The Cost Factor (Landed Cost)

Modified on Thu, Mar 27 at 4:02 PM

This article describes how Connected helps customers estimate and assess the landed cost(s) of inventory by using the Connected Cost Factor.

TABLE OF CONTENTS

Introduction to the Cost Factor (Landed Cost)
Cost Factor Example - Tariffs
The Three Types of Cost Factor
General Ledger Account Distributions and the Cost Factor

Introduction to the Cost Factor (Landed Cost)

The Connected Cost Factor (aka landed cost) is used to more accurately record the landed cost of inventory imported from other countries. When a Purchase Order is issued the item purchase cost should be in the currency that will be payable to the vendor, which could be the Home currency (no exchange) or a foreign currency (exchange factor applied).

When receiving inventory for a Purchase Order, the cost factor(s) (exchange, freight, duty and taxes/tariffs) are multiplied against the purchase cost of the item to determine the landed cost. This factor can consist of an exchange rate, a factor (percentage) for duty and taxes/tariffs, and a factor (percentage) for freight.

NOTE: The Cost Factor will not apply to "Service" (non-inventory) type items.

NOTE: If the Multi-Currency Plug-in is active, please refer to the Purchase Order section of the Multi-Currency Plug-in documentation. Freight and duty calculations are the same and explanations are provided below.

Since the freight and duty and taxes/tariffs may not be known at the time of receiving, these percentages can be estimates. This can also be true for the exchange rate, which may also be estimated.

The cost factor can be specified in either the Vendor Window, Inventory Window, or as a Single Cost Factor. Regardless of the type of cost factor used, each vendor is assigned an exchange rate level. When a vendor is added, they are assigned a number from 1 to 5, which will correspond to an exchange rate level from the exchange table within the A/P Defaults setup screen under the Purchase Orders tab, as shown in the following screen.

IF a vendor is paid in your home currency, they should be assigned the Exchange Rate of anything other than Currency 1, with an exchange of 1. If they are assigned Currency 1, no cost factors will be applied. Purchase Orders for vendors using the "Currency 1" selection are multiplied by a factor of 1, therefore these costs do not change. Levels 2 to 5 will account for the exchange, duty, and freight amounts assigned.

For example, a Canadian company would assign all of its Canadian vendors to level 1, as there is no exchange or landed cost calculation required. However, the United States vendors could be assigned to level 2. In the table for the Cost Factor settings, "Currency 2" could be assigned a value of 1.2 to account for the exchange rate between the U.S. and Canadian dollars. When inventory is received from a U.S. vendor, it will be multiplied by the 1.2, as well as the applicable freight, duty and taxes percentages.

NOTE: When entering the freight and duty percentages, enter them as 0.02 for 2% or 0.12 for 12%, ect.

Freight and duty & taxes percentages are not required so the exchange rates can be used exclusively, if needed. Simply leave the freight and duty & tax percentages at zero if they are not to be used.

Cost Factor Example - Tariffs

The following example illustrates how the cost factor is multiplied against a purchase cost to determine the estimate landed cost.

The "Home" currency is Canadian dollars and "Currency 2" is USD.

A purchase order is entered for a single item at a cost of $100.00 USD. The cost factor has been estimated and set up on the A/P Defaults setup screen as follows:

A Vendor with Currency 2 assigned, that uses an Exchange Rate of 1.25 from the Cost Factor rate table.

Freight costs are estimated at 5 percent or 0.05

Duty & Taxes/Tariffs are estimated at 27 percent or 0.27

When the item is received against the purchase order, the cost factor rates are stored with the receiving. When the receiving is posted, the value of the purchase is multiplied by the cost factor so that the items immediately are valued in the home currency. The cost (landed cost) is calculated as follows:

Item with cost of $100.00. This amount is multiplied by the exchange rate of 1.25 ($100.00*1.25 = $125)

The exchanged amount is then multiplied by the freight percentage to determine the freight cost that will be added to the item ($125.00 * 0.05 = $6.25). The exchanged amount is also multiplied by the duty & taxes percentages ($125.00 * 0.27 = $33.75)

The total landed cost of the item is therefore calculated as:

$125.00 + $6.25(freight) + $33.75(duty, taxes/tariffs) = $165.00

The Three Types of Cost Factor

There are three cost factor options to choose from:

1) From Vendor Window

2) From Inventory Window

3) Single Cost Factor.

