Periodic Inventory - Freight Costs - Online Tutor, Practice Problems & Exam Prep

In inventory accounting, delivery expenses, known as freight costs, are crucial. Under FOB Shipping Point, ownership transfers to the buyer at the shipping point, making them responsible for shipping costs, which are recorded in the Freight In account, increasing inventory value. Conversely, under FOB Destination, ownership transfers at the destination, and the seller covers shipping costs, resulting in no entry for the buyer. Understanding these terms is essential for accurate accounting and maintaining the accounting equation, ensuring assets and liabilities remain balanced.

Periodic Inventory:Freight Costs (FOB Shipping Point)

Well, goods don't just show up on our doorstep, right? Well, they need to be delivered. So let's think of how that delivery expense could be accounted for in our inventory transactions. Someone's going to have to pay those shipping costs, right? It's either going to be the buyer or the seller. Someone's going to pay for it, and we call them freight costs here. When we talk about accounting that delivery expense, we call them freight costs, okay? It's just another way to say the same thing. In a periodic system, we're going to use a special account. We're not going to debit inventory directly, okay? What we're going to do is we're going to use this account, Freight In, that's going to hold all the value for all the delivery expenses that we had to pay to receive inventory. Okay?

So the first type of situation is called the FOB Shipping Point. FOB stands for Free On Board. You don't really need to know that too much though, it's not a big deal. The cue here is this part, the shipping point. Okay? And the whole deal with delivery is who owns the goods while they're in shipment. Does the buyer own them while they're on the truck, or does the seller own them while they're on the truck? Okay, so when we talk about FOB shipping point, that means the ownership of the goods changed hands at the shipping point, okay? So, I like this little drawing that I do here. We've got the seller's warehouse, then we have the delivery, and then the buyer's warehouse. Buyer. I'll just put buyer. Right? So when we talk about FOB shipping point, well, the ownership changes hands right here at the shipping point, right before the delivery happens. So, that means that the buyer owns them during the delivery, right? The buyer is going to own it during the delivery, so the buyer is responsible for the shipping cost, okay? So in this case, the buyer pays the shipping cost, and if you have to pay freight costs to receive your inventory, so think about it. If we didn't pay this freight cost, we wouldn't receive our inventory at all, right? So this cost is a necessary cost to receive our inventory. Well, we're going to include it in that account called Freight In. Freight In. Okay? And this is an inventory sub-account that increases the value of inventory for all the deliveries. Okay? So are all the delivery expenses that we pay I should say. Alright, let's check this example out right here.

Things on shelves ordered 500 things at $5 per thing. The terms of the order are FOB shipping point. So that would be a situation like I've drawn above, right? The buyer has to pay the delivery fee. In this case, we are the buyer, right? We are purchasing things, so we are responsible for this $35 charge from UPS. So let's see how we would account for this. The first thing we would have to do is find out what this inventory is worth. 500 times $5 is 2,500, right? So this would go into our purchases. In our periodic system, we increase purchases when we buy stuff, 25100, and we bought it on account, let's say. It doesn't really say, but let's say we bought it on account, 25100. Right? That's the amount that we owe to our supplier. But what about the shipping cost? In this case, we have to pay for it. Right? We're the buyer, and we have to pay the shipping cost. So we're going to debit our Freight In, this is basically an asset account related to our inventory account. So this is increasing the value of inventory at the end of the day, at the end of the period. So Freight In is going to get $35, and let's just say accounts payable. We haven't paid UPS yet. That could be cash if we paid UPS in cash. Whatever it is, this is increasing the value of our inventory basically. So these assets, the purchases, are going to increase our assets by 2,500, and the freight in is increasing our assets by 35. Okay. So both of those things are going to be what we say capitalized. We capitalize something when we make it an asset. The idea of saying something is capitalized means we're putting it on the balance sheet rather than into the income statement. Okay. So we're capitalizing that delivery expense into the value of inventory. Okay. The other side of this was the accounts payable, right? We had accounts payable that went up by 25100, and then they went up by 35 as well for the other payment. So this stays balanced. Right? We're still balanced here. We're good. Cool. Let's pause here and then we'll discuss the other type of shipping in the next video.

