Accounting: The Language of Business (Part 33)

For generations of Hong Kongers, the only means of upward mobility and the only way to meaningfully contribute to society have been to obtain a respectable university degree (preferably in business administration) and a professional accreditation (in finance, accounting, law or medicine).

Joshua Wong

Accounting for Merchandising Businesses

(Part F)

by

Charles Lamson

Transportation Costs, Sales Taxes, and Trade Discounts

In the preceding two posts, we described and illustrated merchandise transactions involving sales and purchases. In this post, we discuss merchandise transactions involving transportation costs, sales taxes, and trade discounts. 

Transportation Costs

The terms of a sale should indicate when the ownership (title) of the merchandise passes to the buyer. This point determines which party, the buyer or the seller, must pay the transportation costs.

The ownership of the merchandise may pass to the buyer when the seller delivers the merchandise to the transportation company or freight carrier. For example, Chrysler records the sale and the transfer of ownership of its vehicles to dealers when the vehicles are shipped from the factory. In this case, the terms are said to be FOB (free-on-board) shipping point. This term means that the dealer pays the transportation costs from the shipping point (factory) to the final destination. Such costs are part of the dealer's total cost of purchasing inventory and should be added to the cost of the inventory by debiting Merchandise Inventory.

To illustrate, assume that on June 10, NetSolutions buys merchandise from Magna Data on account, $900, terms FOB shipping point, and pays the transportation cost of $50. NetSolutions records these two transactions as follows:

The ownership of the merchandise may pass to the buyer when the buyer receives the merchandise. In this case, the terms are said to be FOB (free-on-board) destination. This term means that the seller delivers the merchandise to the buyer's final destination, free of transportation charges to the buyer. The seller thus pays the transportation costs to the final destination. The seller debits Transportation Out or Delivery Expense, which is reported on the seller's income statement as an expense.  

To illustrate, assume that on June 15, NetSolutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480, and NetSolutions pays the transportation cost of $40. NetSolutions records the sale, the cost of the sale, and the transportation cost as follows:

As a convenience to the buyer, the seller may prepay the transportation costs, even though the terms are FOB shipping point. The seller will then add the transportation cost to the invoice. The buyer will debit merchandise inventory for the total amount of the invoice, including the transportation costs. Any discount terms would not apply to the prepaid transportation costs.

To illustrate, assume that on June 28, NetSolutions sells merchandise to Planter Company on account, $800, terms FOB shipping point. NetSolutions pays the transportation cost of $45 and adds it to the invoice. The cost of the merchandise sold is $360. NetSolutions records these transactions as follows:

Shipping terms, the passage of title, and whether the buyer or seller is to pay the transportation costs are summarized in Exhibit 10.

Sales Taxes

Almost all states and many other taxing units levy a tax on sales of merchandise. The liability for the sales tax is incurred when the sale is made.

At the time of a cash sale, the seller collects the sales tax. When a sale is made on account, the seller charges the tax to the buyer by debiting Accounts Receivable. The seller credits the sales account for the amount of the sale and credits the tax to Sales Tax Payable. For example, the seller would record a sale of $100 on account, subject to a tax of 6%, as follows:

Normally on a regular basis, the seller pays to the taxing unit the amount of the sales tax collected. The seller records such a payment as follows:

Trade Discounts

Wholesalers are businesses that sell merchandise to other businesses rather than to the general public. Many wholesalers publish catalogs. Rather than updating their catalogs frequently, wholesalers often publish price updates, which may involve large discounts from the list prices in their catalogs. In addition, wholesalers may offer special discounts to certain classes of buyers, such as government agencies or businesses that order large quantities. Such discounts are called trade discounts.

Sellers and buyers do not normally record the list prices of merchandise and the related trade discounts in their accounts. For example, assume that an item has a list price of $1,000 and a 40% trade discount. The seller records the sale of the item at $600 [$1,000 less the trade discount of $400 ($1,000 * 40%)]. Likewise, the buyer records the purchase at $600. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 12TH ED., PP. 245-248*

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