I'm Larry Walther and this is principlesofaccounting.com, Chapter 5.
We're continuing with the module on purchase recognition issues for
merchandising businesses.
Specifically focusing this time on freight costs.
Freight costs can be very significant,
it's not an immaterial cost to consider for many businesses.
So in negotiating a purchase and a purchase price, one would typically also
negotiate the freight terms which deal with the place of delivery.
When the risk of loss shifts from the seller to the buyer and
who's to be responsible for the cost of shipping.
In North America we typically refer to this is FOB or Free on Board
point which refers or represents the place where ownership transfer shifts.
So let's see how this works.
And if the goods are FOB destination the seller needs to pay to get the goods to
their destination.
Here's a drawing, our seller is in New York, is paying the freight company and
the goods are moved across the country to Los Angeles to be received by the buyer.
I'm putting a check mark, those freight costs are incurred by the seller.
If we turn this around and look at FOB shipping point
then the buyer agrees to pay to get the goods to the destination.
So here the buyer is paying the freight company and
the buyer is going to record the freight costs on their books.
We can have variations of this, we can have FOB shipping point, freight prepaid.
In this particular case the seller is paying the freight company but
expects to be reimbursed by the buyer
because the terms are FOB shipping point at the point of shipment.
The goods belong to the buyer, as does the obligation to pay for the freight.
The transfer of cash from the seller to the freight company, and
in turn from the buyer to the seller to reimburse,
that's merely an accommodation of the transaction.
But again, the freight cost belongs to the buyer, okay.
The terms shipping point and destination are often replaced with actual areas,
such as FOB New York.
Areas can be intermediate locations, for example, ROB, St. Louis, where we say if
the seller was in New York, we're agreeing that the seller will get the goods to St.
Louis at which point ownership shifts to the buyer at that point.
So that's a way of splitting the obligation for the freight.
Let's look at the accounting for freight, FOB destination,
the freight cost will be incurred by the seller, it's called freight out.
It's a selling expense that's tobe subtracted from gross profit in
arriving at net income.
And so let's look at the journal entry here.
There in addition to our $7,000 sale, debit accounts receivable and
credits sale,
there within that compound journal entry is a debit to freight out and a credit to
cash to represent the payment of the freight cost incurred by the seller.
For the buyer's entry for
this transaction, would barely debit purchases and the credit accounts payable.
Nothing is recorded relative to the freights since the buyer
has no duty with respect to the freight.
If we turn this around and look at the FOB shipping point, then we're going to have
is $8000 sale by the seller and then record the account receivable and sale.
The buyer in their compound journal entry to record the $8,000 purchase.
They'll also record the disbursement of $1500 for freight costs.
We have FOB shipping point, freight prepaid, gets a bit more complicated.
Here the seller has a $10,000 sales transaction but
they're booking $10,400 in accounts receivable.
Because they've also paid the freight company $400 that
they are entitled to be reimbursed for by the buyer.
If we look at the buyer's books,
the buyer is going to record freight in as a $400 cost.
Merchandise purchases the $10,000 cost of the goods and
reflect the $10,400 payment, the amount that's due to the seller.
Notice that the seller's accounts receivable corresponds to
the buyer's accounts payable.
Finally, one question that will come up in your homework is,
do I get a cash discount on freight?
If I bought goods 210 net 30, I get a 2% discount for
timely payment, if I buy $10,000 worth of goods, and
incur $400 of freight costs, is my discount $200, 2% of 10,000 or is $208?
The answer is it's $200.
You're not entitled to a discount on the freight terms.