Tag: Cash Flow

Proforma Invoice

A proforma invoice (also written as pro forma invoice) is one of the documents used in consignment business which contains information regarding the description of goods sent on consignment and the price at which those goods can be sold by the consignee. This document is prepared by consignor and sent to the consignee along with the goods.

The proforma invoice and invoice are not the same and should not be confused with each other. An invoice is sent by a seller to the buyer to provide him the details of goods sold or services provided to him, price of those goods or services and the agreed terms of payment. It indicates seller’s demand for payment after a sale has taken place. A proforma invoice, on the other hand, is not a demand for payment rather it is a memorandum invoice which tells what the actual invoice would be.

Where goods are consigned abroad, the proforma invoice plays an important role in custom clearance. The custom officer uses the information from proforma invoice in conjunction with the general physical examination of the goods to determine the total value of goods and the amount of imposable duty. Many international traders use consignment model of business and attach proforma invoices to their across-the-border shipments.

Invoice Price

The Consignor, instead of sending the goods on consignment at cost price, may send it at a price higher than the cost price. This price is known as Invoice Price or Selling Price. The difference between the cost price and the invoice price of goods is known as loading or the higher price over the cost. This is done with a view to keep the profits on consignment secret.

As such, consignee could not know the actual profit made on consignment. Hence the consignor sends the Proforma invoice at a higher price than the cost price. When the consignor records the transaction in his book at invoice price, some additional entries have to be passed in order to eliminate the excess price and to arrive at the correct profit or loss on consignment.

Items on Which Excess Price is to be Calculated:

Excess Price or Loading is to be calculated on the following items:

1. Consignment stock at the beginning
2. Goods sent on consignment
3. Goods returned by the consignee
4. Consignment stock at the end of the period

(a) To Remove the Excess Price in the Opening Stock:

Consignment Stock Reserve A/c Dr.

  To Consignment Account

(Being the excess value of opening stock is brought down to cost price)

(b) To Remove the Excess Price in the Goods Sent on Consignment:

Goods sent on Consignment Account Dr.

  To Consignment Account

(Being the difference between the invoice price and cost price is adjusted)

(c) To Remove the Excess Price in Goods Return:

Consignment Account Dr.

  To Goods sent on Consignment A/c

(Being to bring down the value of goods to cost price)

(d) To Remove the Excess Price in Closing Stock:

Consignment Account Dr.

  To Consignment Stock Reserve A/c

(Being the excess value of stock is adjusted)

But these adjustments are not needed in consignee’s book. Invoice price does not affect the consignee. When the stock is shown in the Balance Sheet, in Consignor’s Book, the Consignment Stock Reserve is deducted.

Account Sales

Account sales is a statement specifying the price at which the goods are sold, the commission earned by the consignee, the expenses incurred by the consignee on behalf of the consignment and the net balance for which the consignee is liable. It is prepared by the consignee and does not have a fixed or specified format.

Non-recurring Expenses

Non-recurring expenses are incurred for bringing the goods from the place of the consignor to the place of the consignee. Hence, all the expenses incurred till the goods reach the godown of the consignee are non-recurring expenses. These expenses are incurred only once on a particular con­signment. It will increase the value of goods. These expenses are paid by the consignor or by the consignee on behalf of the consignor.

The abovementioned expenses do not occur again like the recurring expenses. These expenses are met on the whole consignment. These expenses are added to the cost of the consignment so as to arrive at the cost price of goods at the point of sale. Again these are taken into consideration when the value of closing stock and abnormal losses are calculated.

Recurring Expenses

These expenses are incurred after the goods have been received at consignee’s godown. These expenses are incurred quite often and of recurring in nature. These expenses occur regularly at fixed intervals. Generally these expenses are incurred after the goods have reached the place of business by consignee. They are met by the consignor or consignee. These expenses do not increase the value of goods.

Ordinary Commission

The ordinary commission is the fees payable by the consignor to the consignee for the sale of goods when there is no guarantee for the collection of money from the consumer. The percent (%) of the commission is lower in such a case.

