Differences between Consignment and Ordinary Sale

What is a Sale?

Sale refers to the complete transfer of ownership of goods from a seller (vendor) to a buyer. The seller relinquishes all rights to the goods in exchange for payment, and the buyer assumes ownership and the associated risks. Once the transaction is completed, the seller no longer has any control or responsibility over the goods, and the buyer has full rights to use, resell, or modify them as they wish.

In accounting terms, a sale is recognized when the following conditions are met:

• There is a transfer of control over the goods to the buyer.
• The seller has a reasonable expectation of receiving payment.
• The buyer has the risks and rewards of ownership.

Sales are recorded as revenue on the seller’s income statement, and the cost of the goods sold (COGS) is recorded as an expense.

What is Consignment?

Consignment is a business arrangement in which goods are sent by a consignor (owner) to a consignee (agent) who will sell the goods on behalf of the consignor. In a consignment transaction, ownership of the goods remains with the consignor until the goods are sold to a third-party customer. The consignee acts as an intermediary, holding and selling the goods, but does not take ownership of them. The consignee earns a commission for their role in selling the goods.

Key characteristics of consignment transactions include:

• The consignor retains ownership of the goods until they are sold.
• The consignee does not own the goods but is responsible for selling them.
• The consignee earns a commission for their services, but they bear no inventory risk.
• The consignor records sales revenue only when the goods are sold by the consignee.

In this arrangement, the consignor records the goods as inventory until they are sold, and the consignee records no inventory on their books. The consignee only records commissions earned from the sales.

Key Differences Between Consignment and Sales:

Example of Consignment vs. Sales

To better illustrate the differences between consignment and sales, let’s consider an example:

• Consignment Example:

A clothing manufacturer (consignor) sends 100 dresses to a boutique (consignee) to sell on consignment. The boutique does not pay for the dresses upfront but agrees to display and sell them. For each dress sold, the boutique will retain a 10% commission. If the boutique sells 60 dresses at $100 each, the boutique will retain $600 in commission (10% of $6,000), and the manufacturer will receive $5,400. The boutique returns the remaining 40 unsold dresses to the manufacturer.

• Sales Example:

The same clothing manufacturer sells 100 dresses directly to a retail store for $8,000. The retail store takes ownership of the dresses upon purchase, records them as inventory, and assumes all responsibility for selling them. The manufacturer recognizes $8,000 in revenue at the time of the sale. If the retail store is unable to sell the dresses, the manufacturer is not obligated to take them back unless specified in a return agreement.

Advantages of Consignment Over Sales:

• Risk Mitigation for the Consignee:

Since the consignee does not purchase the goods upfront, they face minimal financial risk. If the goods do not sell, they can return them to the consignor without bearing the cost.

• Market Expansion for the Consignor:

The consignor can reach a wider market by distributing goods to multiple consignees without having to sell them directly. This allows for broader distribution and increased exposure.

• No Upfront Payment:

Consignees can sell goods without paying for them upfront, which can be beneficial for businesses with limited capital. This arrangement enables them to offer a larger inventory without the need for immediate financial outlay.

• Flexible Return Policies:

Goods that do not sell can be returned to the consignor, reducing the financial burden on the consignee.

Disadvantages of Consignment Compared to Sales:

• Delayed Revenue Recognition:

In a consignment arrangement, the consignor must wait until the goods are sold by the consignee before recognizing revenue. This can delay cash flow and financial reporting.

• Inventory Risk for Consignor:

The consignor bears the risk of unsold goods. If the consignee is unable to sell the products, the consignor must retrieve them, which may involve additional costs.

• Lower Control for Consignor:

The consignor has limited control over how the consignee markets or displays the goods. Poor marketing or positioning may lead to slower sales, affecting revenue.

• Reduced Profit Margin for Consignor:

The consignor must pay a commission to the consignee, which reduces the net profit on each sale.