Mark Farber: Hi.
I'm Mark Farber, and this is Accounting Fundamentals.
We're going to talk today about freight costs, and really, any other kind of cost that's
associated with inventory.
We said before that when we cost out inventory to a company, what we're taking is the price
that the company paid for that inventory as the cost per unit, or for the inventory as
a whole.
It's not just the cost that they physically pay for the inventory itself, it's all the
costs that are acquired in order to make that inventory saleable.
What we mean by that is, if the inventory comes into your store, and it's in pieces,
and the store has to pay somebody to put it together, to put it up on the shelf, and make
it saleable, then the cost of putting it together, those assembly costs, become part of the cost
of the inventory.
Similarly, if you had to pay duties, or you had to pay specific taxes to bring the inventory
into your store, that becomes part of the cost of the inventory.
Finally, if there's discounts, or any other special charges, or rebates that you get,
those come off of the cost of the inventory.
Freight cost is an important one.
If you think about the fact that a lot of the stuff that we sell here in Canada might
come from the U.S., might come from China, the cost of bringing that inventory into Canada,
and into your store can be very high, and a very significant portion of the costs.
The question is, how do we treat freight costs, because in some cases, the company pays for
them.
In some cases, it's not included in the inventory cost.
It really depends on something called an FOB point.
You can look in different tests ... tests ... texts ... Having problems with English
today.
An FOB will be defined as different things.
It'll stand for Free on Board, or Freight on Board.
Doesn't really matter to us what it stands for.
What it means is it's the point at which ownership of the item changes.
Think about a store purchasing something from a manufacturer in China.
While that item is in the manufacturer's facility in China, it's clearly owned by the manufacturer.
When it's in the store, and on their shelves here in Toronto, it's owned by the store.
But who owns it when it's traveling between, when it's on a ship, or it's on a boat, or
on a train, or something?
Who is responsible for the item while it's in transit, and at what point does the ownership
change from the manufacturer to the store?
Well, think about it this way.
Over here is the manufacturer, and over here is the store.
Two obvious points to designate the transference of ownership would obviously be right here,
or right here.
In fact, it can happen at any point, but we're only going to look at these two.
If the change in ownership happens over here, then we say it's FOB Seller.
The person who's selling it, or the company that's selling it, as soon as it leaves their
facility, and quite literally, as soon as that product goes onto a truck at this facility,
the ownership is deemed to have changed.
That means that while it's in transit, if it's FOB Seller, while it's in transit, the
store effectively owns it.
The buyer owns it.
If something happens to it en route, they owned it, and it's their problem to deal with,
essentially.
More importantly, because they own it during this period of time, it means that the buyer
pays for shipping.
If you own it, you have to pay to ship it.
The other possibility, or the other common possibility, would be FOB, and it's usually
called FOB Destination, or FOB Buyer.
In that case, ownership doesn't transfer until the goods arrive at the store, or wherever
they're being shipped to, and the store accepts them.
That's an important feature, because if the manufacturer's shipping over a bunch of glass
products, for instance, and the box arrives here at the store, they come in with a big
box, and they say, "Okay, please sign for them," until the store signs for it, they
haven't accepted ownership of the goods.
If they look at the box, and it looks like it's been beat up pretty bad, and everything
inside is most likely broken, they can choose to not sign for it.
They don't own it.
It goes back to the manufacturer.
On the other hand, if it was FOB Seller, and it gets to the store all broken, well, you
own it.
You've got to deal with it.
You can still go back to the manufacturer and say, "You sent me broken stuff," but it's
yours at that point, whereas if it's FOB Destination, it's not yours until you physically sign for
it.
Moreover, since you don't own it till it gets there, or the store doesn't own it till it
gets there, then the manufacturer, or the seller owned it for this entire process, and
therefore, seller pays for shipping.
Again, as I said, shipping can be a very expensive process, especially if you're shipping stuff
across the globe.
Who pays for that shipping, who's required to pay for it is a very important part of
figuring out the cost of the product.
Now, how do you know whether it's FOB Destination, or FOB Seller, or FOB anywhere else in this
process?
It's going to be defined in the contract.
It's negotiated as part of the price when the store and the manufacturer negotiate what
they're going to buy, how much, and how it's going to be shipped.
That's something that you have to keep in mind.
As an accountant, we have to know what was the FOB point, and therefore, who's responsible
for the shipping charges, and if it's FOB Destination, then they're excluded from the
cost of the inventory, because they were paid for by the manufacturer.
If it's FOB Seller, then they're included, and we have to take those costs and include
it, along with the cost of the product that we purchased, and any other cost involved
in making that item saleable.