Overriding Commission

Overriding commission is a type of commission which a consignor grants to the consignee who achieves a specific sales target or whose total sales revenue exceeds a specified amount. It encourages consignee to realize the best possible price for goods sold. Sometime it is given to consignee as an incentive for putting his efforts to introduce, promote and create market for a new product in certain areas.

Overriding commission is an extra commission which is awarded to the consignee in addition to his ordinary or regular commission.

Del Credere Commission

Del Credre Commission is the additional amount which the consignor pays to the consignee for taking the responsibility of collection of debt from the customers.

When the customers make default in payment, consignee charges the amount of loss of bad debts in his books. We calculate this commission on Total sales.

Normal Loss

• It occurs due to the nature of goods shipped like leakage, evaporation, perishable goods etc.
• We add the normal loss to the cost of goods and thus, it also impacts the gross profit.
• Normal loss is not covered by insurance companies.
• It is certain but it varies from time to time.

Abnormal Loss

• Abnormal loss occurs due to unforeseen circumstances like an accident, natural calamity, fire damage etc.
• The abnormal loss does not impact the gross profit of the entity.
• Generally, insurance covers an abnormal loss.
• The abnormal loss is not certain due to unforeseen circumstances and situations.

A consignor may have some incomplete consignments at the end of his accounting year. An incomplete consignment means that there are some unsold units of goods with the consignee when the accounting period of the consignor comes to an end. These unsold units are termed as closing stock on consignment (or just stock on consignment for short) and need to be properly valued. After valuation, the stock on consignment must be brought into the books and credited to the consignment account so that the profit earned on consignment during the period can be computed correctly. The journal entry for this purpose is given below:

Stock on consignment A/C [Dr]

Consignment A/C [Cr]

The stock on consignment is an asset and is, therefore, shown on the year end balance sheet. In the next accounting period when consignment account is prepared, this stock appears as the first item on the debit side of this account. The following journal entry is made for this purpose:

Consignment A/C [Dr]

Stock on consignment A/C [Cr]

Valuation of stock on consignment

The stock on consignment, like in many other business situations, should be valued using lower of cost or market price principle. The major issue in this regard is the ascertainment of cost price and market price of goods in stock. The rest of this article talks about the procedures of determining these two prices.

Cost price

The total cost of goods is equal to the expenditures incurred by consignor to bring the goods in salable condition plus all the expenditures paid by consignor as well as consignee in the course of transferring those goods to the consignee’s place. These expenditures usually include carriage, freight, insurance, import and export duties, loading and unloading expenses etc. These expenditures are popularly referred to as non-recurring expenditures.

Any expenditures incurred after the goods have reached to the consignee’s place should be ignored for the purpose of computing the value of closing stock on consignment. Usual examples of such expenditures include warehouse rent, warehouse insurance, storage expenses, carriage paid for the delivery of goods to customers, marketing expenses or any other payment made for the sale of goods.

Net realizable value (NRV)/market price

Net realizable value (NRV) of stock is determined by deducting from the market price of stock the possible expenses required to complete the sale of stock including consignee’s commission. Suppose, for example, 100 units of product X are in stock with a consignee and the sales price of one unit of product is $20. The total sales or market price of this stock would be $2,000 (= 100 units × $20). Now if the estimated expenses required to sell this stock are $300 and consignee’s commission on sale is $200, the net realizable value of stock would be $2,000 (= $2,500 – $500).

After computing the cost price and net realizable value (NRV) in accordance with the procedures explained above, the smaller one should be used as the value of closing stock. If no indication regarding the market price or net realizable value is available in an examination problem or a homework assignment, the students should assume that the cost price is lower than the net realizable value. The valuation of stock on consignment should therefore be done on the basis of cost price.

Formula and format for computing closing stock on consignment

For cost price

If cost price method is applicable, the students should follow the following format for computing the value of closing stock:

After computing the total cost using above format, the following formula can be used to find the value of stock on consignment:

Cost of stock on consignment = (Total cost/Total number of units) × Units in stock

Alternatively, the value of stock can also be computed as follows:

For net realizable value (NRV)

If net realizable value method is applicable, the following formula should be used to compute the value of stock on consignment.

