The Cost Factor - Landed Cost for Freight, Duty, and Tariffs

System Requirements: Connected 12.0 or greater

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)
  • Using a Cost Factor without Foreign Currency
• The Three Types of Cost Factor
  • Cost Factor: From Vendor Window
  • Cost Factor: From Inventory Window
  • Cost Factor: Single Cost Factor
• Cost Factor Example - Tariffs
• Cost Factor Example - Freight
  • Receiving Purchase Orders
• 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 Multiple Currencies are active, please refer to documentation for Exchange calculations. 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 sourced from three options:

1) Vendor Window

2) Inventory Window

3) 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, as shown in the following screen.

Using a Cost Factor without Foreign Currency

If a vendor is paid in home currency, they should be assigned the Exchange Rate of 1 but not by using "Currency 1". If Currency 1 is used, no cost factors can or will be applied. Currency 2-5 will account for the exchange, duty, and freight amounts assigned. The following screen shows the setup for a zero exchange but still allows for Freight/Duty/Tariff cost allocation using "Currency 3".  In the example below, Currency 3 would be assigned to the vendor.

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 1.25 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 1.25, 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%, etc.

Freight and duty & taxes percentages are not required so the exchange rates can be used exclusively or vice-versa using an exchange rate of 1 for any currency level other than "Currency 1".

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.

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/tariff 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 enabled,  the "Freight Rate" and "Duty/Tax Rate" fields are visible in the Inventory window. 

NOTE: Tariffs use the Duty/Tax Rate 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.

Exporting a Purchase Order and/or Receiving to Spreadsheet

Complex and lengthy Purchase Orders are often needed in a spreadsheet format. Both a the Purchase Order and the Purchase Order receivings can easily be exported to a spreadsheet.

The following screen shows how to export an unposted Purchase Order receiving by selecting Print-> Spreadsheet, with the "Receivings" tab active.  This can be very useful for complex freight/tariff allocations.  If the "Details" tab is active, the Purchase order body is exported instead of the receiving details.

Cost Factor Example - Tariffs

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

Information:

Currency 1: Home Currency is Canadian (Rate 1.00)

Currency 2: Euros (Rate 1.45)

Freight: 10% 

Tariff: 25%

Item/Total PO Cost: 1,000.00 EUR

Purchase Order is entered for a single item at a cost of $1,000.00 Euros. 

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 $1,000.00. This amount is multiplied by the exchange rate of 1.45 ($1,000.00*1.45 = $1,450.00)

The exchanged amount is then multiplied by the freight percentage to determine the freight cost that will be added to the item ($1,450.00 * 0.10 = $145.00).  The Freight also appears in dollars so precision unit freight cost allocation is possible.

The exchanged amount is also multiplied by the Tariff (aka Duty/Taxes) percentage ($1,450.00 * 0.25 = $362.50)

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

$1,450.00 + $145.00 (10% Freight) + $362.50 (25% Tariff) = $1,957.50

$1,957.50 is the final unit price for this Purchase Order example.

Cost Factor Example - Freight

The following example illustrates how freight costs are allocated by to unit costs by percentage and/or dollar allocations.

Receiving Purchase Orders

When the purchase order is received with a non HOME currency code or a purchase order cost factor for the vendor that is greater than 1, the Freight % and Freight $ fields become editable per line.

Depending on settings selected, some Freight values me be pre-populated with percentages. Factors are shown as whole values instead of percentages. 

Example:

Currency 1 - No Exchange

Freight Estimation from Vendor 10%

Tariff/Taxes - 0 (none) 

Total Freight in $: $7,250.00

The converted Freight $ from these factors will appear to the right of the factor as shown with a total of the Freight amount to be applied to the purchase order receiving.

If the Freight % is entered the Freight $ value will be automatically calculated.

If the Freight $ is entered, the Factor % will automatically re-calculate once Tab key is pressed to pass the Freight $ field.

TIP: Exporting the unposted receiving to a spreadsheet can be very helpful for complex freight allocations by dollar or percentage.

General Ledger Account Distributions and the Cost Factor

Financial accounting for inventory 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 $1,000.

1) G/L Distribution without the Cost Factor

DR    Inventory Asset        $1,000.00

CR    Accounts Payable                        $1,000.00

2) G/L Distribution with the Cost Factor: Exchange rate of 1.45 a Freight percentage of 10%, and a Duty & Taxes/Tariff percentage of 5%

DR    Inventory Asset        $1,957.50

CR    Accounts Payable Euros             $    1,000.00

CR    A/P Exchange Liability                $       450.00

CR    Freight Liability                           $        145.00

CR    Duty & Taxes/Tariff Liability       $        362.50

To balance the increase in inventory value, the three parts of the cost factor are allocated to their respective liability accounts, defined in the A/P Defaults setup screen.

 
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 $362.50 as shown in the example above. You would enter in this bill as a purchase entry of $362.50 for the vendor (customs broker) that has supplied the bill. The distribution for the bill would be as follows:

       DR    Duty & Taxes/Tariff Liability    $362.50

       CR    Accounts Payable                                    $362.50

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, a journal entry adjustment may be needed to clear out the balance of the duty & taxes liability account. This will be the same for the other two liability accounts. Cost factor is used for estimating landed cost, so minor discrepancies are normal and should be expected.  The same would be the case for the freight costs on this shipment.