A consignment agreement is a contractual arrangement in which a consignor provides goods to a consignee to hold and sell on behalf of the consignor. Under these agreements, the consignor retains ownership until the goods are sold and does not recognise any revenue until then. This method of revenue recognition reflects sales only when they happen, not before, ensuring that financial records portray completed sales accurately.

Below, we’ll explain what businesses should know about consignment revenue recognition, including how it works and accounting best practices when dealing with consignment agreements.

What’s in this article?

• Key components of a consignment agreement
  
• How revenue recognition works with consignment
  
• Challenges with consignment revenue recognition
  
• Best practices for accounting and revenue management under consignment agreements
  

Key components of a consignment agreement

Consignment revenue recognition begins with a comprehensive consignment agreement. Here are examples of the information this type of agreement can include.

• Parties involved: The consignor (party that provides the goods) and the consignee (party that sells the goods)

• Description of goods: The goods being consigned, including details such as type, quality, condition, and any unique identifiers

• Consignment period: The duration of the consignment agreement, with start and end dates, and conditions under which the agreement might be extended or terminated early

• Pricing and selling terms: How the goods will be priced, including any discounts, promotions, and returns, and any pricing flexibility the consignee might have

• Payment terms: How and when the consignor will be paid for sold goods and what happens to unsold goods

• Inventory and sales reports: How often the consignee needs to report sales and inventory status to the consignor, and what the format and detail of the reports should be

• Responsibility for goods: Which party is responsible for the goods during transportation and storage, and which party bears the risk of loss or damage

• Return of unsold goods: Procedures and conditions for the return of unsold goods, including which party will cover return costs

• Dispute resolution: How the consignor and consignee will resolve disputes related to the agreement

• Termination clauses: How either party can terminate the agreement and the conditions that warrant termination

Under these agreements, the consignor retains ownership of the goods while they are in the consignee’s possession. If the goods do not sell, become obsolete, or decrease in value while they are with the consignee, the consignor is responsible for them and absorbs these potential costs. If any goods are damaged, lost, or stolen while with the consignee, however, the consignee must pay the consignor for those goods.

Although the goods are physically with the consignee, the consignor often retains control over pricing strategies and sales terms, and can manage how the goods are marketed and sold to maximise returns. The consignor benefits from any profits made when the goods are finally sold to the end customer.

How revenue recognition works with consignment

Revenue recognition in a consignment arrangement depends on when the consignee sells the goods to the end customer. Under accounting standards such as Accounting Standards Codification (ASC) 606 and International Financial Reporting Standard (IFRS) 15, the consignor must not recognise revenue when the goods are shipped to the consignee because control of the goods has not yet been transferred. Here are the main criteria for recognising revenue.

• Sale occurrence: The consignor can recognise revenue only when the consignee sells the consigned goods to a third party (i.e. the end customer).

• Reliable transaction information: The consignor can recognise revenue when they have received reliable and timely reports from the consignee about sales transactions. These reports should detail the quantities of goods sold and their prices.

• Payment certainty: The consignor can recognise revenue when there is a reasonable assurance that the payment from the consignee will be collected. For example, assurance might be determined by the end customer’s creditworthiness and the consignee’s reliability in handling payments.

• Transfer of control: The consignor can recognise revenue when the goods are under the control of the consignee, meaning the consignee has the authority to sell or manage the goods at their discretion.

Challenges with consignment revenue recognition

Because consignment revenue recognition differs from other types of recognition, it can present unique challenges. Here are some common issues.

• Tracking and reporting sales: To recognise revenue properly, the consignor relies on the consignee to report sales accurately and promptly. If the consignee fails to do this, it can lead to incorrect revenue figures in the consignor’s financial statements.

• Inventory management: The consignor must maintain precise records of inventory sent to any and all consignees and monitor the status of all goods –possibly with multiple consignees. Mismanagement can lead to stock discrepancies and financial misstatements.

• Risk of obsolescence: Goods held on consignment might sit unsold for extended periods. There is a risk of obsolescence, especially in fast-moving industries such as electronics or fashion. Since the consignor retains ownership of the goods, they bear the cost of any products that become outdated, which can impact their profitability and inventory valuation.

• Dependence on the consignee’s performance: The consignor’s revenue is dependent on the consignee’s ability to sell the consigned goods. Poor sales efforts, inadequate market reach, or financial instability can adversely affect the consignor’s revenue realisation.

• Financial reporting: The consignor must recognise revenue from consignment sales in accordance with IFRS 15 and ASC 606, which involves determining when control is transferred. Given that the transfer of control might be delayed during this determination, this can be a complicated issue.

• Legal and contractual compliance: The consignor must draft and maintain consignment agreements that clearly outline the terms of revenue recognition, parties’ responsibilities, and liabilities. They must also ensure these agreements comply with local laws and accounting standards, and that both parties adhere to them.

• Returns and allowances: The consignor must account for potential returns by the end customer. This can delay revenue recognition or require adjustments to previously recognised revenue.

Best practices for accounting and revenue management under consignment agreements

Here’s what consignors should keep in mind when accounting for and recognising revenue for consignment sales.

• Start with a clear, detailed consignment agreement: Ensure that the agreement covers details such as payment timing, what happens with unsold goods, and how to handle disputes and returns. A strong contract sets clear expectations.

• Get routine sales reports from the consignee: Set up a system in which the consignee sends you sales updates regularly. Automating this process and using software that pulls sales data directly from the consignee’s system can help minimise errors.

• Pay attention to stock that is with the consignee: Use inventory management software that can monitor your stock levels in real time and notify you if something doesn’t add up. Regular checks and audits ensure that your records match your stock.

• Examine the consignee’s sales reports: Compare the sales figures from the consignee with your own records on a regular basis. This helps catch and fix any mismatches quickly and keeps your books accurate.

• Understand market trends and product lifecycles: Being aware of trends can help you avoid getting stuck with outdated items. You should also pick consignees wisely those that work in strong markets for your products – and consider setting time limits on how long your goods sit unsold.