Accounting Treatment for Consignment Stock: A Discussion with a Trader’s Son

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By Noor Nakato Nakabugo

Denis: Hi James! I heard you enrolled for CPA, how is it going?

James: Yes I did and I am progressing well. I will soon finish my Level 2 examinations.

Denis: Good for you, James! Can I please get some accounting advice?

James: Sure.

Denis: Is there an accounting standard that provides for how to treat inventories?

James: Yes, International Accounting Standard (IAS) 2 is the standard that prescribes accounting treatment for inventories.

Denis: Right! My father operates a wholesale shop in Kikuubo which deals in general merchandise including cosmetics. Occasionally, AB Ltd (a renowned distributor of cosmetics) supplies cosmetics to my father’s shop. The arrangement is such that once the cosmetics are delivered, my father sells them to third parties and remits any earnings from the sales after deducting an agreed commission. This is usually done at month end. Does this form part of inventory in my father’s shop?

James: No.

Denis: But the cosmetics are stored in my father’s shop.

James: Your father can only recognise the cosmetics as inventory to the extent that he has the present ability to direct their use and obtain economic benefits that may flow from them. Since your father is obliged to return the cosmetics to AB Ltd in case a sale has not been made, he does not have control and cannot therefore recognise them as inventory. This is irrespective of whether or not the cosmetics are stored in his shop.

Denis: So how should he account for the cosmetics?

James: From your explanation, the cosmetics are consignment stock. Your father does not need to record the consigned stock as inventory, but, may prudently keep a separate record of them for purposes of reconciliation.

Denis: Oh, I get it now. So in whose accounting books is the inventory recorded?

James: Since AB Ltd retains control of the cosmetics regardless of their physical location, it should continue to record them as inventory in its accounting records until such a time when they are sold. Once a sale is made, your father will credit AB Ltd account with the amount of sale due to AB Ltd (excluding the agreed commission) and debit the cash account.

At the end of the month, your father will debit AB Ltd’s account and credit the cash account with the amount of proceeds arising from the sale of cosmetics in that month. The inventory in the books of AB Ltd will periodically be reconciled to cater for any sales made.

Denis: Interesting! Because of the seasonal sales in Kikuubo, sometimes the cosmetics expire while they are still in my father’s shop and they are returned to AB Ltd. Who incurs this loss?

James: Again, since AB Ltd retains control of the cosmetics, it bears such risk and hence will incur the loss.

Denis: And how would such a loss be treated in the books of AB Ltd?

James: IAS 2 states that inventories shall be measured at the lower of cost and net realizable value. Therefore, the original value of the inventories held in the books of AB Ltd would be written down by the value of expired cosmetics. This written-down amount would be expensed in the profit or loss account of AB Ltd.

Denis: Wow, thank you so much James. Accounting is very exciting! I would like to enroll for the CPA course as well. What do I need?

James: That is a great idea, my friend. Visit www.icpau.co.ug to find out more on how to enroll.

Denis: I sure will!

Note: The names used in this conversation are pseudonyms.

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