Accounting for Freight in vs Freight Out
What is Freight in?
The freight-in definition refers to freight as when customers receive freight and are therefore responsible for paying the delivery expenses and other fees. If those goods are a part of the inventory, it’s considered to be the cost of goods sold. It is reported on a multi-step profit and loss statement underneath the sales section. Cost of Goods Sold is reported on a single statement and can be analyzed, but it is listed in a different position.
Accounting for Freight in
Remember, freight in is the cost of bringing goods into the company. There are several ways to deal with this. It can be included in the cost of inventory. When handled like this, some of the costs for freight in could be capitalized in the month-end inventory. As such, it wouldn’t appear as a part of the cost of goods sold until the inventory items in question are sold to consumers. This approach is the best if you want to delay expenses appearing in your accounts.
Another option for freight in income statement is to charge it to expenses as incurred. This is a good option if there isn’t much freight overall. This also reduces how much work is needed to figure out the amount of freight cost that goes into the ending inventory balance. The downside is that it could leave you charging more to expenses upfront than you would otherwise.
Most experts recommend charging off freight in as soon as possible. This approach does accelerate expense recognition, but that expense won’t be very big for most companies. The reason you should charge off the freight in immediately is to prevent freight from messing up your inventory records. Freight is just another item that gets lumped into the bill of materials or allocated from overhead. It’s just one more item for auditors to be aware of when looking through the inventory balance at the end of the year. Moreover, you must also factor freight costs back out when doing a market analysis.
While we recommend charging freight in to an expense account as quickly as possible, there are some situations where that isn’t the best idea. One example is businesses with seasonal sales. Suppose your business produces goods all year but only sells them during peak season, such as over winter holidays or during the summer.
If you charged freight to the expenses across the year, then you’d have some strange-looking financial statements where you spent barely anything on the cost of goods sold but no sales to offset them as you only generate sales during the peak season.
If that’s your business, you should consider capitalizing the freight in cost to avoid any unwanted questions from investors about why you have strange expenses showing up on your income statement.
What is Freight Out?
The freight out definition states freight out is when manufacturers and suppliers ship and export goods to customers through a freight company, making them responsible for the shipping charges. Such an expense is freight out. The cost for the transportation of goods is an operating expense and is recognized in the freight out income statement in the operating expense section. Freight charges might not stand out much if you’re using a single-step profit and loss statement, but they are easier to track with a multi-step income statement.
Accounting for Freight Out
As with freight in, there are several ways to account for freight out. The most basic method is charging freight out to the expense account as soon as the cost comes in. One problem with this approach is the timing of the expense recognition. Under a matching principle, every cost associated with a sale is supposed to be recognized at the point of sale. However, it’s possible it could take until the next month to receive the invoice from the freight company. This means that the expense isn’t recognized at the right time, which throws off your books.
Given how much freight out costs, many companies don’t bother accruing the expense in the appropriate period. Instead, they wait until they get the invoice from the freight company and record it in the books then. Accruing freight at the appropriate time is more trouble than it’s worth. It would take matching every shipment to every freight bill to see which shipments have yet to be invoiced. You’d also have to estimate when you expect to receive the invoice and then create the accrual from there.
Another problem with freight out is what you need to do if you re-bill the costs to the customer. Your choices are to treat the bill as a kind of revenue or offset the billing against the recorded freight out expense.
Billing customers for freight out should only ever be treated as revenue if doing this is the primary way your business generates money. A business that does this would have one of the strangest business models ever. What normally happens is that companies offset freight billings to customers against the line item for the freight out expense. The result is a small expense on freight out.
There could even be some cases where you have negative freight out costs. This happens if the amount billed is typically higher than the expense. Don’t worry if that happens, as it’s perfectly fine.
One problem with both freight in and freight out is where to put them on the income statement. You should put them in the cost of goods sold. Some argue that the costs for freight out should go to the sales department, but we don’t see the logic to that. Freight is a direct cost connected to selling goods, so it should be listed in the cost of goods sold section. Freight costs aren’t connected to the regular operation costs of a business, so it doesn’t belong in the sales department or the general and administrative section. The cost of goods sold is the only place that makes sense for it.
Freight in vs Freight Out
There are clear differences between freight in and freight out. Suppliers must make a note of an operating expense if they are the ones responsible for the costs, while customers could potentially include it in the cost of goods sold. If customers aren’t going to place the goods in inventory, then it should be accounted for properly. When negotiating for a contract, buyers and sellers alike must ascertain who is responsible for freight and shipping. Failing to classify freight in and freight out properly could affect the gross margin and cause other financial problems. Stay on top of the situation and always know who is responsible for what.