We are a manufacturing company and currently pay freight charges to logistics companies to transport products from our warehouse to customers. We do not separately charge freight to customers on invoices. Based on my understanding, cost of goods sold (COGS) consists of inventory costs, which are costs necessary to produce and prepare goods for sale, so freight seems to be classified as a selling expense rather than COGS. However, I see other companies including freight in COGS, and some within our company believe this is the correct approach. What is your view?

Accounting standards perspective: the boundary of inventory costs

Under International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP), inventory costs include all necessary expenditures to bring inventory to its "current location and condition." For a manufacturing company, transporting products from the warehouse to customers is typically considered part of sales activities, not a necessary step in production or preparation for sale. Therefore, in most cases, freight (i.e., "freight-out") should be classified as a selling expense rather than COGS.

However, exceptions exist in practice. If freight occurs before the product reaches a saleable condition (e.g., transporting from production site to central warehouse), then such freight is part of inventory costs. But the scenario you describe is "from warehouse to customers," which typically falls under sales fulfillment costs.

Industry practice and divergence

You mention that other companies include freight in COGS, which is not uncommon. Some companies may choose to include freight in COGS for the following reasons:

  • Freight is directly related to sales revenue, and including it in COGS can more accurately reflect gross profit (i.e., revenue minus directly related costs).
  • In certain industries (such as e-commerce or distribution), freight is a core fulfillment cost and may be viewed as a necessary expenditure to "obtain sales," rather than general administrative expense.
  • Internal management reports may treat freight as a variable cost for contribution margin analysis.

However, note that accounting standards do not mandate including freight in COGS. The U.S. Securities and Exchange Commission (SEC) in SAB Topic 11.B has indicated that freight and handling costs can be classified as selling expenses or as COGS, provided the disclosure is consistent and not misleading to investors. Therefore, both treatments are compliant, but consistency must be maintained.

Recommendations and conclusion

Based on your description, your company does not charge freight to customers, and freight occurs after products are shipped from the warehouse, which aligns more with the definition of selling expenses. Therefore, I lean toward recommending that freight be classified as a selling expense, unless your company has a special business model or management needs. If you choose to include it in COGS, ensure that this policy is clearly disclosed in the financial statement notes and maintained consistently across periods.

Ultimately, the choice should be based on the substance of the business and financial reporting objectives. It is recommended to discuss with your company's auditors or financial advisors to determine the most appropriate classification.