What Is Freight In? An Accounting Definition
Grasp the accounting definition of freight in, its impact on inventory valuation, and its role in financial reporting.
“Freight in” refers to the costs a business incurs to transport purchased goods from a supplier to its own location. These expenses are directly associated with bringing raw materials, merchandise, or supplies into the business’s possession. It represents a direct cost component of acquiring inventory, ensuring the goods are available for sale or use.
Accounting for Freight In
Freight in costs are typically capitalized, meaning they are added to the cost of purchased inventory rather than being immediately expensed. This accounting treatment aligns with the “cost principle” under Generally Accepted Accounting Principles (GAAP), which requires assets to be recorded at the total cost incurred to acquire them and prepare them for their intended use. The sum of these costs, including the purchase price and freight in, is often referred to as the “landed cost.”
When a business pays for freight in, it debits the inventory account and credits cash or accounts payable. This ensures the transportation expense is integrated directly into the inventory’s value on the balance sheet. By incorporating freight in costs, businesses accurately reflect the total investment made to acquire goods and prepare them for sale or production.
How Freight In Impacts Inventory Valuation
Including freight in costs directly impacts inventory valuation on a company’s balance sheet. Adding these transportation expenses to the initial purchase price increases the inventory asset’s overall value, providing a more accurate representation of the total investment.
When this inventory is sold, the higher cost (including capitalized freight in) transfers from the balance sheet to the Cost of Goods Sold (COGS) on the income statement. This means the expense recognized for sold goods is higher than if freight in had been expensed immediately, linking acquisition cost to revenue.
The increase in COGS directly reduces the gross profit, which is calculated as sales revenue minus COGS. A lower gross profit, in turn, leads to a lower net income, impacting the company’s overall profitability. Accurately accounting for freight in is crucial for understanding the true profitability of goods sold, adhering to the matching principle.
Differentiating Freight In from Other Shipping Costs
“Freight in” differs from “freight out” and other shipping expenses due to their distinct accounting treatments and financial statement impacts. Freight out refers to costs incurred by a business to transport goods from its location to customers. Unlike freight in (a cost of acquiring inventory), freight out is a cost of selling and delivering goods.
As a result, freight out is typically treated as a selling expense or an operating expense on the income statement, separate from the Cost of Goods Sold. This categorization reflects that freight out is an expense incurred after the goods are ready for sale and is directly associated with the sales process, not the acquisition of inventory. Expensing freight out immediately impacts the period’s net income as an operating cost.
Other shipping costs can also arise, such as those for inter-company transfers, or return shipping. The accounting treatment for these varies depending on their purpose; for instance, shipping costs for returned goods might reduce sales revenue or be recorded as a separate expense. The key distinction lies in whether the cost is incurred to bring inventory into the business’s possession (freight in), or to deliver it to a customer (freight out), as this determines its classification and impact on financial statements.