Net realizable value = Market price of stock – (Expected expenses to be incurred to sell the stock + Consignee’s commission)

Adjusting entries are made at the end of an accounting period after a trial balance is prepared to adjust the revenues and expenses for the period in which they occurred.

Adjusting entries must involve two or more accounts and one of those accounts will be a balance sheet account and the other account will be an income statement account. You must calculate the amounts for the adjusting entries and designate which account will be debited and which will be credited. Once you have completed the adjusting entries in all the appropriate accounts, you must enter it into your company’s general ledger.

These entries are posted into the general ledger in the same way as any other accounting journal entry. The purpose of adjusting entries is to show when money changed hands and to convert real-time entries to entries that reflect your accrual accounting.

5 Accounts That Need Adjusting Entries

Adjusting entries are a crucial part of the accounting process and are usually made on the last day of an accounting period. They are made so that financial statements reflect the revenues earned and expenses incurred during the accounting period.

Adjusting entries impact five main accounts.

1) Accrued Revenues

For any service performed in one month but billed in the next month would have adjusting entry showing the revenue in the month you performed the service.

You make the adjusting entry by debiting accounts receivable and crediting service revenue.

2) Accrued Expenses

Wages paid to an employee is a common accrued expense.

To make an adjusting entry for wages paid to an employee at the end of an accounting period, an adjusting journal entry will debit wages expense and credit wages payable.

3) Unearned Revenues

Payments for goods to be delivered in the future or services to be performed is considered an unearned revenue.

For example, if you place an online order in September and that item does not arrive until October, the company who you ordered from would record the cost of that item as unearned revenue. The company would make adjusting entry for September (the month you ordered) debiting unearned revenue and crediting revenue.

4) Prepaid Expenses

Prepaid expenses refer to assets that are paid for and that are gradually used up during the accounting period. A common example of a prepaid expense is a company buying and paying for office supplies.

During the accounting period, the office supplies are used up and as they are used they become an expense. When office supplies are bought and used, an adjusting entry is made to debit office supply expenses and credit prepaid office supplies.

5) Depreciation

Depreciation is the process of assigning a cost of an asset, such as a building or piece of equipment over the economic or serviceable life of that asset.

Adjusting entries for depreciation are a little bit different than with other accounts. A company has to consider accumulated depreciation.

Accumulated depreciation refers to the accumulated depreciation of a company’s asset over the life of the company. On a company’s balance sheet, accumulated depreciation is called a contra-asset account and it is used to track depreciation expenses.

Adjusting journal entries are accounting journal entries that update the accounts at the end of an accounting period. Each entry impacts at least one income statement account (a revenue or expense account) and one balance sheet account (an asset-liability account) but never impacts cash.

When a company sells an investment, it results in a gain or loss which is recognized in income statement. A gain on sale of investment arises when the (disposal) value of an investment exceeds its cost. Similarly, a capital loss is when the value of investment drops below its cost.

Accounting treatment of a disposal of investment depends on:

• The nature of the investment i.e. whether it is a share of common stock, preferred stock, a bond, etc.,
• The extent of the investment i.e. the percentage holding, and
• The initial recognition and continuing accounting of the investment.

Investments in shares of common stock are accounted for using either the fair value through profit and loss, fair value through other comprehensive income, equity method or consolidation depending on the extent of ownership.

An association of two or more persons or we may say temporary partnership combined for the carrying out a specific business, and divide profit or loss thereof in agreed ratio is called a Joint Venture. Concerned parties to joint venture are known as co-venturers. The liabilities of co-venturers are limited to their profit sharing ratio or as per agreed terms:

Suppose ‘A’ and ‘B’ undertake the job to develop a park for a consideration of Rs. 10,000/- Lacs. Since they come together for a work on a specific project, it will termed as joint venture and each of them (A and B) will be called as a co-venturer. Further, this venture will automatically terminate once the project is completed.

