When Is Shipping Considered Part of Cost of Goods Sold?
Decipher how shipping expenses affect your Cost of Goods Sold. Learn the critical distinctions for accurate financial reporting and inventory valuation.
The classification of shipping costs in a company’s financial statements, especially their inclusion in the Cost of Goods Sold (COGS), is a common question. Accurate classification is important for precise financial reporting and understanding a business’s true profitability. How shipping costs are accounted for depends on their nature and purpose within operations.
What is Cost of Goods Sold?
Cost of Goods Sold (COGS) represents the direct costs attributable to the production of goods sold by a company. This metric appears on a company’s income statement and is subtracted from revenue to calculate gross profit. COGS primarily includes the costs of materials and labor directly used in creating a product.
The main components typically found within COGS are direct materials, which are the raw materials and parts that become part of the finished product, and direct labor, representing the wages paid to workers directly involved in manufacturing. For manufacturing businesses, COGS can also include manufacturing overhead, comprising indirect costs such as factory utilities or depreciation of manufacturing equipment. COGS helps assess a business’s profitability on its core products.
Distinguishing Between Types of Shipping Costs
Shipping costs are generally categorized into two main types: inbound shipping costs, also known as freight-in, and outbound shipping costs, referred to as freight-out. This differentiation is important for proper expense classification and financial analysis.
Inbound shipping costs are expenses incurred to transport raw materials, components, or finished goods inventory into a business’s facility, such as from a supplier to a warehouse. These costs are part of getting goods ready for sale or production. Conversely, outbound shipping costs are those incurred to deliver finished goods from the business to its customers. These expenses arise after the products are manufactured or acquired and are ready for distribution.
When Shipping is Included in COGS
Inbound shipping costs (freight-in) are generally included as part of the Cost of Goods Sold. These expenses are considered a direct cost of acquiring inventory and preparing it for sale. The rationale is that these costs are necessary to bring the inventory to its intended location and condition, making them an integral part of the total cost of the inventory itself.
For example, if a company purchases raw materials from a supplier and pays for their transportation to its factory, these shipping charges are considered freight-in. These costs increase the cost basis of the inventory on the balance sheet. When the inventory is subsequently sold, these capitalized shipping costs flow through to the income statement as part of COGS, thereby impacting the gross profit. This treatment ensures that the full cost of obtaining salable goods is reflected in COGS.
When Shipping is Not Included in COGS
Outbound shipping costs (freight-out) are typically not included in the Cost of Goods Sold. These expenses are incurred after the goods are produced or acquired and are ready for delivery to the customer. They are considered part of the selling and distribution process, rather than a cost of acquiring or manufacturing the goods themselves.
Instead, outbound shipping costs are usually classified as operating expenses on the income statement, often appearing as selling expenses or part of Selling, General, and Administrative (SG&A) expenses. Examples include the cost of delivering products directly to customers, postage for mailed items, or fees for shipping goods from a distribution center to retail stores. This classification reflects that these costs are associated with the act of selling and delivering, rather than the intrinsic cost of the product.