Each is explained in the following sections.

NOTE: The Exchange rate, Freight rate, and Duty & Tax rate can optionally be edited when a purchase order is received. This option is available by user privilege. See Intro to User Accounts and Access Privileges for more information on how to set this option by user access.

Cost Factor: From Vendor Window

Choosing to use the cost factor From Vendor Window will activate the "Exchange Rate", "Freight Rate" and "Duty & Tax Rate" fields, as shown in the following screen:

Note: The "Exchange Rate" is always active in the Vendors window, once the Cost Factor is enabled.

Each vendor can be assigned a Freight Rate and a Duty & Tax Rate percentage. This makes the cost factors more precise, especially if you have vendors in various countries, as freight charges can vary depending on the country of origin.

Cost Factor: From Inventory Window

Choosing to use the cost factor From Inventory Window lets different freight and duty & tax percentages be assigned for each inventory item. Vendors will still have their own exchange rate level as used with the other cost factor methods. When selected, two additional fields appear on the inventory items window, Freight Rate and Duty and Tax Rate.

NOTE: Tariffs would be accounted for in the Duty and Tax percentage. This value, along with the other cost factor variables, can be edited at the time a Purchase Order is received.

The following screen shows the location of each factor in the Inventory Item window:

This method is quite useful for those companies that have inventory items whose freight and duty & tax costs vary greatly.

Cost Factor: Single Cost Factor

The Single Cost Factor means that a central cost factor is used from the Cost Factor setup in the A/P Defaults. When a receiving is entered, the cost factor amounts for the Freight and Duty and Taxes default to the values specified in the A/P Defaults.

NOTE: The exchange rate can be used on its own; it is not mandatory to fill in the percentages for freight or duty.

General Ledger Account Distributions and the Cost Factor

The General Ledger account distribution for inventory items received on a purchase order is created when the vendor bill is matched against the purchase order receiving. Each area of the cost factor (exchange, freight, duty & taxes) has a separate General Ledger account, as each area of the cost factor is tracked separately. There is an exchange liability account, freight liability account, and a duty & taxes liability account.

Below are examples of the account distributions that can be created when a bill from a vendor is entered against an outstanding purchase order. For the purposes of this example, assume that you are purchasing an inventory item costing $100.

1) G/L Distribution without the Cost Factor

DR Inventory Asset $100.00

CR Accounts Payable $100.00

2) G/L Distribution with the Cost Factor: Exchange rate of 1.25 a Freight percentage of 5%, and a Duty & Taxes/Tariff percentage of 27%

DR Inventory Asset $165.00

CR Accounts Payable $ 100.00

CR A/P Exchange Liability $ 25.00

CR Freight Liability $ 6.25

CR Duty & Taxes/Tariff Liability $ 33.75

To balance the increase in inventory value, the three parts of the cost factor are allocated to their respective liability accounts. These accounts have been previously set in the A/P Defaults Setup screen under the Purchase Order tab.

The above exchange, freight, and duty & taxes/tariff liability accounts will continually increase with Purchase Orders that use a cost factor. Below is an example of how these accounts are cleared out.

When a bill for the duty & taxes/tariff is received, it is typically a separate bill to a different vendor from the inventory purchase. It will be entered on the Purchases window separately. For example, suppose the duty & taxes/tariff bill for this transaction was indeed $33.75 as shown in the example above. You would enter in this bill as a purchase entry of $33.75 for the vendor (customs broker) that has supplied the bill. The distribution for the bill would be as follows:

DR Duty & Taxes Liability $33.75

CR Accounts Payable $33.75

This transaction would bring the duty & taxes liability account to a net of zero. In reality however, the actual bill may not match the estimated amount that was created by the cost factor. This means at month end or year end, you may have to enter an adjustment in the General Journal to clear out the balance of the duty & taxes liability account to the income statement. This will be the same for the other two liability accounts. The cost factor is used for estimating landed cost only, so there will likely be minor discrepancies.