Major Features and Characteristics of Joint Venture

• There is an agreement between two or more persons.
• Joint venture is made for the specific execution of a business plan/project.
• It is a temporary partnership without the use of a firm name.
• Agreement for joint ventures is automatically dissolved as soon as specific project is over.
• Profit & Share are shared on the same terms and conditions agreed upon. However, in the absence of any agreement, profit & share will be divided equally.

Salient Features of Joint Venture

1. Agreement: Two or more firms come to an agreement, to undertake a business, for a definite purpose and are bound by it.
2. Joint Control: There exist a joint control of the co-venturers over business assets, operations, administration and even the venture.
3. Pooling of resources and expertise: Firms pool their resources like capital, manpower, technical know-how, and expertise, which helps in large-scale production.
4. Sharing of profit and loss: The co-venturers agree to share the profits and losses of the business in an agreed ratio. The computation of the profit and loss is usually done at the end of the venture, however, when it continues for the long duration, the profit and loss is calculated annually.
5. Access to advanced technology: By entering into joint venture firms get access to various techniques of production, marketing and doing business, which decreases the overall cost and also improves quality.
6. Dissolution: Once the term or purpose of the joint venture is complete, the agreement comes to an end, and the accounts of the coventurers, are settled, as and when it is dissolved.

The co-venturers are free to carry on their own business, unless otherwise provided in the joint venture agreement, during the life of the venture.

Partnership and Joint Venture

There are following differences between partnership and joint venture −

• Partnership always carried on with firm’s name, but for the joint venture, no such firm’s name is required.
• The persons who run the business on partnership are called as partners and the persons who agreed to take the project as joint venture are called as co-venturers.
• Normally, a partnership is constituted for a long period (including various projects), whereas joint venture is formed to complete a specific job/project.
• Partnership is governed under the Partnership Act, 1932, whereas there is no enactment of such kind for the joint ventures. However, as a matter of fact in law, a joint venture is treated as a partnership.
• There is no limit specified for the numbers of co-venturers, but the number of partners is limited to 10 under banking business and 20 for any other trade or business.
• Liability of a partner is unlimited and may extent of his business and personal estate, whereas under joint venture, liabilities of co-venturers are limited to the particular assignment or project agreed upon.

Joint Venture and Consignment

Major differences between joint venture and consignment may be summarized as −

• Relationship: The co-venturers of a Joint venture are the owners of a Joint venture, whereas relationship of a consignor and consignee is of owner and Agent.
• Sharing of Profits: There is no distribution of profit between a consignor and consignee, consignee only gets commission on sale made by him. On the other hand, the co-venturers of a joint venture share profits as per the agreed profit sharing ratio.
• Ownership of Goods: Ownership of the goods remains with the consignor. Consignor transfers only possession to the consignee, but every co-venturer of a joint venture is the co-owner of the goods/project.
• Contribution of Funds: Investment is done by the consignor only. On the other hand, funds are contributed by all co-ventures in a certain agreed proportion.
• Continuity of Business: In case of a joint venture, there is no continuity of the business once project is completed. On the other hand, if, everything goes smooth, consignment is a continuous process.

Accounting Records

To keep a record of the joint venture transactions, there are three following types of accounting methods:

• When one of the Venturers keeps Accounts,
• When Separate Books of Accounts are kept for the Joint Venture, and
• When Separate Books of Accounts are not kept for the Joint Venture.

Let’s discuss each of them separately:

When one of the Venturers keeps Accounts

If one of the co-venturers is appointed to manage the joint venture, he is awarded an extra commission or remuneration out of the profit for his services.

Journal Entries

When Separate Books of Accounts are kept for the Joint Venture

Under this method, all co-venturers contribute their share of investment and deposit their shares in a Joint Bank account — newly opened for the specific purpose of the Joint Venture. They may use this bank account to make any kind of payments and to deposit sale proceeds or any other kind of receipts.

In addition to Bank account, a Joint venture account is also opened in the books to keep records of all transactions routed through this account.

