In the past, accounting for rising freight costs wasn’t a primary concern for many organizations. The fluctuations were often mild, and mistakes wouldn’t have mattered as much in the grand scheme of operations.
However, as the supply chain continues to rebuild after the pandemic, many companies are facing growing freight complications and the rising costs associated with it. Due to these rapid price increases, ‘traditional’ ways of accounting for freight may not work in these times, and mistakes will quickly and visibly add up if they are not accounted for correctly.
Much of the pain stems from companies’ inability to unload containers in a timely manner. As a result, many organizations are receiving thousands of dollars in demurrage, detention, and chassis fees months after the inventory has already been received into the system with sales activity against it. Historically, these charges were typically immaterial and not significant in nature. However, they have recently become significant, and improper accounting could cause errors on the financial statements, including misstatement of inventory and cost of goods sold, resulting in a misstatement of income either now or in future periods.
Proper Freight Accounting Treatment
In general, if the freight costs are a normal part of obtaining the inventory, they should be capitalized, per Accounting Standards Codification (ASC) 330, Inventory.
Cost as applied to inventories typically includes the “sum of applicable expenditures and charges directly or indirectly incurred to bring inventory to its existing condition and location.” This means the costs associated with your inventory, including duty, freight, and more should all be reflected in the cost of your inventory. As such, the inflated freight costs should be capitalized into the cost of the inventory.
An exception to capitalizing freight costs would be “abnormal” costs, which should be expensed. However, abnormal is defined as excess or redundant costs (i.e., moving product from one warehouse to another because of an internal error), and an increase in supply costs is, while frustrating, not abnormal. Additionally, it’s important to note that freight costs attributed to economic issues arising as a result of the COVID-19 pandemic are not considered “abnormal.”
If you conclude your freight costs are abnormal costs, they should be defined as such, noted that they cannot be capitalized, then expensed. If the freight costs are “normal” but high, then they should be capitalized.
Many organizations paid high freight costs in order to stockpile inventory in 2021 to fulfill customer demands in a timely manner. As these inventory levels have normalized in 2022 and 2023, the resulting impact is a drop in gross margin, as the higher cost of inventory flows through the income statement. In the USDA’s monthly reporting on changes to ocean freight rates, we can see that there were modest changes to prices over the period 2014 – 2020. However, the average spot rate to ship a 40 foot container from the West Coast to China, rose dramatically, from $860 in December 2020, to a peak of $1,710 in the fall of 2021, followed by a decline to $1,260 in December 2022.
In most instances, companies should capitalize the high freight costs. If the inventory costs are deemed abnormal, they should be expensed.
If you have questions concerning how to account for your rising freight costs, send me an email and I’d be happy to help.
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