Consignment, Joint Venture, Branch
ITown is a medium sized Industrial town.
M/s Innova Steels manufactures and sells different kinds of steel utensils locally.
Metro is a metropolis 30km to the north of I. City a city 25 km to the west of ITown and STown a small town 25 km to the south of ITown.
Innova steels had been consistently making profits for the last few years.
Objectives of Business
The basic objective of business is to make profits. Growth is one another objective of business. The indirect objective behind targeting growth/expansion, is bringing in growth in overall profits.
Growth of Business
Innova Steels is contemplating growing its business by expanding the market areas to nearby cities and towns.
It identified M, C and T as the potential markets.
A preliminary study was conducted, regarding the potential and conditions of the market in these three places, to enable Innova steels to decide upon, how to go about the process of expansion.
New places - New business associates
Innova Steels approached M/s Maruthi Steel Traders, which was identified to be the dominant business selling steel utensils at Metro, for a business association for sale of the manufactured steel utensils.
Being conservative natured, the ownership of M/s Maruthi Steel Traders, offered to sell the product made by Innova Steels on the following conditions
- They (M/s Maruti Traders) would not be required to invest anything for the business
- They would only stock the goods of Innova Steel
- Selling price to be decided by Innova Steel.
- They would sell the goods on a commission basis (@ 10% of the sale proceeds)
- M/s Maruthi Traders to be reimbursed any incidental expenses incurred by them.
This proposal was agreed to by Innova Steels.
M/s Rahim Traders was identified to be the dominant business house dealing in selling steel utensils. M/s Rahim Traders was approached for a business association (to sell the products manufactured by Innova Steels at City).
They made an offer similar to the one agreed upon between them and M/s Maruthi Steel Traders at Metro.
The ownership of M/s Rahim Traders was not willing to the proposal. They being people willing to take risk in anticipation of making profits, asked Innova Steels to work out a different plan for them.
They told Innova Steels that they could assess the profits made by M/s Innova Steels which they think would be around 40% of the sale proceeds. For that reason they wanted returns based on the profits made by Innova Steels on goods sold by them. However they were not willing to invest capital.
For this reason, Innova Steels worked out a profit sharing deal with M/s Rahim Traders. The following were agreed upon
- The transactions relating to the business would be accounted for separately
- M/s Innova Steels would invest stock as its share of investment
- M/s Rahim Traders would make efforts for sale as their contribution for the business
- Expenses are to be borne by both but are to accounted for in deciding the profits
- Profits of the business would be shared between them in a proportion to be agreed upon from time to time
No proper business house dealing in selling steel utensils could be identified at this place. There were only a few small shops selling steel utensils.
They came to the conclusion that it would be appropriate to set up a trading unit on its own to sell its products. Since it was a small town, it would not cost them much to set up a shop and they would be able to retain the total margin made on sale.
The shop would be directly working under their control and the affairs at the shop could be managed by a single employee.
Different Business Methodologies
If we go through the deals proposed to be made by Innova Traders at the three places we will notice that there is are fundamental differences between the three options/methods for doing business.
at Metro - Consignment
The method of business adopted at Metro where M/s Maruthi Steel Traders would sell stock on behalf of M/s Innova Steels is Consignment.
The delivery of goods for sale or disposal.
Send or give over to another for care or safekeeping.
The act of sending goods is called Consigning.
The person sending the goods is called the "Consignor" (M/s Innova Steels here)
The person receiving and selling the goods is called the "Consignee" (M/s Maruthi Traders here).
Consignor has ownership and risk in the goods
The ownership and thereby risk in the total stock is with the Consignor. The consignee holds the goods on behalf of the consignor.
The consignor is responsible for the acts of the consignee in his status as an agent.
Consignee is the Agent
The Consignee sells goods on behalf of the consignor and receives commission for his efforts. Any incidental expenses on the sale are normally to be reimbursed by the consignor unless there is an agreement to the contrary.
The consignee only acts as the agent of the consignor.
Consignor and Consignee : Principal - Agent relationship
The Consignee acts in the status of an agent to the consignor, i.e. the relationship between the Consignor and the Consignee is that of a Principal and Agent.
The transactions between them are governed by the agreement made between them as well as by the provisions of the Law of Agency.
at City - Partnership/Joint Venture.
The method of business adopted at City where M/s Rahim Traders sell goods for the joint benefit of M/s Innova Steels and themselves is called Partnership and if this relationship is for a short duration we call it a Joint Venture.
Both the parties are owners of the business. The profits of the business are shared between them as agreed upon by them at the time of getting into the relationship.
Learn accounting for Joint Ventures for a greater understanding.
at STown - Branch
The method of business adopted at STown where M/s Innova Steels are setting up a shop on their own is called a Branch.
The person conducting the business at the branch would be the employee of M/s Innova Steels. All the ownership and risk in the business is with Innova Steels.
Learn Branch accounting for Joint Ventures for a greater understanding.
With this understanding in mind we shall now move on to the process of designing the accounting system for consignments. We have to note that M/s Innova Steels as well as M/s Maruthi Traders have an existing business for which they have been preparing their Trading a/c's to decide the basic profit (gross profit) of the business and also a Profit & Loss a/c's to ascertain the net profits made by the organisation.