Tag Archives | product

Freight on Board (FOB)

See Also:
Ex Works (EXW)
How to manage inventory
Just in Time Inventory System
Inventory Cost
Accounting Principles

Freight on Board (FOB) Definition

Freight on Board, known internationally as Free on Board, are the terms of a transaction within a contract. The terms are there to determine liability and when revenue recognition can take place between two parties. This becomes of interest to companies during the transportation of goods from one company to another. There are commonly two types of fob revenue recognition and liability, fob destination and fob shipping.

Freight on Board Destination

Freight or free on board destination means the terms of the transaction as it pertains to liabilities of the goods being delivered for a company will not pass on to the customer or the purchaser until it arrives on location of that customer. Therefore a company cannot and should not recognize revenue until the goods have arrived on location of the customer.

Freight on Board Shipping

Freight or free on board shipping point means that a company is allowing the purchaser or customer to assume the responsibility as soon as the goods have left the seller’s warehouse or business location. The seller is then allowed to recognize revenue as soon as the goods leave because the payment for these goods is certain as they leave the location.

Freight on Board Example

Acme inc. supplies TNT explosives and anvils to its various customers around the globe. Wile E. Coyote has hatched a plan to once and for all destroy the Road Runner. He orders some TNT explosives from Acme in order to set his plan in motion. Acme uses fob shipping point when it has to deliver goods. Therefore Acme recognizes the revenue immediately as the goods leave the warehouse. Even if the truck were to crash on its way the company can still expect payment because Wile. E Coyote is liable. If the terms had been fob destination and the truck had crashed on the way then Wile E. Coyote would not be expected to pay for that shipment of goods and Acme inc. would be required to accept the loss.

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freight on board

freight on board

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Direct Materials

See Also:
Direct Cost vs Indirect Cost
Direct Labor
Cost Driver
Direct Labor Variance Formulas
Direct Material Variance Formulas
Absorption Cost Accounting

Direct Materials Definition

In accounting, direct materials are the resources used to make a product. You must clearly link these resources to the product you are producing. Direct material costs are one of the costs associated with producing a product. Furthermore, direct materials are in contrast to indirect materials. Indirect materials are materials used to produce a product not clearly linked or traceable to the final product.

Examples of direct materials include the following:

  • Wood used to make tables
  • Glass used to make windows
  • Fabric used to make furniture

Direct Material and Overhead Allocation

Sometimes it may be appropriate to use direct materials as a cost driver to allocate indirect costs to a production process.

Indirect costs, such as overhead costs, are not directly traceable to the final product; however, they are necessary for the production of the process. Therefore, incorporate them in the overall cost of the product and then allocate them to the final product by way of a cost driver.

In production processes in which direct material is an appropriate cost driver, on can allocate indirect costs to the cost of units of output via direct material. The measurement of the cost driver depends on the type of material. If it’s wood, then the cost driver may be based on feet of wood used, or pounds of wood used.

Using direct materials as a cost driver requires quantifying the direct material with some physical or otherwise quantifiable measure. Then allocate indirect costs to the units of output using a cost driver rate, such as $2 dollars per foot of wood, or $0.40 per square foot of fabric, depending on what direct material you use and the specifics of the production process.

direct materials

Source:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

 

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Direct Cost vs Indirect Cost

See Also:
Direct Labor
Direct Materials
Cost Driver
Direct Labor Variance Formulas

Direct Cost vs Indirect Cost

In accounting, there is a distinction between direct cost vs indirect cost. You can trace direct costs to a particular cost object. However, you cannot trace indirect costs to a particular cost object. A cost object is something that can incur cost. For example, a cost object could be a company division, a product line, a unit of inventory, or even a decision.

The idea is to analyze business decisions by determining the incremental costs that would result from that decision. If a decision affecting a certain cost object determines whether the cost is incurred, then it is a direct cost. If the cost is incurred regardless of the outcome of the decision at hand, it is an indirect cost.

Examples of Direct and Indirect Costs

Examples of direct costs includes the following:

Whereas some examples of indirect costs include the following:

  • The rent and the utility expenses incurred by an office building that houses several different business areas of a company
  • The salary of a manager that supervises more than one factory

Indirect Costs Become Direct Costs

A cost can be an indirect cost in regard to one cost object and a direct cost in regard to another object. For example, consider the salary of the manager who supervises multiple plants an indirect cost for any one of those plants. But, also consider the manager’s salary a direct cost for the division encompassing all of those plants.

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direct cost vs indirect cost

direct cost vs indirect cost

 

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Delivery Order

See Also:
Economic Order Quantity (EOQ)
Sales Order
Business Intelligence and Finance
Mergers and Acquisitions (M&A)

Delivery Order Definition

The delivery order definition is the document which details the delivery information of an item, is very important in distribution. A delivery order is an important document in 2 ways: it has full details of how the delivery will take place and, in some cases, warrants the release of a shipment from port or other authorities.

Delivery Order Explanation

delivery order, explained as the full details and information regarding a delivery, is important for 3rd party deliverers. A delivery order contract includes the complete details of a delivery. It is generally an official document which is placed on company letterhead.

When having an item delivered, the delivery order outlines who it will be shipped to, how it will be shipped, special needs for the delivery, and when to release the delivery. This information is important because delivery is one of the most important aspects to the sales process. This is the difference between a delivery order vs task order: with a delivery order the only task is delivery of the product.

Additionally, when having an item shipped out of port, a delivery order provides even more value. The delivery order includes all of the above information. In this situation, send a delivery order when port authorities should release an item for shipment. It shows that shipment charges have been paid for. If the item stays at port and shipment is not paid for, the item will eventually be claimed for the expenses of the shipper and sold as an asset.

