Introduction

Accounting for consignment inventory is essential in accordance with IAS-2 (Inventories) as it provides guidance on how to recognize, measure, and value inventory. Since ownership remains with the consignor, they must report consigned goods as inventory. By valuing inventory at the lower of cost or net realizable value, IAS-2 helps consignors accurately report inventory and prevent overstatement.

Overview of IAS-2

IAS-2 defines inventories as assets held for sale in the normal course of business, in the process of production for sale, or as materials or supplies for use in production or services. The objective of IAS-2 is to establish the accounting treatment for inventories, including determining their cost and recognizing expenses, such as any write-down to net realizable value. It provides guidance on cost formulas such as FIFO (First-In, First-Out), weighted-average, and specific identification methods.IAS 2 establishes that the lower of cost and net realisable value should be the basis for the valuation of inventories.

What are Consignment Sales?

Consignment sales involve a business arrangement where the owner of goods sends products to a seller to be sold. The seller, known as the consignee, sells the products on behalf of the owner, who is referred to as the consignor. The consignee typically earns a commission for their services. This arrangement allows the consignor to reach a wider market without the upfront costs of traditional retail, while the consignee benefits from offering a diverse range of products with minimal financial risk. By retaining ownership until the goods are sold, the consignor can effectively manage inventory turnover, and both parties share in the reduced risk, making it a mutually advantageous arrangement. For example, jewelry businesses and agricultural produce often operate under consignment models.

Accounting for Inventory in Consignment Sales

The recognition and measurement of inventory in consignment sales follow these principles:

         Consignor’s Accounting: The consignor retains ownership of the goods until sold and must report the goods as inventory on their balance sheet. Inventory is valued at the lower of cost or net realizable value, as per IAS-2.

         Consignee’s Accounting: The consignee does not record the goods as inventory since they do not own them. Instead, the consignee recognizes commission or fees earned as revenue when the goods are sold.

It is crucial to ensure that:

1. Consigned goods are properly tracked and reflected in the consignor’s records to avoid misstatements in inventory.
2. Proper disclosures, as required by IAS-2, must be made in the financial statements.

Journal Entries for Consignment Inventory

Here’s a detailed example to illustrate accounting treatments:

Scenario:

Manufacturer ships 100 tons of Product A to consignee’s warehouse under a consignment agreement. Consignee will take title and pay AED 100/ton only when the product is consumed. Manufacturer’s cost per ton is AED 60/ton. 

Initial shipment to consignee’s warehouse (in the consignor’s books):

             Inventory (consignments)                     AED 6,000

                       Finished goods inventory                              AED 6,000

Note: Consignee does not make any journal entries, except for entries in their inventory system to track received and consumed consigned inventory.

Recording sales upon consumption: The consignee consumes 70 tons and notifies the consignor, who bills them accordingly.

             Account Receivable                                  AED 7000

                     Revenue – Consignment Sales                             AED 7000   

             Cost of Goods Sold                                  AED 4200

                     Inventory (consignments)                                    AED 4200

Replenishment of consigned stock: The consignor ships 70 tons to the consignee to restock their warehouse.

              Inventory (consignments)                             AED 4200

                          Finished goods inventory                                    AED 4200

Disclosure Requirements as per IAS-2

IAS 2 requires disclosures on inventory:

• Policies for inventory measurement (e.g., FIFO, weighted-average).
• Carrying amounts classified as Raw Materials, Work-in-Progress, and Finished Goods.
• Inventories valued at fair value less costs to sell.
• Expenses from inventory, including write-downs and reversals.
• Circumstances leading to write-down reversals.
• Inventories pledged as security for liabilities.
• Classification of service provider inventories as Work in progress.

Conclusion

The accounting treatment of consignment inventory under IAS-2 ensures accurate recognition and measurement by establishing clear principles for ownership and valuation. Consigned goods remain on the consignor’s financial statements until sold, while the consignee records only commission or fees earned. This approach reduces the risk of inventory misstatements and enhances transparency in financial reporting, fostering investor confidence. By adhering to IAS-2, businesses can efficiently manage consignment arrangements while ensuring compliance and accuracy in financial statements.

Article By

Preethi D