Physical Inventory Count, Ownership of Goods, and Consigned Goods: Videos & Practice Problems

Consignment

Consigned goods refer to items that are held for sale by one party (the seller) but are owned by another party (the supplier). This arrangement is common in boutique shops, where the store displays products from suppliers without taking ownership of them. The seller earns a commission only when the goods are sold, and if the items do not sell, they remain the property of the supplier.

In accounting for consigned goods, it is crucial to note that these items do not appear in the seller's inventory. The seller only records transactions related to sales and the revenue generated from those sales. For instance, if a boutique sells dresses on consignment, the seller will not include these dresses in their inventory records. Instead, they will recognize revenue only when a sale occurs.

Consider a scenario where Jan's boutique sells dresses for Sophie. If Jan receives \$1,000 for each dress sold and earns a commission of \$100 per dress, the accounting entries would reflect this. If Jan sells two dresses, she collects \$2,000 in cash but must pay Sophie the majority of that amount. The journal entries would be as follows:

1. **Debit Cash** for \$2,000, reflecting the total cash received from the sale.

2. **Credit Revenue** for \$200, representing Jan's commission from the sale (2 dresses x \$100 commission).

3. **Credit Payable to Sophie** for \$1,800, indicating the amount owed to Sophie for the dresses sold (total cash received - commission).

In this case, Jan's inventory balance remains at \$0, as the dresses are not her property. Her revenue from the commission is \$200, while her liabilities reflect the \$1,800 owed to Sophie. This example illustrates the key principles of accounting for consigned goods, emphasizing that the seller does not own the goods and only earns a commission upon sale.

Here's what students ask on this topic:

What is the difference between owned inventory and consigned goods in physical inventory counts?

Owned inventory consists of goods that a company legally owns and includes in its inventory records. These goods are counted during a physical inventory count because the company has ownership rights and financial responsibility for them. Consigned goods, however, are items held by a company (the consignee) but owned by another party (the consignor). Although consigned goods may be physically present in the store or warehouse, they are not recorded as inventory by the consignee because ownership remains with the consignor. The consignee only recognizes commission revenue when these goods are sold and records a liability for the amount owed to the consignor. Therefore, physical possession alone does not determine inventory inclusion; ownership is the key factor.

How should consigned goods be recorded in the accounting books of the consignee?

Consigned goods should not be recorded as inventory by the consignee because the consignee does not own these goods. Instead, the consignee records commission revenue only when a sale occurs. For example, if the consignee sells consigned goods, they debit cash for the total amount received, credit commission revenue for the commission earned, and credit a liability account (such as "Payable to Consignor") for the amount owed to the consignor. This liability represents the portion of cash collected that must be remitted to the owner of the goods. No inventory transaction is recorded by the consignee since the goods remain the property of the consignor until sold.

Why is it important to distinguish ownership when performing a physical inventory count?

Distinguishing ownership during a physical inventory count is crucial because only goods owned by the company should be included in inventory records. Including goods that are physically present but not owned, such as consigned goods, would overstate inventory and misrepresent the company's financial position. Ownership determines who bears the risks and rewards of the goods and who should report them as assets. Accurate inventory reporting ensures proper matching of costs and revenues and compliance with accounting principles. Therefore, companies must verify ownership rights before including items in their inventory counts.

What journal entries are made when consigned goods are sold by the consignee?

When consigned goods are sold, the consignee makes the following journal entries: debit cash for the total amount received from the sale, credit commission revenue for the commission earned, and credit a liability account (e.g., "Payable to Consignor") for the amount owed to the consignor. For example, if two dresses are sold for \$1,000 each and the consignee earns a \$100 commission per dress, the entries would be: debit cash for \$2,000, credit commission revenue for \$200 ($2\times \mathrm{\backslash \$100}$), and credit payable to consignor for \$1,800 ($2\times \mathrm{\backslash \$1,000}-\mathrm{\backslash \$200}$). This reflects that the consignee only earns commission revenue and owes the remaining proceeds to the consignor.

How does the presence of consigned goods affect the financial statements of the consignee?

Consigned goods do not appear as inventory assets on the consignee's balance sheet because the consignee does not own them. Instead, the consignee records commission revenue on the income statement when sales occur. On the balance sheet, the consignee records a liability for the amount collected from customers that must be paid to the consignor. This liability reflects the obligation to remit proceeds from the sale of consigned goods. Therefore, consigned goods increase neither inventory assets nor cost of goods sold for the consignee; only commission revenue and related liabilities are recognized.