2. Accounting for inventory consignment arrangement

Let’s take a look at an example of this type of inventory consignment arrangement from an accounting standpoint. A company (Manufacturer) which produces Product A wants to attract a new customer (New Customer). New Customer is interested in Product A but doesn’t want to freeze (invest) cash in inventory and negotiates an inventory consignment arrangement with Manufacturer. Manufacturer will initially ship 100 tons of Product A to New Customer’s warehouse and will replenish this inventory as New Customers uses the product. New Customer will not take title to the product until the product is consumed by New Customer. The selling price for one ton of Product A is set at $100. Manufacture’s cost of one ton of Product A is $60.

At the beginning of October 20X2, Manufacturer ships 100 tons of Product A to New Customer. The following journal entry is recorded by Manufacturer:

The consignment inventory amount was determined as $60 x 100 tons = $6,000.

Note: no journal entries are made by New Customer except for entering entries in an inventory system to track how much consigned inventory was received and consumed.

During October 20X2, New Customer uses 70 tons of Product A and notifies Manufacturer about this consumption by sending an account statement. Manufacturer uses the account statement to issue an invoice to New Customer and record the sale of 70 tons along with the related cost of goods sold:

The sales amount was determined as $100 x 70 tons = $7,000.

The cost of goods sold amount was determined as $60 x 70 tons = $4,200.

At the end of October 20X2 or beginning of November 20X2, Manufacturer ships 70 tons of Product A to replenish the stock at New Customer’s warehouse and makes the following journal entry:

3. Physical counts of consigned inventory

In an ideal world, communication between Manufacturer and New Customer about goods consumed will be timely and accurate. However, due to multiple reasons (e.g., poor New Customer’s inventory tracking system, lack of appropriate processes and procedures in place), the communication may not be as good as one would like it to be. Therefore, it may be a good idea to reconcile the consigned inventory quantities on hand at New Customer’s warehouse and Manufacturer’s records (i.e., control account for consigned inventory). Such reconciliations may be performed monthly, quarterly, or annually. They may be based solely on records from both parties or may include a visit by Manufacturer’s representatives to New Customer’s warehouse to physically count Manufacturer’s goods.

Note: At some point New Customer can start buying these goods (i.e., take title before the goods are consumed) in additional to using the consigned inventory of Manufacturer. In such case, New Customer should clearly segregate own goods and consigned goods to ensure accurate physical counts and record-keeping.

Such reconciliation procedures will help ensure that Manufacturer’s inventory and cost of goods sold, on one hand, and sales and accounts receivable, on the other hand, are accurate. They will also help New Customer in accurately recording its cost of inventory.

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