3.4: Transportation Costs for Merchandising Transactions

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Merchandise often must be delivered from the seller to the buyer. It is important to know which company - either the seller or the purchaser - owns the merchandise while it is in transit and in the hands of a third-party transportation company, such as UPS. The company that owns the merchandise must absorb the transportation cost as a business expense.

The shipping terms specify which company owns the merchandise while in transit. Terms may be FOB destination or FOB shipping. The acronym FOB stands for “Free On Board” and is a shipping term used in retail to indicate who is responsible for paying transportation charges. It is also the location where ownership of the merchandise transfers from seller to buyer.

If the shipping terms are FOB destination, ownership transfers at the destination, so the seller owns the merchandise all the while it in transit. Therefore, the seller absorbs the transportation cost and debits Delivery Expense. The buyer records nothing.

If the terms are FOB shipping, ownership transfers at the origin as it leaves the seller’s facility, so the buyer owns the merchandise all the while it is in transit. The buyer therefore absorbs the transportation cost and debits Merchandise Inventory; the transportation charges just become part of the purchase price of the inventory. In the case of FOB shipping, the buyer may contract directly with the transportation company (and the seller records nothing) OR the seller may pre-pay the shipping costs and pass them along in the invoice to the buyer.

There are three possible scenarios regarding transportation, as follows:

1. Terms are FOB destination The seller calls UPS to pick up the shipment from his loading dock. The seller is billed by UPS and ultimately pays the bill and absorbs the expense.

BUYER				SELLER
11. Purchase 50 items on account for $10 each, terms FOB destination. Transportation charges are $20 on account.				12. Sell 50 items on account for $10 each, terms FOB destination. Each item cost $4. Transportation charges are $20 on account.
Date	Account	Debit	Credit	Date	Account	Debit	Credit
11	Merchandise Inventory	500		12	Accounts Receivable	500
	Accounts Payable		500		Sales		500
The purchaser does not record transportation charges at all since terms are FOB destination.
				Date	Account	Debit	Credit
				12	Cost of Merchandise Sold	200
					Merchandise Inventory		200

				Date	Account	Debit	Credit
				12	Delivery Expense	20
					Accounts Payable		20
				The seller uses Delivery Expense to record transpor- tation charges only when terms are FOB destination.
				NOTE: If the information about the transportation says the seller is billed or invoiced by UPS, credit Accounts Payable (as shown above.) If the informa- tion says the buyer paid UPS, credit Cash instead.

11. You pay the amount invoiced at the time of the purchase.				11. Your customer pays you the amount invoiced for the sale.
	Account	Debit	Credit		Account	Debit	Credit
▼	Accounts Payable	500		▲	Cash	500
▼	Cash		500	▼	Accounts Receivable		500

2. Terms are FOB shipping The purchaser calls UPS to pick up the shipment from the seller’s loading dock. The purchaser is billed by UPS. Since the buyer is dealing with two different parties – the seller and the transportation company, the buyer records two journal entries.

BUYER				SELLER
13. Purchase 50 items on account for $10 each, terms FOB shipping. Transportation charges are $20 on account.				14. Sell 50 items on account for $10 each, terms FOB shipping. Each item cost $4. Transportation charges are $20 on account.
Date	Account	Debit	Credit	Date	Account	Debit	Credit
13	Merchandise Inventory	500		14	Accounts Receivable	500
	Accounts Payable		500		Sales		500

Receive an invoice from UPS for the shipping.

Date	Account	Debit	Credit	Date	Account	Debit	Credit
13	Merchandise Inventory	20		14	Cost of Merchandise Sold	200
	Accounts Payable		20		Merchandise Inventory		200
The purchaser uses Merchandise Inventory to record transportation charges when terms are FOB shipping. Shipping becomes part of the cost of the merchandise. The first Accounts Payable is to the seller; the second one is to the shipping company.				The seller does not record transportation charges at all since terms are FOB shipping.
NOTE: If the information about the transportation says the buyer is billed or invoiced by UPS, credit Accounts Payable (as shown above.) If the informa- tion says the buyer paid UPS, credit Cash instead.

