Top 3 Best Practices for Cost Allocation of Freight in Cost of Goods Sold Calculation
Calculating the Cost of Goods Sold (COGS) is a crucial aspect of financial management for any business that deals with physical products. COGS represents the direct costs associated with the production or purchase of goods that are sold. One important component of COGS is the cost of freight or shipping. Allocating the freight costs accurately is essential for maintaining the integrity of your financial statements and making informed business decisions. In this article, we will discuss the top 3 best practices for cost allocation of freight in COGS calculation.
1. Document and Track Freight Costs
The first step in accurate cost allocation is to document and track all freight costs associated with the purchase or production of goods. This includes not only the shipping charges billed by the carrier but also any additional fees, such as insurance, customs duties, or handling charges. It is important to maintain detailed records of these costs, including invoices, receipts, and shipping documents, to ensure transparency and accuracy in your calculations.
By diligently tracking freight costs, you can have a clear understanding of the expenses incurred for transporting goods from suppliers to your warehouse or directly to customers. This information will serve as a basis for allocating these costs appropriately in your COGS calculation.
2. Choose a Suitable Allocation Method
There are several methods you can use to allocate freight costs to the COGS. The most commonly used methods are:
- Weight-Based Allocation: This method allocates freight costs based on the weight of the goods. Heavier items are assigned a higher proportion of the total freight costs.
- Value-Based Allocation: This method allocates freight costs based on the value of the goods. Higher-value items bear a greater share of the freight costs.
- Quantity-Based Allocation: This method allocates freight costs based on the number of units or quantity of goods. Larger quantities are assigned a larger portion of the freight costs.
- Specific Identification: In some cases, it may be appropriate to allocate freight costs based on the specific identification of the goods. This method requires tracking the actual freight costs for each individual item or SKU.
It is important to select a method that best reflects the nature of your business and the relationship between freight costs and the goods being shipped. The chosen method should be consistent and applied uniformly across all relevant transactions to ensure accuracy and comparability in your COGS calculations.
3. Regularly Review and Adjust Allocation
Cost allocation is not a one-time task but an ongoing process that requires regular review and adjustment. As your business evolves, changes in shipping methods, carrier contracts, or distribution channels may impact the proportion of freight costs incurred for different types of goods.
It is essential to periodically evaluate your allocation method and make adjustments as necessary to ensure the accuracy and fairness of the cost allocation. This may involve re-evaluating the allocation factors, considering industry benchmarks, or consulting with financial experts to ensure best practices.
By regularly reviewing and adjusting your cost allocation, you can maintain the integrity of your financial statements and make informed decisions based on accurate COGS calculations.
Accurate cost allocation of freight in the COGS calculation is vital for businesses to understand their true product costs and make informed financial decisions. By following these top 3 best practices, including documenting and tracking freight costs, choosing a suitable allocation method, and regularly reviewing and adjusting the allocation, you can ensure accuracy, transparency, and comparability in your financial reporting.
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