Freight Costs and Shipping Terms
Freight costs determine how much inventory actually costs on the books and who records those costs. The shipping terms written into a purchase agreement control two things: (1) when ownership of goods transfers from seller to buyer, and (2) who pays for transportation. Getting these right matters because they directly affect inventory valuation, cost of goods sold, and expense recognition on financial statements.
Freight-In vs. Freight-Out Costs
These two categories look similar but land in completely different places on the financial statements.
Freight-in is the cost the buyer pays to get goods transported from the seller to the buyer's location (warehouse, store, etc.).
- Freight-in is part of the cost of purchasing inventory, so it gets added to the Merchandise Inventory account.
- Think of it this way: the total cost of your inventory is the invoice price plus freight-in. This combined figure is sometimes called the landed cost of inventory.
Freight-out is the cost the seller pays to deliver goods to the buyer.
- Freight-out is a selling expense, recorded in a Freight-Out or Delivery Expense account.
- It does not get folded into cost of goods sold. Instead, it shows up as a separate operating expense on the seller's income statement.
The quick distinction: freight-in increases inventory cost for the buyer. Freight-out is an operating expense for the seller.
FOB Destination Shipping Terms
Under FOB (Free on Board) destination, the seller owns the goods during transit and bears the shipping cost. Ownership transfers to the buyer only when the goods arrive at the buyer's location.
Buyer's accounting treatment:
The buyer records the purchase at the invoice price only. No freight costs appear in the buyer's records because the seller is paying for shipping.
- Journal entry when goods are received:
| Account | Debit | Credit |
|---|---|---|
| Merchandise Inventory | Invoice price | |
| Accounts Payable (or Cash) | Invoice price |
Seller's accounting treatment:
The seller records the sale at the invoice price and separately records the freight cost as a selling expense.
- Journal entry for the sale:
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable (or Cash) | Invoice price | |
| Sales Revenue | Invoice price |
- Journal entry for the freight cost:
| Account | Debit | Credit |
|---|---|---|
| Freight-Out (Delivery Expense) | Freight cost | |
| Cash (or Accounts Payable) | Freight cost |
FOB Shipping Point Terms
Under FOB shipping point, the buyer takes ownership as soon as the goods leave the seller's location. The buyer is responsible for freight costs from that point forward.
Buyer's accounting treatment:
The buyer records the purchase at the invoice price plus any freight-in costs. Both amounts go into Merchandise Inventory because freight-in is part of the inventory's total cost.
- Journal entry when goods are received:
| Account | Debit | Credit |
|---|---|---|
| Merchandise Inventory | Invoice price + freight-in | |
| Accounts Payable (or Cash) | Invoice price + freight-in | |
| For example, if a buyer purchases goods with an invoice price of and pays in freight, the debit to Merchandise Inventory is . |
Seller's accounting treatment:
The seller records only the sale at the invoice price. Since the buyer is responsible for shipping, the seller has no freight expense to record.
- Journal entry when goods are shipped:
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable (or Cash) | Invoice price | |
| Sales Revenue | Invoice price |
Shipping Terms and Inventory Valuation
The choice between FOB destination and FOB shipping point determines the exact moment ownership transfers, which has two practical consequences:
- Inventory counts at period-end. Goods in transit under FOB shipping point belong to the buyer, so the buyer should include them in inventory even if they haven't physically arrived yet. Under FOB destination, those same goods in transit still belong to the seller.
- Cost recognition timing. Freight-in costs under FOB shipping point increase the buyer's inventory balance immediately upon shipment. Under FOB destination, the buyer's inventory isn't affected until goods arrive.
Applying the correct shipping terms ensures that inventory is neither overstated nor understated on the balance sheet, and that expenses are recorded by the correct party in the correct period.