Handling the Landing Cost of Products Purchased

Two Alternative Approaches

When managing the landing cost of purchased products, there are two alternative approaches to consider. Below is a detailed explanation of each approach:

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Approach 1: Periodic Inventory Adjustment

1. Maintaining a Shipping Cost Account:

• Setup: Create a dedicated account to track shipping costs associated with inventory purchases, separate from other COGS (Cost of Goods Sold) accounts. Record all incurred shipping costs in this account rather than directly allocating them to individual inventory items.
• Tracking Costs: As you receive shipping bills, log the expenses into this shipping cost account. This allows you to aggregate all shipping costs over a specific period (e.g., quarterly or semi-annually).

2. Periodic Adjustment:

• Timing: At the end of each period (quarterly or semi-annually), review the accumulated shipping costs in this account.
• Allocation: Calculate the total value of the inventory received during that period. Apportion the accumulated shipping costs to this inventory based on the value or weight of the items.
  • Example: If you received $100,000 worth of inventory and incurred $10,000 in shipping costs, allocate a portion of the $10,000 shipping costs across the inventory items proportional to their value.
• Adjustment Entry: Make a journal entry to transfer the shipping costs from the shipping cost account to the inventory account. This adjustment increases the value of your inventory and reflects a more accurate cost of goods sold when those items are sold.
  • Example Entry:
    • Debit Inventory: $10,000
    • Credit Shipping Costs (COGS): $10,000
• Impact: This process ensures that the shipping costs are accurately reflected in the cost of inventory, aligning with the matching principle in accounting.

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Approach 2: Use of a Standard Rate

1. Estimating a Standard Shipping Rate:

• Calculation: Based on historical data, estimate an average shipping cost per unit or per batch of products. This can be calculated using past invoices and shipping costs to determine an average.
  • Example Calculation: If over the last year you shipped 1,000 units and incurred $20,000 in shipping costs, the average shipping cost per unit would be $20.
• Application: Apply this standard rate to each unit or batch of inventory when you receive it, rather than waiting for the actual shipping bills. This provides an estimated shipping cost that can be immediately included in inventory valuation.

2. Periodic Adjustment:

• Review and Reconciliation: Periodically (e.g., quarterly or annually), compare the standard shipping costs applied to the actual shipping costs incurred.
• Adjustment Entry: If there’s a significant discrepancy between the estimated shipping costs and the actual costs, make an adjustment to reconcile the difference.
  • Example Entry:
    • If actual shipping costs were higher than estimated, debit the inventory account and credit the shipping cost account to reflect the additional expense.
    • Conversely, if actual costs were lower, reverse the entry.
• Impact: This method smooths out the variability of shipping costs over time and helps maintain consistent inventory valuations. However, regular review is necessary to ensure accuracy.

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Considerations for Both Approaches

• Compliance and Accuracy: Both methods aim to improve the accuracy of inventory valuation and COGS, requiring regular review and adjustments to maintain accuracy.
• Complexity vs. Simplicity: The periodic adjustment method aligns more closely with accounting principles but can be more complex to implement. The standard rate method simplifies day-to-day operations but may require more significant adjustments if estimates are off.
• Inventory Reporting: Regularly adjusting the value of inventory ensures that financial statements accurately reflect the cost of goods sold, leading to better business decisions based on reliable financial data.

These alternative approaches help manage the complexities of apportioning shipping costs without the need for constant manual adjustments, thereby improving the efficiency and accuracy of accounting practices.