What Are Freight Out Charges? (And How to Record Them)
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A company's financial statements contain information that can help them achieve its business objectives. This includes freight charges, which refer to the costs of freight shipping. Understanding these expenses is crucial if you're looking to start a career in accounting or if you want to know how to record them properly. In this article, we define what freight out charges are, distinguish these from freight in costs, provide information on how to record them in financial statements, highlight the importance of recording them, discuss factors that affect freight pricing, and define freight-related terms.
What are freight out charges?
Freight out charges are expenses that result from transporting goods or raw materials from suppliers to customers, which can either be companies or private individuals. These transactions in financial statements aren't operating costs because they're not part of a company's day-to-day expenses. A business only incurs these costs when they sell goods to customers. In these instances, they classify the expenses under cost of goods sold (COGS) in the income statement. Shipping costs are common in large companies, especially businesses that transport goods internationally.
Difference between freight in charges
While these two shipping expenses operate on similar principles, the terms are also different because they describe where the goods originate and where they end up. Here are some details that can help you tell them apart:
This is the shipping cost for deliverables away from the supplier or seller to customers or buyers. It's a common expense for factories, wholesalers, and manufacturers. The length of time that items reach the buyer can affect the time of recording the expense. The seller typically notes the cost at the time they incur it in the cost of goods sold (COGS) section or as a selling expense except when buyers shoulder the shipping fee.
These are handling charges that are incurred when the buyer receives the items they ordered from stock providers. Examples of these sources are showrooms, stores, and other places that manufacture, supply, and transport materials. In a freight in charge, the buyer pays the shipping cost. The shipping company may record their billing to the customer as revenue if the act of transporting goods is their main source of income.
How to record shipping expenses correctly
An organization often pays attention to cost recording because this can affect the integrity of its financial statements. If these contain inaccurate information or there are missing data, they may not be able to determine the company's financial position and comply with government regulations. These can affect overall business performance. Here are the steps to properly account for shipping out expenses:
1. Register outgoing delivery costs as the company incurs them
It may be helpful to register shipping costs in the income statement at the time of occurrence to ensure proper accounting of these transactions. Doing this may not be possible in many instances because of the delay in releasing invoices that provide the actual cost of shipping. As a solution, many businesses disregard the time they incur the cost and record this freight expense when they receive the invoice for it.
2. List freight expenses as cost of goods sold
There's generally a direct relationship between shipping costs and the quantity of goods a business sells within a period of time. This means that their shipment expense becomes higher as the number of sales they make increases. Since this is the case, companies typically consider expenses relating to transporting the goods from seller to buyer as part of the cost of goods sold (COGS) section in the income statement.
You can record this freight expense under COGS by calculating the total amount paid by the company to ship goods to customers. It may be a good idea to check the invoices from the shipping company to ensure accuracy of information. You can then add the total shipment cost to the other expenses the organization incurred to produce their product. These may include the cost of packaging, labour, and raw materials. The sum of these expenses is the figure that corresponds to COGS in the financial statement.
3. Send cost of transport to customers
When the company bills customers for the cost of transporting the goods to them, you can list the fees as unpaid bills following shipping expenses in the income statement. This usually offsets the freight costs the company incurred. The total freight expense of the business depends on the amount they paid for shipping and how much they charge the customers. In some instances, the expense may come out as negative. This means that the company billed the customers more than the actual cost of shipping.
The importance of recording freight expenses correctly
Just like other business costs, it's important to list freight charges for reasons of transparency and monitoring. Documenting these expenses enables the organization to determine their income accurately, which is especially important for businesses that ship on a regular basis. Correctly recording freight expenses can also help with:
Pricing products: A company can determine a price point for their product that generates profit and appeals to their target market. They can also avoid underpricing or overpricing their items, which may affect the company's performance.
Billing customers: Accurate recording can help a business determine how much they can charge their customers if their agreement stipulates that the buyer is responsible for the cost of shipping their order. This allows the company to offset the cost of transporting goods or even make a profit.
Minimizing expenses: Proper recording of freight expenses can help a company determine if changes are necessary to minimize the cost of transporting their products and consequently increase their profit. If the expense significantly affects the company's net income, it may be wise to look for less costly shipping alternatives or bill customers for the cost of shipping.
Factors that affect the cost of shipping
Many businesses look for ways to save on shipping costs to be able to maintain competitive pricing for their product. They also do this to maximize their profit. When considering shipping options for a company, it's important to take note of the factors that may affect the cost of delivering items to customers, such as:
Laws and regulations: Some guidelines that pertain to restrictions of delivery trips, taxes, and cargo capacity directly impact freight charges. These protocols may also change from time to time, which adds to the difficulty of calculating shipping costs.
Mode of delivery: The cost of transporting goods varies depending on the type of transport used. A business may use trucks, planes, ships, or trains, shipping goods via land, water, or air. The chosen mode of delivery has an impact on shipping fees.
Associated dangers: As risks and hazards may make transporting goods dangerous, such factors also affect fees. The cost of shipping may be higher in instances wherein extra equipment or freight assistants are necessary.
Fuel: When fuel prices increase, the price of delivery also rises. Companies often address this by increasing the price of their goods.
Load: There's generally a direct relationship between cargo weight and shipping cost. Heavier, bulkier, and bigger items often incur higher delivery costs than lighter and smaller loads.
Competition: Higher demand for freight needs often results in shipping companies charging more for their services.
Definition of freight-related terms
Many people find terms that are relevant to shipping confusing. It's important to understand these if you're responsible for recording freight-related expenses for a business or considering a career in accounting. Knowledge of these terms can help you record shipping costs correctly and ensure the accuracy of a company's income statement:
Free on board (FOB)
Free on board is a universal accounting term that determines the bearer of responsibility while goods are in transit. This trading term identifies if the seller or buyer shoulders the cost of item damage, loss, and destruction. A contract between the two parties often includes FOB details.
Free on board (FOB) shipping point
This term confirms that the buyer takes all accountability of item-related concerns from the exact time that the seller ships their order. Both parties consider the shipping point as the selling point and where transfer of ownership occurs. This typically means the buyer pays the delivery charge and gains ownership of the goods even while still in transit.
Free on board (FOB) destination
FOB destination means the liabilities stay on the seller's side until the products reach the customer. They also retain ownership of the item during the shipping process. In this setup, the seller typically settles the fees. The transfer of ownership only happens when items reach the point of delivery, which may be a loading dock, post office, or the customer's personal address.
Transfer of sale
This term correlates to FOB shipping point and FOB destination. It refers to the shift of ownership of goods that are the subject of a sales transaction. As items leave the seller, they transfer legal possession to the buyer either at the point of shipment or delivery.
This is a company's profits resulting from billing customers on shipping. Sellers usually don't record this separately in their income statement. Instead, their freight expense becomes negative. Companies whose main income-generating activity is shipping record these customer billings as revenue.
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