[Anonymous]

Seafood Trading Co. commenced operations during the year as a large importer and exporter of seafood. The imports were all from one country overseas. The export sales were conducted as drop shipments and were merely transshipped at Seattle. Seafood Trading reported the following data:

Purchases during the year $12.0 million

Shipping costs from overseas $1.5 million

Shipping costs to export customers $1.0 million

Inventory at year end $3.0 million

What amount of shipping costs should be included in Seafood Trading’s year-end inventory valuation?

a.$375,000

b.$625,000

c.$250,000

d.$0

The correct answer is “a.” According to Becker, we will have to first find the COGS without including the shipping costs from overseas, despite the fact that it is a Freight-In. This will be $12million – $3 million = $9 million. (This step isn’t really necessary to solve the question, but please keep this fact in mind; I am going to go back to it.) The amount of shipping cost to be allocated at year end’s inventory will be $3 million / $12 million x $1.5 million = $375,000.

Ok, here is the thing. Freight-In WILL increase the value of inventory. As a result, if we want to find the COGS, shouldn’t it be $12 million +$ 1.5 million = $13.5 million (Total Costs of Goods Available for Sale.) Then, $13.5 million – $ 3million = $10.5 million, which is the COGS. Anyway, the amount of shipping costs to be allocated to inventory should be $3M/$13.5M = .2222. As a result,

.2222 x $1.5M = $333,333.

So why isn’t $333,333 the right answer? In fact, I already posted a thread under the title of “Becker MCQ question on Freight-Out…” in which Becker added the Freight-In to Beginning Inventory and Purchases in order to get the Total Costs of Goods Available for Sale. (I am not going to post it here because it will be wayyyy too much text to read in one post.)

Once again, thank you so much everyone! Good luck with FAR!

[tphil]

I'm struggling to find a good way to explain it, but I do think Becker's answer is correct. Think of it this way, you bought a certain amount of inventory this year (and since it's the first year of operations, it's a little easier): $12 million. It would probably be conceptually easier to explain if the amounts were in units, but this should work nonetheless. This inventory is going to either end up in COGS or Ending Inventory, so let's find an amount for shipping costs per dollar of inventory: 1.5 mil / 12 mil = .125 per dollar of inventory, so for each $1 of inventory we buy, it costs us 12.5 cents in shipping. We can then allocate this shipping cost between the goods sold and those left in ending inventory.

$9 million worth of goods sold x .125 = $1,125,000 shipping included in COGS

$3 million worth of goods in ending inventory x .125 = $375,000 shipping in inventory

Notice that the total shipping allocated equals the 1.5 million.

I don't think adding in the $1.5 mil of shipping to find COGS like you did would be appropriate, because it doesn't really account for the fact that some will be included in ending inventory (since you have ending inventory equal to the 3 mil given, the whole 1.5 mil in shipping is being allocated to COGS in your equation). Additionally, if you think 333,333 should be allocated to ending inventory, then the ending balance in your equation should then be 3,333,333 and it would throw off the amount you calculated for COGS.

Ultimately, using the correct amounts, you end up with an equation that balances:

$12 mil purchases + 1.5 mil shipping – 9 mil cost of goods – 1.125 mil shipping allocated to COGS = 3.375 mil ending inv (which is the 3 mil given plus the 375,000 allocated shipping)

I realize this was a super confusing explanation, but I hope it helped a little. Best of luck in your studies!

[Anonymous]

Thank you for the excellent reply tphil! (Congrats on rocking REG!) After pondering your explanation, it brings up an additional question that I have with Becker's solution. Let's look at a similar problem.

The following information pertained to Azur Co. for the year:

Purchases

$102,800

Purchase discounts

$10,280

Freight-in

$15,420

Freight-out

$5,140

Beginning inventory

$30,840

Ending inventory

$20,560

What amount should Azur report as cost of goods sold for the year?

a. $118,220

b. $123,360

c. $128,500

d. $102,800

According to Becker, the COGS for the year would be

Beginning Inventory + Purchases- Purchase Discount + Freight Ins -Ending Inventory = COGS. So, the correct answer would be “a.”

Ok, now let's go back to the Seafood Trading Co question. Since Becker included the full amount of Freight-Ins into Total Costs of Goods Available for Sale for the Azur Co problem, then the same logic applies to Seafood Trading Co as well.

$12 million +$ 1.5 million = $13.5 million (Total Costs of Goods Available for Sale.) Then, $13.5 million – $3 million = $10.5 million, which is the COGS.

If we apply the full amount of freight-in into the Total Costs of Goods Available for Sale and our ending inventory is $ 3 million, this means that the percentage of Freight-In applied to ending inventory would be zero; All of the freight-in costs are allocated to the COGS ($9 million + $1.5 million). So, shouldn't the answer be zero or “d” then?

Thank you so much for the help again! 🙂

[tphil]

I think the main difference between those two questions is the “call of the question” is different, so the numbers have to be interpreted differently. For Azur, the call of the question is what is COGS, not how to allocate freight-in, so you can assume that the ending inventory amount given in the question accounts for the fact that some of the freight-in is still in ending inventory and the equation works out fine. For Seafood Trading however, the call of the question is how should freight-in be allocated between COGS and ending inventory, so it's better to assume that the ending inventory amount that is provided in the question is before shipping costs have been applied. Because of this, it wouldn't be correct to use the same type of equation used in the Azur question since we don't actually know what ending inventory is with freight-in included, which leaves us with two unknowns, COGS and ending inventory, so an unsolvable equation.

You certainly wouldn't want to expense all of the freight-in in the current period because this would violate the matching principle (you'd be recognizing revenue in the next period when the ending inventory is sold without all of the associated costs of that revenue). Since freight-in is a product cost, it should stay with the related units of inventory. Expensing it all would be incorrectly treating it as a period cost, similar to freight-out. 25 percent of the years purchases are still in ending inventory, so 25 percent of the freight-in better still be in ending inventory as well.

I do see where the confusion is coming from though. Hope this helped clarify it a little more.

[thehip41]

You are close in your thinking OP.

The Beginning inventory is $0

The Goods available for sale is 13,500,000 (the purchases + the freight in) (the freight out is period expense, not COGS)

So at year end, the cost of the inventory left is 3,000,000, but this is just the cost of the inventory, NOT the cost of inventory + freight in.

So you have to add in the 25% of the freight in that hasn't been sold.

I always try to add in numbers, makes it easier.

Say you bought 1000 items, all the same thing, in the year.

Each item cost $12,000 + freight. So each item cost 13,500 on the books.

We know we have 25% of these items left on the books at the end of the year.

So we have 1000 items * 25% = 250 items left.

250 items X 13,500 = $3,375,000 ending inventory

That is 3,000,000 of inventory and 375,000 allocated from the freight in.

FAR - 83
AUD - 73 92
BEC - 83
REG - 88

Licensed CPA in the state of Michigan

[Author]

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