Consignment definition
/What is a Consignment?
A consignment occurs when the owner of goods leaves them with another party to be sold. When the goods are eventually sold, the consignee retains a commission and pays the consignor the residual amount. If the goods are not sold, then the consignee eventually returns them to the consignor. If the unsold goods are perishable, the consignor might instruct the consignee to throw them away, rather than returning them. These arrangements minimize the amount of inventory that a consignee must retain on the premises.
Consignment arrangements are relatively common for certain types of retail sales. Online auction sites are a form of consignment arrangement, since a third party is undertaking the sales role.
Consignment Payment Arrangements
In a consignment arrangement, the consignee typically has a standard fee it charges in exchange for selling goods on behalf of the consignor. However, if the consignor wants to sell a very valuable item, then the consignee might be willing to cut its standard fee to a substantially lower amount. For example, the executor of a person’s estate asks an art gallery to sell the estate’s paintings, which the art gallery owner agrees to do, in exchange for a 25% fee on anything sold. If any paintings have not been sold after one year, then the gallery will return them to the executor. However, the estate includes a valuable Matisse, with a street value of several million dollars. For this one painting, the gallery owner is willing to cut her commission to 10% of the eventual sale price.
Accounting for a Consignment Arrangement
In a consignment arrangement, the consignor continues to own the goods until they are sold, so the goods appear as inventory in the accounting records of the consignor, not the consignee. When the consignee makes a sale, it records an increase in cash (from the customer’s payment), commission income for itself, and a liability for the residual amount of the sale, which it must forward to the consignor. When the consignor receives this payment from the consignee, it records the cash as revenue.
Advantages of a Consignment Arrangement
From the perspective of a consignor, the advantages of a consignment arrangement are as follows:
It does not have to deal with the end customer, which means that it does not have to set up a storefront. This allows the consignor to concentrate on manufacturing, and avoid the sales and marketing functions.
It does not have to invest in any sales and marketing activities, which may reduce its operating expenses substantially.
From the perspective of a consignee, the advantages of a consignment arrangement are as follows:
It does not have to pay for inventory up front. This can be a major advantage when the inventory investment would otherwise be quite large.
It has complete control over being paid a commission, since it extracts a commission from customer payments. It does not have to wait for the consignor to send it this payment.
Disadvantages of a Consignment Arrangement
From the perspective of a consignor, the disadvantages of a consignment arrangement are that it is not paid up front for its inventory, and it must pay a commission to the consignee. From the perspective of a consignee, the disadvantages of a consignment arrangement are that it must track who owns the inventory it is selling, and it has some responsibility for damage to the inventory held on its premises.