This category of accounts is a personal account of the each co-venturer. Thus following three accounts are opened −

• Joint Bank Account
• Joint Venture Account
• Personal account of co-venturers

When Separate Books of Accounts are not kept for the Joint Venture

It is of two types:

• When all venturers keep separate accounts
• Memorandum joint venture method

When all Venturers keep Separate Accounts:

• Separate Joint venture account and personal accounts of other co-venturers are opened under this method of accounting.
• Joint venture account is debited and bank account or creditor account is credited on the account of goods purchased or expensed.
• Joint venture account is credited and a bank account or debtor account is debited in case of either cash sale or credit sale.
• Each co-venturer debits joint venture account and credits personal accounts of other co-venturer on the account of either goods purchased or expensed by other co-venturers.
• Joint venture account is credited and personal account of others co-venturer account is debited in case of sale made by other co-venturers.
• Joint venture account is debited and commission account is credited if, commission is receivable, but if commission is receivable by other co-venturer, then the concerned co-venturer account will be credited instead of the commission account.
• If unsold stock is taken, then goods account will be debited by crediting Joint venture account. On the other hand, if unsold stock is taken by any other co-venturer, then personal account of the co-venturer will be debited.
• Balance in the joint venture accounts represents profit or loss and later that amount of profit or loss will be transferred to the personal accounts of co-venturers.

Note: Above transactions are possible only when all the co-venturers exchange information’s on regular basis.

Objectives of Joint Venture

• To enter foreign market and even new or emerging market.
• To reduce the risk factor for heavy investment.
• To make optimum utilisation of resources.
• To gain economies of scale.
• To achieve synergy.

Joint ventures are primarily formed for construction of dams and roads, film production, buying and selling of goods etc.

The type of joint venture is based on the various factors like, the purpose for which it is formed, number of firms involved and the term for which it is formed.

Key differences between Joint Venture and Consignment

Joint Venture

Joint Venture is a business arrangement where two or more parties come together to undertake a specific project or business activity, sharing resources, risks, and profits. Unlike a partnership, a joint venture is usually formed for a temporary period or a single project, after which it may dissolve. Each party maintains its distinct identity while contributing assets, capital, and expertise to achieve mutual goals. Joint ventures are common in large-scale projects like infrastructure, technology development, and international business expansion, where collaboration enhances competitive advantage and market reach.

Consignment

Consignment is a business arrangement where a consignor (owner) sends goods to a consignee (agent) to be sold on their behalf. The consignor retains ownership of the goods until they are sold, while the consignee earns a commission for facilitating the sale. The consignee is responsible for marketing and selling the goods but does not bear the financial risk of unsold inventory. Once the goods are sold, the consignee remits the proceeds to the consignor, keeping a portion as agreed. This arrangement is common in retail and distribution businesses.

Consignment accounting is a specialized area of accounting that deals with the relationship between a consignor (the owner of goods) and a consignee (the person or entity that sells the goods on behalf of the consignor). Under this arrangement, the consignee holds the goods, sells them, and remits the proceeds to the consignor, while the consignor retains ownership of the goods until they are sold. Consignment accounts help track and record the movement of goods and their financial implications for both parties involved.

In this system, the consignee does not own the goods but acts as an agent of the consignor, meaning the goods remain on the books of the consignor until they are sold to a third party. This system is widely used in industries like retail, agriculture, and manufacturing, where goods are distributed through various channels before reaching the end consumer.

Key Terms in Consignment Accounting:

1. Consignor:

The owner of the goods who sends them to the consignee for sale. The consignor retains legal ownership of the goods until they are sold by the consignee.

2. Consignee:

The person or entity that receives the goods from the consignor and is responsible for selling them. The consignee does not own the goods but holds them on behalf of the consignor and earns a commission for the sale.

3. Consignment:

The act of sending goods from the consignor to the consignee with the purpose of selling them. The sale does not transfer ownership until the goods are sold to the final buyer.

4. Proforma Invoice:

A document that accompanies the consignment, listing the goods sent and their expected selling prices. It is used for accounting purposes but does not serve as a formal sales invoice.

5. Commission:

The fee or percentage of sales that the consignee earns for selling the consignor’s goods. The commission is usually agreed upon before the consignment transaction begins.

