its inventory, its gross profit increases due to inventory profit.

Therefore, businesses do not adjust the accounts at the time of profit. That is different from inventory loss due to impairment, where a business has to record it straight away.

Conclusion

Inventory consists of physical stock that a business holds and uses in its daily operations to generate revenues and profits. The business can use different valuation methods for its inventory and can also classify the inventory into different categories based on the completion level.

Sometimes, the value of inventory can increase when held in a business, known as inventory profit. Inventory profit can occur due to inflation or appreciation in value. There is no accounting treatment of inventory profit.

How to organize inventory for small businesses?

Inventory management

Inventory management is the efficient mechanism of ordering, storing, and use of the company’s inventory. The process includes the management of raw materials, components as well as finished goods. Further, the management of warehoused products and work in process items also fall under efficient inventory management.

Inventory management helps to know when to re-stock inventory, what amounts to purchase or produce, what price the products can be sold as well as the timing of sales to be made.

How to organize Inventory for small businesses?

Small businesses need to be cost-effective in the selection of various methods of inventory management. Here are the ways small businesses can use to organize their inventory:

1) Managing purchase orders

Small businesses shall start with creating and submitting accurate purchase orders. Purchase orders are used for the requisition of raw materials or goods to make resale. Managing purchase orders helps in tracking the movement of stock purchase efficiently to placement and payment of bills.

Purchase orders management helps the owners to estimate the cash flows of the business and also the need to re-stock the inventory levels. The stock re-order alerts can also tell which items are sold fast and slow and which needs refilling or restocking early.

2) Organizing vendor data

Small businesses need to set up stock and vendor information in their software or daily books. They can use excel sheets however they need to manually organize their spreadsheet. They need to organize data using point of sale mechanism.

They need to record each product’s information along with subsequent vendor details. The various details that need to depicted are product name, a short description of the product, product category, sizes, regular selling price, reorder quantities, details of the package, etc.

Using the Point of Sale mechanism helps to keep product details organized and in real-time. Further, it helps to track various post-sales aspects such as vendor billing information, payment terms, and contact of the vendor.

3) Tagging and Labelling inventory

This is the step when the inventory comes into the hands of small businesses. This means managing the products on your hand. Tagging means allocating the prices and affixing price tags while product label displays mean using bar code labels, tracking the inventory to speed checking out i.e. selling the product.

The use of good allocation of time to tag and labeling of inventory helps in making quick checkout of the product. The point of sale mechanism emphasizes the use of bar code scanners. These scanners also come with the function of effective labeling and scanning.

ted, labels can be affixed directly to product packaging or attached to hang tags. Some inventory might even arrive prelabeled with manufacturer’s bar codes, which you can also track in your POS. In that case, your job is easy. You can just add a price label.

4) Physically counting inventory levels

This is a very time-consuming task and excessively mundane. However, this process is a must for small businesses. All the irregularities and reconciliations can be easily solved through physical verification and counting of inventories. For tax purchases, annual counting is a must and done at the end of the fiscal year.

Doing physical counts helps to reduce shortages, displacement, and errors in receipt of stocks. To catch these mistakes, counts should be done in a smaller time period. This can include spot counts at the time of receipt of the product from the vendor.

While stock count should be started with inventory in hand, spot counts should be matched to invoice or purchase orders.

POS mechanism can be used by scanning the items and it can be nearly as useful as physical counting. However, when shortages are found, one should resort to physical counting.

5) Reconciliation of differences in inventory

After the physical counting of stocks, the differences if any shall be reconciled. This can be done by following the procedure of reconciliation. The first step would be to identify the discrepancy in counting. This can be due to inventory missing due to theft, damaged, and not reported and stock recorded as received but not actually received.

In a few cases, it can be just due to reasons owing to wrong labeling. If reasons cannot be known, the stock sheet needs to be adjusted to reflect physical balance in hand. After the adjustment in the books, the difference in any shall be accounted for loss in inventory as inventory shrinkage.

The small businesses shall carefully look if any human error has occurred intentionally or unintentionally. Further, small businesses can use various security features like access policy to stock and locking systems in order to reduce theft of stocks done intentionally.

How do inventories affect the costs of goods sold?

Inventory is a current asset appearing in the balance sheet under the head current asset as well as a major item of the income statement.

Inventories are goods held for sale in the ordinary course of business that can help the management of the company to control and improve the business profitability and operate efficiently.

By nature, the cost of goods sold is an expense and the main component of the income statement.

Cost of goods sold can be calculated using the following formula;

COST OF SALE

                  Opening Stock                        XXX

Add:         Purchases                              XXX

Less:        Closing Stock              (XXX)                     

COGS                                                 XXX

There are several impacts of inventory on the cost of goods sold including Purchase and production cost of inventory plays an important role in recognizing gross profit for the period.

The figure for gross profit is achieved by deducting the cost of sale from net sales during the year.

