Goods in Transit: Who Counts Inventory at Year-End?

Goods in transit are goods that have left the seller but have not reached the buyer on the reporting date. They belong in the ending inventory of the party that controls them. Under free on board (FOB) shipping point, the buyer counts them once the carrier takes them. Under FOB destination, the seller counts them until delivery.

A physical count tells you what is on the premises. A balance sheet must also capture goods the business controls elsewhere and exclude goods it holds for someone else. The distinction matters most when the truck leaves in December and arrives in January.

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Professor Farhat explains how goods in transit and goods held on consignment affect the count.

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Who owns goods in transit: FOB shipping point vs. FOB destination?

Under FOB shipping point, the buyer controls goods in transit and counts them in its ending inventory. Under FOB destination, the seller keeps them in its inventory until they arrive.

Read the contract from the perspective of the company preparing the accounts. Mark the shipment date, the delivery date and the reporting date. The table assumes conforming goods, an ordinary domestic sale and no separate acceptance condition. If the reporting date falls between shipment and delivery, the agreed delivery point determines the usual result.

Control means the ability to direct how the goods are used and to obtain substantially all of their remaining benefits. This wording follows FASB’s definition of control in ASC 606-10-25-25. Legal title is one indicator. A carrier can hold a package throughout the trip while either the buyer or the seller controls it. The Uniform Commercial Code’s title rule and its FOB delivery terms explain the ordinary U.S. shipment and destination cases.

Who pays freight on goods in transit?

The FOB term usually tells you who pays for shipping, too. Under FOB shipping point, the buyer normally pays the freight. That cost, called freight-in, is part of the cost of the inventory. Under FOB destination, the seller normally pays. That cost, called freight-out, is not added to inventory. Most textbooks and the CPA exam treat it as a selling expense, although some companies report it in cost of goods sold.

For example, a buyer orders goods costing $2,000 FOB shipping point and pays the carrier $150. The buyer’s inventory cost is $2,150.

Watch for the terms “freight prepaid” and “freight collect.” Freight prepaid means the seller pays the carrier up front. Freight collect means the buyer pays the carrier on delivery. These terms describe who writes the check, not who owns the goods. If a seller prepays freight on an FOB shipping point sale, it typically adds that cost to the buyer’s invoice.

What about international shipments?

Many international contracts use the International Chamber of Commerce’s Incoterms 2020 rules instead of U.S. Uniform Commercial Code delivery terms. Under Incoterms 2020, FOB is meant only for sea and inland waterway transport, and risk passes to the buyer once the goods are on board the vessel at the port of shipment. Incoterms deal with delivery, risk, and costs, not ownership, so also read the contract’s title clause before deciding who counts the goods.

How to reconcile goods in transit at year-end

Hypothetical example. Harbor Field Supply counts $74,000 of goods at its shop on December 31. Each figure below is at cost. For each item, ask two questions. Does Harbor control it? Has the count already included it?

Correct ending inventory is $82,300 ($74,000 + $5,600 + $4,100 − $1,400). The goods shipped to the customer stay in Harbor’s inventory at their carrying cost. Using the customer’s selling price would put an unearned profit into the inventory balance.

Next, reconcile the ledger. If Harbor also omitted the $5,600 credit purchase from its perpetual records, it debits Inventory and credits Accounts Payable for $5,600. If both accounts already include the purchase, Harbor adjusts only the physical count reconciliation. Recording the invoice twice would create a second error.

Harbor’s outbound order needs a ledger check too. Suppose Harbor recorded the sale on December 30 at a hypothetical selling price of $6,500. Under FOB destination, the customer does not control the goods yet, so Harbor reverses the sale and puts the goods back into inventory:

Without this fix, December revenue would be overstated by $6,500, cost of goods sold by $4,100, and gross profit by $2,400. Harbor records the sale in January, when the goods are delivered. Left uncorrected, a cutoff error like this reverses itself the next year, overstating one year’s income and understating the next. See how inventory errors affect two years of income.

Common mistakes on exams and at year-end

• Using the invoice date or payment date instead of the delivery terms to decide who owns the goods.
• Adding an outbound FOB destination shipment at its selling price instead of its cost.
• Forgetting to remove goods held on consignment for someone else from the count.
• Recording a purchase in the ledger a second time while fixing the physical count.
• Assuming whoever pays the freight bill owns the goods.

Auditors test these issues under the cutoff assertion, which checks that transactions land in the correct period. Learn more in this guide to audit assertions.

Consigned goods: who counts inventory on someone else’s shelves?

The consignor supplies the goods and retains control in a typical consignment. The consignee holds them for sale on the consignor’s behalf. At year-end, the consignor includes unsold units at cost, even if the units are displayed in another store. The consignee keeps a custody record and excludes the goods from its own inventory.

For example, a potter sends ten serving bowls costing $32 each to a gallery. Four sell before year-end. The potter includes $192 for the six remaining bowls. The gallery’s commission on bowls sold is separate from the cost of those six. If consigned stock is material, the consignor should consider separate disclosure of the amount held by others.

What about bill-and-hold sales?

In a bill-and-hold arrangement, the seller bills the customer but keeps the goods in its own warehouse until the customer asks for them. The goods are on the seller’s shelves, so they show up in the physical count, but they may no longer belong in the seller’s inventory.