Periodic Inventory:Freight Costs (FOB Destination)

Alright. So we discussed FOB Shipping Point. Well, let's see the similarities here. FOB Destination. Now, FOB Destination means that the ownership of the goods changes hands at the destination. Right? So, if I draw the same little thing I did above, we've got the seller, then we've got the delivery, and then it gets to the buyer's warehouse. Right? So it goes from the seller's warehouse into the delivery truck and then to the buyer's warehouse. Here, it's changing hands at the destination. In this case, the seller pays the delivery fees. Right? That's what we're exactly going to see here. The seller is paying the delivery fees in a FOB destination situation.

If you have to pay freight cost to sell your inventory, this is in a situation where we're making sales. Well, this is a selling expense when we're making sales and we have to pay for delivery, okay? Because we couldn't make the sale if we didn't make that selling expense. So let's see what happens here. TOS ordered 500 things at $5 per thing. The terms are FOB destination, right? So notice in an FOB destination, we're the buyer in this case. The buyer doesn't have to pay the delivery, right? The seller pays the delivery. So, we're good. We don't owe any money to UPS. Our supplier is going to have to pay UPS. So we would make an entry for the 500 things at $5 a thing. We would make a purchase entry when we purchase those things. Purchases, 2,500 with a debit and accounts payable for 2,500, right? We bought those things on account.

Now, what about the delivery fee? There's a $35 delivery fee, but it's not coming out of our pocket. So we don't care. We don't have to make an entry at all. There's no entry related to the delivery. Now, on the seller's books, if we were talking about the seller, this is strictly hypothetical just so you know. If we're talking about the seller's books, they would make an entry for this delivery expense with something like a debit to selling expense. That increases the expense by $35 and a credit to accounts payable or cash, however they paid for it: $35, right? So the seller would take this expense on their books, but on our books, the only entry they make is the purchase entry. There's no entry for the delivery. Right? So let's see what happened. The assets, the purchases went up, brought our assets up by $2,500 and accounts payable also went up by $2,500. So we're good. Right? This equation still balances.

Alright. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What are freight costs in periodic inventory accounting?

Freight costs in periodic inventory accounting refer to the delivery expenses incurred to transport goods from the seller to the buyer. These costs are essential for receiving inventory and are recorded differently based on the shipping terms. Under FOB Shipping Point, the buyer is responsible for the freight costs, which are recorded in a special account called Freight In, increasing the inventory's value. Conversely, under FOB Destination, the seller covers the freight costs, and the buyer makes no entry for these expenses.

How are freight costs recorded under FOB Shipping Point in a periodic inventory system?

Under FOB Shipping Point in a periodic inventory system, the buyer is responsible for the freight costs. These costs are recorded in a special account called Freight In. For example, if a buyer orders goods worth $2,500 and incurs a $35 shipping fee, the entry would be a debit to Purchases for $2,500 and a debit to Freight In for $35. The corresponding credit would be to Accounts Payable for $2,535. This increases the inventory's value by including the necessary delivery expenses.

What is the difference between FOB Shipping Point and FOB Destination in terms of freight costs?

The main difference between FOB Shipping Point and FOB Destination lies in who is responsible for the freight costs. Under FOB Shipping Point, ownership transfers to the buyer at the shipping point, making the buyer responsible for the shipping costs, which are recorded in the Freight In account. Under FOB Destination, ownership transfers at the destination, and the seller covers the shipping costs. In this case, the buyer makes no entry for the delivery expenses, as the seller is responsible for them.

How does the Freight In account affect the value of inventory in a periodic system?

In a periodic inventory system, the Freight In account is used to record delivery expenses incurred by the buyer. These costs are necessary to receive the inventory and are therefore capitalized, meaning they are added to the inventory's value. For example, if the buyer incurs a $35 shipping fee, this amount is debited to the Freight In account, increasing the inventory's value by $35. This ensures that the total cost of inventory includes all necessary expenses to bring the goods to their intended location.

Why is it important to understand FOB terms in inventory accounting?

Understanding FOB terms in inventory accounting is crucial because they determine who is responsible for the freight costs and when ownership of the goods transfers. FOB Shipping Point means the buyer is responsible for shipping costs and owns the goods during transit, while FOB Destination means the seller covers the shipping costs and retains ownership until the goods reach the buyer. Accurate accounting of these terms ensures that delivery expenses are correctly recorded, maintaining the balance of the accounting equation and providing a true representation of inventory costs.