Is Shipping Part of COGS? What to Include and Exclude
Understand the nuances of including shipping in COGS and how it impacts financial reporting and business profitability.
Determining whether shipping costs should be included in the Cost of Goods Sold (COGS) can significantly impact a company’s financial statements and profitability analysis. This decision influences how businesses calculate gross margin and make strategic decisions about pricing and cost management.
Understanding what constitutes COGS is essential for accurate financial reporting. Here’s a closer look at when freight costs are considered part of COGS and when they are not.
When Freight Belongs in COGS
Freight costs are included in COGS when they are directly tied to acquiring or producing inventory. According to GAAP, expenses that prepare inventory for sale fall under COGS.
Inbound Freight
Inbound freight expenses are part of COGS because they are necessary for acquiring inventory. These costs include transportation fees for shipping raw materials or goods from suppliers to a company’s warehouse or production facility. Under GAAP’s matching principle, these costs are recorded in the same period as the revenue they help generate. For example, if a retailer purchases goods from a manufacturer, the shipping charges to transport these goods to the retailer’s location are a direct cost of acquiring inventory.
Packaging and Handling
Packaging and handling expenses are included in COGS when they are essential to preparing goods for sale. In manufacturing, raw materials may require specific packaging to ensure they are ready for processing or sale. For instance, if a company imports delicate components requiring special packaging to prevent damage during transit to the production facility, these costs are added to inventory. Under IFRS, such expenses are considered part of the production process and included in COGS.
Production Transportation
Transportation costs within the production process, such as moving goods between production sites or stages, are often included in COGS. For example, in automotive manufacturing, components transported between assembly lines for further processing are a direct part of production. IFRS guidelines consider these costs as contributing to inventory value, which is expensed as COGS when the final product is sold.
When Freight Does Not Belong in COGS
Freight costs not directly tied to production or acquisition are excluded from COGS. These expenses occur after production or acquisition and are categorized differently in financial reporting.
Outbound Shipping
Outbound shipping costs, incurred when delivering finished goods to customers, are excluded from COGS. These expenses are classified as operating expenses under GAAP and IFRS guidelines. For instance, shipping fees for delivering online orders to customers are associated with the sales process, not with production or inventory acquisition.
Post-Sale Delivery
Post-sale delivery costs, incurred after a sale is completed, are also excluded from COGS. These costs are considered selling expenses. For example, if a furniture retailer offers free delivery as part of a promotion, the associated delivery costs are recorded as selling expenses.
Distribution to End Users
Distribution costs, such as transporting goods from warehouses to retail locations or directly to consumers, are not included in COGS. These expenses are categorized as operating expenses because they are not directly tied to production or acquisition. For example, a company distributing products to retail stores records these transportation costs as operating expenses.
Accounting for Shipping in Financial Statements
Accurate classification of shipping costs is vital for proper financial reporting and compliance with accounting standards. Shipping costs, whether included in COGS or recorded as operating expenses, influence a company’s financial metrics.
When shipping costs are part of the procurement process, they are included in inventory costs, affecting inventory valuation on the balance sheet and metrics such as inventory turnover. Conversely, shipping costs related to customer delivery are recorded as operating expenses, impacting the operating margin.
Tax considerations also play a role. In the United States, the IRS requires costs directly associated with production or acquisition to be included in inventory costs for tax purposes, affecting taxable income and liability. The Tax Cuts and Jobs Act further emphasizes the importance of accurately reporting these costs when calculating the Qualified Business Income Deduction.
Advancements in technology, such as Enterprise Resource Planning (ERP) systems, have improved the tracking and allocation of shipping costs. These systems enable businesses to allocate expenses accurately, ensuring transparency and compliance. Automated systems also reduce human error, enhancing accuracy in financial statements and supporting better cost management and strategic planning.