Is Freight In an Expense or Cost of Goods Sold?

Freight in refers to the costs a business incurs to bring goods into its possession. This includes shipping charges, handling fees, and insurance premiums paid for incoming inventory. Understanding how to account for these costs is important for accurate financial reporting and determining the true cost of inventory.

Understanding Freight In

Freight in encompasses all costs necessary to get inventory ready for sale or use. For instance, when a company purchases raw materials for manufacturing, the shipping charges from the supplier to its production facility are considered freight in. Similarly, if a retailer buys finished goods from a wholesaler, the transportation costs to bring those goods to its warehouse or store are also freight in.

Accounting Treatment for Freight In

For accounting purposes, freight in is not treated as an immediate operating expense. Instead, it is capitalized, meaning these costs are added directly to the cost of the inventory. This approach aligns with accounting principles that require assets to be recorded at their full acquisition cost, including all expenses needed to make them ready for use or sale. Therefore, when inventory is purchased, the freight-in amount is debited to the inventory account, not an expense account.

This capitalization ensures the inventory’s true economic value is reflected on the balance sheet. For example, if a business buys goods for $1,000 and incurs $100 in freight in, the inventory is recorded at $1,100.

Impact on Financial Reporting

Capitalizing freight in directly impacts a business’s financial statements. When the inventory is eventually sold, the capitalized freight in costs become part of the Cost of Goods Sold (COGS). This means the total cost of goods sold, including freight in, is recognized as an expense on the income statement when the revenue from the sale is recognized.

This treatment directly affects gross profit, which is calculated as revenue minus COGS. A higher COGS due to capitalized freight in will result in a lower gross profit. Subsequently, net income is also affected as gross profit is a component of its calculation. On the balance sheet, capitalizing freight in increases the value of the inventory asset until the goods are sold.

Freight Out and Its Accounting

In contrast to freight in, freight out refers to the costs of shipping goods to customers. These costs are incurred after the sale has occurred and are considered a selling or operating expense. Freight out is not capitalized into inventory but is expensed in the period it is incurred, often appearing as a separate line item under operating expenses on the income statement.