Treatment of warehousing and similar costs
August 10, 2014
Some costs are easy to identify as those which can be capitalized as part of inventory costs because they are clearly related to the manufacturing process. This is the case with direct costs and some indirect costs. Other costs are not as easy to analyze from the standpoint of inventory capitalization. In this article we will look at such costs and whether they should be included in inventory costs.
Most manufacturing and retail/distribution companies own (or lease) warehouses. Warehouses can be used to store raw materials, work in process inventory, finished goods and supplies. Warehousing costs may be significant. How should such warehousing costs be treated for financial accounting purposes? Can they be included as part of inventory costs?
The answer depends on the company and the industry it operates in. Generally, manufacturing companies may include warehousing costs related to raw materials and work in process inventory as part of inventory costs. Such costs, therefore, become an asset until the inventory is sold at which point the asset becomes an expense (i.e., cost of goods sold). Warehousing costs related to finished goods are included in period costs (expensed when incurred) and are not included in inventory costs.
Retail or distribution companies, on the other hand, may be able to include warehousing costs as part of inventory costs because all their inventory is finished goods and warehousing costs are directly related to making the inventory ready for sale.
It is important to note that, before a company starts spending time and energy on detailed analysis of warehousing costs with the purpose of either capitalizing or expensing them, it is beneficial to remember the materiality principle. If warehousing costs are not material to the company, then it probably doesn’t matter – for external financial reporting purposes – whether such costs are capitalized as part of inventory costs or expensed when incurred.
An example of how warehousing costs are treated by a major corporation is provided below:
“The majority of shipping and handling, warehousing and internal transfer costs for finished goods are included in selling, general and administrative expenses. An exception to this is in the Pictures segment where such costs are charged to cost of sales as they are an integral part of producing and distributing motion pictures and television programming. All other costs related to Sony’s distribution network are included in cost of sales, including inbound freight charges, purchasing and receiving costs, inspection costs and warehousing costs for raw materials and in-process inventory. Amounts paid by customers for shipping and handling costs are included in net sales.”
(The above extract comes from the March 31, 2014 annual report of Sony Kabushiki Kaisha.)
Along with warehousing costs, there are other costs that can be included in inventory costs. Analysis should be performed by company management as to treatment of such costs. Some examples of such costs are presented below:
- Rent (of factory buildings, etc.)
- Indirect materials and supplies
- Factory administrative expenses
- Insurance related to manufacturing processes or assets (e.g., factory insurance)
- Property taxes related to manufacturing buildings
- Costs of quality control and inspection
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