A delivery order is simply proof of the delivery details. These days, many send a delivery order, often through email, to the shipper. There are also other delivery methods which place delivery order online, directly in the database of the shipper. Technology has removed the paper order of the past.

Delivery Order Example

Joe is purchasing a product from China. He will resell this exported item in the United States. Due to this fact, he will be working closely with a 3rd party shipper.

He has made all arrangements with the seller. Everything seems to be in order. Now, Joe must pay for shipping. He does this with the excitement that he will make a good amount of money when the project is finished.

Joe pays for shipping and receives a copy of the delivery order. He also sends a copy to the port authorities. Once they receive it, they release the shipment and send it to Joe.

A discrepancy occurs with the delivery order number; the port authorities did not receive it. Luckily, Joe did receive a copy. In order to clear up the issue Joe will send a copy to the port authorities.

Once the port authorities receive the delivery order they release the item for shipment. Receiving the notice that this has happened puts Joe’s mind at easy. He does not need any more issues with this product. He is ready to sell it and is wasting time and money. With this, his business operations can continue.

delivery order definition

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Ex Works (EXW)

See Also:
Freight on Board (FOB)
Transfer Risk
How to manage inventory
Accounting Principles
Accounting Concepts

Ex Works (EXW) Definition

Ex works is an agreement between a buyer and a seller that the seller assumes no responsibility for the cost or liability for a product after it is produced and has left the seller’s warehouse.

Ex Works (EXW) Meaning

Ex works is the same as Freight on Board (FOB) Shipping. The two terms can be used interchangeably because they assume the same terms and agreement between the buyer and seller. The advantage of ex-works from a seller’s standpoint is that the seller is allowed to recognize revenue once the product has been picked up or a contract has been signed. If a contract has been signed then a seller could potentially recognize revenue as the product finishes going through the manufacturing process. On the other side ex works means that a buyer has a potential for loss for the transportation part of the purchase.

Ex Works (EXW) Example

Wawadoo Inc. is a company that specializes in the production of widgets. Wawadoo was recently able to sign ex works shipping terms with another company named, Wanna Widget Inc. Due to these terms, Wawadoo can save on the transportation cost associated with the charge focus solely on production. This becomes beneficial to both companies because Wanna Widget has a well established transportation network and is able to transport the products at a lower cost. Therefore, Wawadoo can drop the price of its widgets to Wanna Widget. Wanna Widget can lower its expense and sell widgets for lower because they can buy the product at a lower price and transport it for cheaper than Wawadoo could.

ex works

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Deferred Revenue

See Also:
Deferred Income Tax
Deferrals
Income Statement
Accounting Principles
Generally Accepted Accounting Principles (GAAP)

Deferred Revenue Definition

Deferred revenue is considered a liability to companies that contain them. It occurs because a customer has paid for a product or service, but the company has yet to provide the product or perform the service.

Deferred Revenue Meaning

Deferred revenue means that a company may have received a form of payment, but recognizing the revenue would inflate revenue as well as the net income. This is because the company has not incurred its cost for the payment received. This is why accounting for this type of revenue requires that the payment amount be considered a liability and is put into the deferred revenue account. Once the product or service has been provided then the company can reduce the liability and recognize the revenue.

Deferred Revenue Example

For example, Widget Co. buys it supplies from Wawadoo Co. Often times Widget will buy the supplies through a contract at an established price. This allows the two companies to smooth out their earnings and removes some of the volatility in the market. Widget even sends payment a month in advance on what it foresees demand to be that month. This payment requires that Wawadoo record deferred revenue on its books until it provides the supplies that Widget company needs. Once the supplies are sent to Widget Co., Wawadoo records the revenue and cost of the sales. The company will also reduce the amount of revenue deferred as it earns more of the pre-paid cash.

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deferred revenue

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Contingent Liability

See Also:
Current Liabilities
Balance Sheet
Accounting Principles
Accounting Concepts
Subsequent Events

Contingent Liability Definition

A contingent liability, defined is an obligation that a company might or might not have to recognize. This is because the event(s) are uncertain. It is also necessary for future events to occur to determine whether or not the obligation is true or not. Contingent liability exposure or the amount estimable may or may not be recognizable.

Contingent Liability Meaning

Furthermore, contingent liabilities can be anything ranging from litigation proceedings to accounts payable if a supplier did not provide a product or service to a company. Contingent liability recognition typically depends on two things, the likelihood of loss and the ability to estimate the loss. There are three descriptors to estimate the likelihood. These range from remote, to reasonably probable, to probable. Estimates are measured in two dimensions, which are reasonably estimable to not-reasonably estimable. Companies typically want to understand where they stand with a contingent liability, because the factors determine how a company should provide contingent liability disclosure in its financial statements.

Contingent Liability Example

For example, Blowout Preventer Inc. makes blowout preventers for drilling companies. Recently one of its products “malfunctioned” causing a massive explosion on a rig owned and operated by one of its primary customers Big Chief Inc. Big Chief has sued Blowout for the total sum of the rig as well as each worker’s salary. Big Chief has estimated this amount at an even $10 million dollars. Blowout Preventer’s lawyers have determined that it is probable that they will lose the case and have to pay the sum amount. Blowout Preventer must first accrue the $10 million on it’s books because the amount is reasonably estimable and also make a note on its financials. If the amount had not been reasonably estimable there would simply need to be a note in the financials discussing the case and probability that the company would need to pay some sort of monies.

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