11. You pay the amount invoiced to the vendor. (You do not pay the UPS invoice yet.)				11. Your customer pays you the amount invoiced for the sale. Assume payment terms are 2/10, net 30 under the gross method.
	Account	Debit	Credit		Account	Debit	Credit
▼	Accounts Payable	500		▲	Cash	500
▼	Cash		490	▲	Sales Discounts	10
▼	Merchandise Inventory		10	▼	Accounts Receivable		500

Terms are FOB shipping As a courtesy and convenience, the seller calls UPS to pick up the shipment from his loading dock. The seller is billed by UPS and adds what UPS charges him to the purchaser’s invoice. When the purchaser pays his bill, he pays for the product and reimburses the seller for prepaying the transportation for him.

BUYER				SELLER
15. Purchase 50 items on account for $10 each, terms FOB shipping. Transportation charges are $20 on account.				16. Sell 50 items on account for $10 each, terms FOB shipping. Each item cost $4. Transportation charges are $20 on account.
Date	Account	Debit	Credit	Date	Account	Debit	Credit
15	Merchandise Inventory	520		16	Accounts Receivable	520
	Accounts Payable		520		Sales		500
The purchaser includes the shipping cost as part of the inventory cost and pays the seller not only the cost of the merchandise, but also reimbursement for the transportation charges.				Date	Account	Debit	Credit
				16	Cost of Merchandise Sold	200
					Merchandise Inventory		200
				The seller is owed the cost of the merchandise and the cost of the transportation. However, the seller owes those transportation charges of $20 to the shipping company.

Notice above that the buyer can combine the merchandise and transportation costs into one journal entry because the buyer is getting one invoice for both from the seller. Also notice that the seller can combine both the sale and the transportation added into one journal entry and send one invoice. Also notice that the transportation cost pre-paid by the seller does not become part of the Sales account.

The following transactions are ALTERNATIVE ways of presenting those above, splitting both the buyer’s and the seller’s transaction into two journal entries.

BUYER				SELLER
15. Purchase 50 items on account for $10 each, terms FOB shipping. Transportation charges are $20 on account.				16. Sell 50 items on account for $10 each, terms FOB shipping. Transportation charges are $20 on account.
Date	Account	Debit	Credit	Date	Account	Debit	Credit
15	Merchandise Inventory	500		16	Accounts Receivable	500
	Accounts Payable		500		Sales		500

Date	Account	Debit	Credit	Date	Account	Debit	Credit
15	Merchandise Inventory	20		16	Accounts Receivable	20
	Accounts Payable		20		Accounts Payable		20
The purchaser includes the shipping cost as part of the inventory cost and pays the seller not only the cost of the merchandise, but also reimbursement for the transportation charges.				Date	Account	Debit	Credit
				16	Cost of Merchandise Sold	200
					Merchandise Inventory		200
				The seller is owed the cost of the merchandise and the cost of the transportation. However, the seller owes those transportation charges of $20 to the shipping company.

Regardless of which alternative was used to record the purchase and to record the sale, the following transactions record payment to the vendor when purchasing and payment by the customer when selling.

11. You pay the amount invoiced to the vendor.				11. Your customer pays you the amount invoiced for the sale. Assume payment terms are 2/10, net 30 under the gross method.
	Account	Debit	Credit		Account	Debit	Credit
▼	Accounts Payable	520		▲	Cash	510
▼	Cash		510	▲	Sales Discounts	10
▼	Merchandise Inventory		10	▼	Accounts Receivable		510
(500 – (500 x .02)) + 20 = 510				(500 – (500 x .02)) + 20 = 510

Important: When a purchases or sales discount is involved, be sure to only take the discount on the merchandise cost or sales price, respectively, and not on the transportation cost.

Accounts Summary Table - The following table defines and summarizes the new accounts for a merchandising business.

ACCOUNTS SUMMARY TABLE
ACCOUNT TYPE	ACCOUNTS	TO INCREASE	TO DECREASE	NORMAL BALANCE	FINANCIAL STATEMENT	CLOSE OUT?
Asset (*temporary)	Merchandise Inventory Account that keeps track of Items in stock for resale to customers. Used only in closing en- tries under the periodic system. Purchases * Account that keeps track of the dollar amount of purchases of merchan- dise for sale made by a company Freight-in * Account that keeps track of the transportation charges that a buyer has incurred for the purchase of inventory	debit	credit	debit	Balance Sheet	NO
Contra Asset (*temporary)	Purchases Returns * Account that keeps track of the dollar amount of returns of merchandise previously purchased by a company Purchases Discounts * Account that keeps track of the dollar amount of discounts that the pur- chaser has claimed	credit	debit	credit	Balance Sheet	NO