What is Freight Expense?
Freight expense refers to the price that is charged by a carrier for sending out cargo from the source location to the destination location. The expense is paid by the person who wants the goods transported from one location to another. The amount of freight expense charged depends on the mode of transportation used to deliver the cargo.
Some of the common modes of transport that can be used include ship, airplane, train, or truck. Also, freight companies charge different freight costs depending on the weight of the cargo.
Factors that Affect Freight Costs
Companies that hold inventory see freight expense as one of the key costs of doing business. The cost may be incurred when transporting goods from the manufacturer’s warehouse to the company’s warehouse, or from the company’s warehouse to the retail or customer site. The shipping cost may be invoiced either beforehand or after the delivery of the cargo.
Some of the factors that affect freight expense include:
1. Fuel costs
Some shipping companies include a fuel cost component in the freight cost pricing model. The cost of road and maritime shipping is dependent on the cost of fuel, and the final cost charged to the consumer must factor in the cost of fuel at the time of shipping.
If the price of fuel is low, road and maritime transport will be cheaper to use, and the benefit will be passed on to the consumer as cost savings. However, if the price of fuel increases, road and maritime transport will be expensive, and the additional cost will be passed on to the consumer.
2. Demand for freight
The cost of freight is also affected by the demand for freight services. During periods of higher demand for shipping space, there will be large volumes of products for shipping, and users will be competing for the limited space. As a result, shipping companies can sell the limited space at a premium price.
On the other hand, when the demand for freight services is low, shipping companies will lower their prices in order to compete for the fewer users looking to ship cargo.
3. Emerging events
Emerging events such as terrorism, piracy, and a rogue government can result in increased freight costs as shipping companies attempt to recover losses incurred. Costs may also increase due to shippers opting to use longer shipping routes that offer more safety. For example, maritime shipping passing through pirate-prone shipping routes such as Somalia are forced to charge a higher cost to cover the increased risk, higher insurance premiums, and longer shipping routes.
When using trucks to transport cargo through areas prone to terrorism and criminal gangs, shipping companies may charge a higher fee in order to hire security or shift cargo to safer modes of transport in such areas.
4. Government regulation
In some countries, the government may introduce a policy that directly affects shipping companies. For example, government authorities may limit the maximum driving hours for truck drivers at certain periods of the year. This means that the cargo will take longer to get to the destination point.
Shipping companies raise the freight costs charged to their customers to cover expected losses. Other government regulations that may affect freight costs include a ban on night driving, emission tax laws, limiting the volume of cargo that trucks can carry, etc.
How to Record Freight Expenses in Accounting
For businesses that ship cargo on a regular basis, freight expense will be a significant cost for the business. They must record it appropriately in order for their financial books to be accurate. Usually, freight expenses are recorded as other “general expenses”. How the cost is recorded may depend on who is paying the freight cost and whether the cost is included in the asset’s value/price.
FOB shipping point
For FOB shipping point, the sale occurs at the shipping point, and the buyer is responsible for the freight costs to the destination. On the buyer’s side, the transaction is classified as a freight-in, since the seller bills the buyer for shipping. In this case, the seller will not book any delivery expense in its books.
The goods transfer from the seller to the buyer after the goods have been placed on the delivery truck or ship. Prior to the arrival of the goods at the point of origin (shipping point), the seller must cover all costs, such as taxes, customs, and other fees. The buyer only becomes responsible for freight expense after the cargo has reached the point of origin (shipping point).
FOB destination means that the sale and transfer of responsibility for the goods occurs when the goods have been delivered at the buyer’s designating receiving point (such as a port or warehouse). The seller will record the freight cost as a delivery expense, and it will be debited to the freight-in account and credited to accounts payable. The seller still legally owns the goods during the shipping process. The title of ownership changes from the seller to the buyer when the goods have been delivered to the buyer’s specified location.
Thank you for reading CFI’s explanation of Freight Expense. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
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