6. Del Credere Commission:

An additional commission paid to the consignee for assuming the risk of bad debts. If the consignee offers a del credere commission, they guarantee payment to the consignor, even if the buyer defaults on their payment.

7. Account Sales:

Statement prepared by the consignee for the consignor that shows the details of goods sold, including sales proceeds, commission, and any expenses incurred during the sales process.

Features of Consignment Accounting:

• Ownership of Goods:

In a consignment arrangement, the ownership of the goods remains with the consignor until they are sold. Even though the goods are physically located with the consignee, they are not recorded as inventory on the consignee’s books.

• Risk and Reward:

The risk and rewards associated with the goods remain with the consignor. The consignee is not responsible for unsold goods and only accounts for the goods they have sold.

• No Sales Revenue Until Sale:

The consignor does not recognize sales revenue until the consignee actually sells the goods. Any goods that remain unsold are recorded as inventory on the consignor’s balance sheet.

• Consignee’s Commission:

The consignee earns a commission on the goods they sell, which is usually expressed as a percentage of the sales value. This commission is deducted from the sales proceeds before remitting the net amount to the consignor.

• Expenses on Consignment:

The consignee often incurs expenses in relation to the sale of goods, such as shipping, storage, or marketing costs. These expenses are either borne by the consignee (in which case they are deducted from the sales proceeds) or reimbursed by the consignor.

Accounting Entries in Consignment:

1. Consignor’s Books:

The consignor must account for goods sent on consignment as well as record any sales made by the consignee and commissions payable to the consignee.

• Goods Sent on Consignment: When goods are sent on consignment, they are not recorded as a sale. Instead, the consignor debits a Consignment Account and credits Inventory or Goods Sent on Consignment.

Journal Entry:

• Debit: Consignment Account
• Credit: Inventory/Stock

• Expenses Incurred by Consignor: Any expenses incurred by the consignor (e.g., freight or insurance) are debited to the Consignment Account.

Journal Entry:

• Debit: Consignment Account
• Credit: Bank/Cash

• Recording Sales by Consignee: When the consignee sells the goods, the consignor records the sale by debiting Cash or Accounts Receivable and crediting the Consignment Account for the net amount received (sales value minus commission and expenses).

Journal Entry:

• Debit: Cash/Accounts Receivable (for the amount received)
• Credit: Consignment Account (net of commission and expenses)

• Recording Commission: The commission payable to the consignee is recorded by debiting the Consignment Account and crediting the Commission Payable

Journal Entry:

• Debit: Consignment Account (for the amount of commission)
• Credit: Commission Payable

2. Consignee’s Books:

Since the consignee does not own the goods, they do not record the consigned goods as inventory. However, they must record any commissions earned and expenses incurred.

• Goods Received: The consignee does not make any entry when they receive goods from the consignor, as the ownership remains with the consignor.
• Sale of Goods: When the consignee sells the goods, they record the cash or receivables from the buyer.

Journal Entry:

• Debit: Cash/Accounts Receivable (for the sale value)
• Credit: Consignor’s Account (net of commission and expenses)

• Commission Earned: The commission earned by the consignee is recorded as revenue.

Journal Entry:

• Debit: Consignor’s Account (for the commission amount)
• Credit: Commission Revenue

• Expenses Incurred: Any expenses paid by the consignee on behalf of the consignor (e.g., shipping costs) are recorded as receivables from the consignor.

Journal Entry:

• Debit: Consignor’s Account (for the amount of expenses)
• Credit: Cash/Bank (for the amount paid)

Importance of Consignment Accounting:

Consignment accounting plays a critical role in industries where products are distributed across multiple channels and locations, and where the final sale of goods is not immediately guaranteed. It allows businesses to:

• Manage Inventory Efficiently:

The consignor can expand their market reach by distributing goods through consignees without the risk of immediate unsold stock.

• Track Sales Accurately:

Consignment accounting ensures that both consignor and consignee have clear records of sales, expenses, and commissions, facilitating transparency and smooth business transactions.

• Reduce Risk for Consignees:

Since the consignee is not responsible for the ownership of the goods, they can participate in selling without bearing the risks of holding inventory.