For a bill-and-hold arrangement, assess the general transfer-of-control guidance in ASC 606-10-25-30. In addition, ASC 606-10-55-83 requires all four of these conditions: the arrangement has a substantive reason, such as a customer request; the goods are identified separately as the customer’s; the goods are ready for physical transfer; and the seller cannot use them or send them to another customer. Meeting these four conditions alone is not enough; the customer must also have obtained control. Once control has transferred, the seller excludes the goods from its reported inventory but continues to track them separately as goods held for the customer. They may still be counted physically for custody purposes. If control has not transferred, the goods remain in the seller’s inventory.

Returns and repurchases can change the analysis

A customer’s right to return goods differs from a consignment. If control has transferred, the seller recognizes revenue for the amount it expects to keep, subject to the revenue constraint, and a refund liability for expected refunds. It also records a separate asset for the right to recover returned goods, measured from their former carrying amount less expected recovery costs and any decrease in value. Significant uncertainty can constrain revenue, even to zero. Assess transfer of control separately.

In a financing arrangement, a business might receive cash for goods and commit to buy them back for the same amount or more. If the customer never obtains control, the business continues carrying the goods and records a financial liability for the cash. Moving cartons to another warehouse cannot establish a sale by itself. See FASB’s Topic 606 guidance on returns, repurchases and consignments (ASC 606-10-55-22 through 55-29 for returns, 55-66 through 55-78 for repurchases, and 55-79 through 55-80 for consignments) and Farhat’s worked guide to repurchase agreements.

Once you identify the units to count, determine the costs included in inventory. A supplier’s early-payment offer can affect the recorded cost too. See how a buyer records purchase discounts.

Do the tax rules treat goods in transit the same way?

Mostly, yes. For federal income tax purposes, Treasury Regulation §1.471-1 says merchandise belongs in inventory only if the taxpayer holds title. A buyer includes purchased goods once title has passed, even if they are still in transit. A seller keeps goods out on consignment in its inventory and removes goods once title passes to the buyer.

One caution for Enrolled Agent (EA) candidates: eligible small businesses that meet the gross receipts test and are not tax shelters prohibited from using the cash method under IRC section 448(a)(3) may use alternative inventory methods under Internal Revenue Code (IRC) section 471(c). Meeting the gross receipts test alone is not enough. Check the business’s eligibility and whether it uses one of those methods before applying the general inventory rules.

Key takeaways

• Goods in transit go in the ending inventory of the party that controls them on the reporting date.
• Under FOB shipping point, the buyer counts them once the carrier has them. Under FOB destination, the seller counts them until delivery.
• Add your own goods held elsewhere, including goods out on consignment, and remove goods you hold for someone else.
• Value goods shipped to customers at cost, never at selling price.
• Invoice dates, payment dates, and freight bills do not decide ownership. The delivery terms do.
• Fix the ledger only for what it actually missed, so nothing gets recorded twice.

Practice questions

1. A buyer gets an invoice on December 28. Goods ship December 30 FOB destination and arrive January 4. Who counts them on December 31?

Answer. The seller. The invoice date documents the billing, while delivery at the named destination determines the cutoff under these facts.

2. A supplier ships an unpaid $3,200 order FOB shipping point before year-end. The buyer omits both the purchase and the goods. Which balances are wrong?

Answer. Inventory and accounts payable are each understated by $3,200. Because the goods are unsold, omitting both sides does not itself reduce gross profit.

3. A retailer counts $19,500 on its shelves, including $2,100 held on consignment. Its own $900 of unsold goods are at another retailer on consignment. What does it report?

Answer. $18,300. Subtract the supplier’s $2,100 and add the retailer’s own $900. Identify the owner of each lot before adjusting the count.

Frequently asked questions

Does paying freight prove who owns a shipment?

The contract controls. A party may prepay freight and bill it to the other party. Check the named delivery point and any special terms before using the freight bill as evidence.

What if the goods arrived before year-end but the invoice arrived in January?

If the buyer already obtained control in December, recognize the inventory and the corresponding unpaid obligation in December. The January invoice can help confirm the amount.

What does FOB stand for?

FOB stands for free on board. You may see “freight on board” online, but free on board is the correct term, and it is the name used in the International Chamber of Commerce’s Incoterms rules. FOB shipping point is also called FOB origin.

Are goods in transit included in inventory on the balance sheet?

Yes, by the party that controls them. They are reported at cost as part of inventory, a current asset, even though they are not sitting on that company’s shelves. The usual write-down rules still apply, such as the lower of cost and net realizable value test.

Who bears the risk of loss while goods are in transit?

Under the Uniform Commercial Code (section 2-509), risk of loss generally follows the same delivery point. In a shipment contract such as FOB shipping point, risk passes to the buyer when the seller delivers the goods to the carrier. In a destination contract, it passes when the goods are tendered, meaning made available to the buyer, at the destination. The contract can change this, so read it first.

How does the buyer record a purchase shipped FOB shipping point?

On the shipment date, the buyer debits Inventory (in a perpetual system) or Purchases (in a periodic system) and credits Accounts Payable. The bill of lading, which is the carrier’s shipping document, confirms the date the goods left the seller.

About the author

Professor Mansour Farhat, DBA, CPA, CIA, MAcc, is a veteran accounting educator and the founder of Farhat Lectures and its YouTube channel. He teaches students and exam candidates from their first accounting course through the CPA, CMA, and Enrolled Agent (EA) exams, using clear explanations and step-by-step worked examples. Read more about Professor Farhat.