An increase in closing inventory decreases the amount of cost of goods sold and subsequently increases gross profit.

Similarly, another impact is the difference in valuation. Inventories are measured using these three methods i.e. FIFO (first in first out) LIFO (last in first out) or weighted average cost method.

Based on these methods closing stock for the period is determined which gives different results.

Because when costs of inventories are not uniform either due to price fluctuation or inflation the choice of inventory method may either increase or decrease the value of the closing stock which increases or decreases the cost of goods sold during the year.

Inventory directly affects the cost of goods sold during the year in a number of ways either opening inventory of the current period belongs to last year closing inventory or closing inventory of the current period.

But the main causes of the cost of goods sold the account to increase or decrease is as follow,

Opening inventory

The opening inventory for the current period is the stock leftover from last year means items of goods that are not sold during the previous year.

Every organization wants to sell its opening inventory as soon as possible because there is a risk of obsolescence or deterioration that’s why the first items of every cost of sale account show opening stock.

An overstated amount of opening stock increases the amount of cost of sales significantly and vice versa.

Closing inventory

Similarly closing stock represents the items that are not yet sold at the end of the period.

When a closing stock is wrongly calculated say overstated it lowers the cost of goods sold and increases gross profit for the year.

On the other hand for an understated amount of closing stock when adjustment entry is made to remove the effect of extra stock it increases the cost of sale directly which increases the amount of cost of goods sold significantly and ultimately decreases the profitability of the company.

Another impact of inventory on the cost of sale is their physical obsolescence, deterioration, theft, shortage or decline in prices.

These items may not be able to sell at their original selling price that’s why they are carried at net realizable value ( NRV) in this case a reduction in price is charged to the cost of goods sold thus reducing the value of closing stock and increases the gross profit.

How are inventories reported on financial statements?

Financial Statements:

According to the international accounting standards and generally accepted accounting principles, every entity is supposed to prepare annual financial statements including the following:

These statements or reports are made in order to provide a clear understanding of how the business is performing financially so far.

It includes and reports each and every transaction that has occurred throughout the year.

After the preparation of financial statements by the financial department, an audit firm is hired that audits all the statements and makes sure it shows the true and fair view of the business. One of the major line items of financial statements is the inventory.

What is inventory?

Inventory which is also known as stock are the goods or commodities that is sold by the company for trading purposes. Inventory is held by the entity in the warehouses with the ultimate goal of reselling them.

These are current assets since inventories have a useful life of less than a year, the owner holds the risks and rewards of the goods and has a right to transfer these goods to anyone he wants.

At the end of each year an inventory count is done at the warehouse to calculate the amount of closing inventory i.e. how much inventory is still left at the warehouse and is not sold.

It is treated as a current asset on the financial statements and also makes a part of cost of goods sold.

Inventory on income statement:

The formula to calculate profit is Revenue – Cost and similar is the format of income statement.

It reports the annual turnover first, the amount of which is extracted from the sales ledger.

As per IAS 01, the gross profit and net profit shall be distinctly reported. Hence the cost of goods sold is deducted from the sales in order to calculate the gross profit.

Revenue – Cost of Goods Sold = Gross Profit

The operating expenses are then deducted from the gross profit with the aim of arriving at the net profit.

In this article, since we are talking about the inventory, we will discuss the cost of goods sold only. The formula to calculate cost of sales is as follows:

Opening Inventory + Purchases – Closing Inventory

The opening inventory is the closing inventory of the preceding year and the amount can be extracted from previous financial statements.

The purchases amount is taken from the purchase ledger while the closing inventory is calculated at the year end.

For example, if the accounting period ends at 31st December, the inventory count is done at 31st December each year. These are valued at lower of cost or NRV as per IAS 2.

Net realizable value is the difference between the selling price at which the damaged goods can be sold and any costs incurred in order to sell the good. The cost of goods sold is then deducted from the revenue amount.

This means that the closing inventory is indirectly added to the revenue in order to calculate the net profit.

Inventory on Balance Sheet:

Closing inventory is classified as a current asset since it has a useful life of less than a year and is a tangible good from which future economic benefits are expected.

The assets are reported in the order of liquidity on the balance sheet. The least-liquid item is reported the foremost which is the inventory whereas cash and bank are reported as the last current asset.

The closing inventory is reported at its cost or net realizable value, whichever is lower.

Inventory on statement of cash flow:

Change in closing inventory is adjusted in the operating activities section of the cash flow statement.

Working capital changes are reported under the operating profit for the year with the aim of achieving net cash flow from operating activities.

An increase in closing inventory is deducted from the cash flow statement since cash is paid for purchases but no cash has been received against such purchases which results in a decrease in cash flow.

Similarly, a decrease in closing inventory is added to the operating profit in operating activities section of the cash flow statement. Inventory on statement of changes in equity: There is no impact of inventory on statement of retained earnings.