When to accrue for goods in transit

[Adriano]

Hello,
I have recently started at this new company and found out that at month end they have been accruing for this large order coming from China. It's being shipped by sea so its taking months to arrive and it's very large in cost so therefore material. The supplier has already issued us the invoice months ago but the terms on the invoice say that title is transferred only when goods reach the company's premises. My question is why do we accrue for something we still have to receive? I would understand an accrual for goods that we have received but for which we have not been invoiced yet, but in this case we have no goods yet. We just placed a large order and it's on its way and the goods will only be used once delivered. Shouldn't we just expense them once we get them then? Or is this accrual necessary because this is a "provision" that is a future expense virtually certain that can be reasonably estimated? Please let me know your thoughts.

 

[kirby]

The usual terms follow the “free on board” (FOB) rules.
FOB shipping means it is considered owned by buyer once it ships, and at that point a related liabilty for payment should be recorded by the buyer.
FOB destination, which is your case, means it is considered owned by the buyer once it is delivered, and at that point a related liabilty for payment should be recorded.

So your thought that the company is recording a type of “provision” is indeed what is happening. Not sure if this is OK but might be an industry practice.

What debit side entry do they actually make? Are they actually debiting inventory?

 

[Adriano]

Hi Kirby Thank you for your reply! The debit side is "goods in transit" whereas the credit is to accounts payable

 

[DrStrangeLove]

Adriano, do you remember if the invoice used the terms DAP (Delivered At Place) or DPU (Delivered at Place Unloaded)? Carriage contracts, especially ocean carriage of goods, use a long list of terms to specify exactly when title of goods passes.

FOB (Free On Board) would mean that once the goods have been loaded on the ship for transport--they actually make it to the deck of the transporting ship--then title and responsibility passes from seller to buyer. Before they make it to the ship in port, they're still the responsibility of the seller. Accruing for goods when they leave the seller and are picked up by the shipper would EXW (Ex-Works). DAP and DPU mean title doesn't pass until the goods arrive at the buyer's facility, either still on a vehicle (DAP) or unloaded from a vehicle (DPU).

If your company is accruing for them, they may think the goods were shipped FOB. Since the goods are on a ship underway that they have hired to carry the goods, title and responsibility have passed to them, so they have a claim to those goods as assets. An account titled "Goods in Transit" would let them recognize the goods when title and responsibility have passed to them. One wrinkle: If the seller arranged the ship, FOB would mean when the ship has arrived in the destination port, and the goods leave the deck of the ship.

Yeah, it's a little much. But it's the logistics industry's bread and butter.

 

[Adriano]

Hi again and thank you for looking into this.
The invoice says DAP so in theory from my understanding title hasn't passed to us yet. So either my company is making an error with this or we are being prudent and considering delivery virtually certain and making a provision for this liability and did so from the month it was incurred.

 

[UKFCA_London]

There should be symmetry between when the seller recognises revenue & you recognise the purchase: under DAP the seller is responsible for getting goods to the destination port, off the boat and into the terminal, only then does the title pass to you. I can understand why your company would want to log the invoice on the system once the invoice was received, with some sort of memorandum entries (eg DR Goods in transit, CR invoice for payment) but I don't think they should feed into the IFRS/local GAAP balance sheet. A good test for whether you should have the inventory on your balance sheet when it is still in transit to you is if you are insuring it (and are therefore the party exposed to the risks in transit).