What Are Distribution Costs in Accounting?
Understand the costs of getting a product to a customer, how they are treated as period expenses, and used to measure logistical efficiency.
Distribution costs are the expenses a business incurs to move a product from its point of creation or storage to the final customer, encompassing the entire process of order fulfillment and delivery. These expenditures directly influence pricing strategies and profitability for any company that sells physical goods. The scale of these costs can fluctuate based on factors like product size and weight, the geographic spread of the customer base, and supply chain complexity.
Components of Distribution Costs
A primary category of distribution costs relates to warehousing and storage. This includes the expense of renting or owning a distribution center where finished goods are held before being shipped. It also covers associated utility costs, insurance premiums paid to cover the value of the goods held in storage, and the salaries for all warehouse personnel. The depreciation of warehouse equipment, like shelving and conveyor belts, also contributes to these costs.
Transportation and freight expenses form another portion of distribution costs. These are the costs associated with moving products from the warehouse to the customer, commonly referred to as “freight-out.” This category includes payments to third-party carriers for shipping services. For companies that maintain their own delivery fleet, it encompasses fuel costs, vehicle maintenance, insurance, and vehicle depreciation. The wages and benefits paid to delivery drivers are also a direct transportation expense.
Order fulfillment and handling costs are also classified under distribution expenses. This involves the cost of all packing materials used to prepare an order for shipment, such as boxes, tape, and protective fillers. The salaries for employees responsible for picking items from warehouse shelves and packing them are a part of fulfillment costs. Additionally, expenses tied to order processing systems, including software for inventory management, fall into this category.
Accounting for Distribution Costs
Under Generally Accepted Accounting Principles (GAAP), distribution costs are classified as period costs. This is because they are not incurred to manufacture the product itself but are associated with the activities of selling and delivering it. In contrast, product costs, such as direct materials and labor, are capitalized as part of inventory and are only expensed as Cost of Goods Sold when the product is sold.
Because distribution costs are period costs, they are not attached to inventory on the balance sheet. Instead, they are recognized as an expense on the income statement in the period they are incurred. This treatment aligns with the matching principle, which dictates that expenses should be recorded in the same accounting period as the revenues they help to generate. For example, the cost of shipping a product to a customer in March is recorded as an expense in March.
On the income statement, the classification of distribution costs can vary. A common approach is to report these expenses within the Selling, General, and Administrative (SG&A) section, where they are deducted from gross profit to calculate operating income. However, companies may also include certain distribution costs, particularly shipping and handling, within the Cost of Goods Sold (COGS). If classified as COGS, these costs are deducted from revenue as part of the calculation of gross profit.
Distribution costs can be further understood as direct or indirect. Direct distribution costs are those that can be traced to a specific unit sold, such as the freight charge for a single customer order. Indirect distribution costs support the overall distribution process but cannot be tied to a single unit, like the salary of a warehouse supervisor or the rent for the distribution center.
Analyzing Distribution Costs
One common metric is calculating distribution costs as a percentage of sales. This ratio is found by dividing total distribution costs by total net sales for a specific period. The resulting percentage shows how much of every dollar in revenue is consumed by the expenses required to get products to customers. A lower percentage suggests greater efficiency in logistics and fulfillment operations.
Tracking this percentage over time allows a company to identify trends and assess the impact of changes in its operations or cost structure. For instance, a rising percentage could signal increasing fuel prices, higher carrier rates, or internal inefficiencies. Comparing this metric against industry benchmarks also provides context on performance against competitors.
Another performance indicator is the cost per unit distributed. This is calculated by dividing the total distribution costs for a period by the total number of units or orders shipped. This metric provides a clear figure for the average cost to fulfill and deliver a single item. Understanding this cost is important for setting appropriate product prices to ensure that each sale is profitable.
This per-unit analysis is also used for logistical planning and budgeting. If a company knows its average cost per unit, it can more accurately forecast total distribution expenses based on sales projections. It can also use this data to evaluate the cost-effectiveness of different shipping methods or packaging options.