The Timing of a Freight Invoice
Kestrel Bay Traders runs an accrual accounting system with a 30 June year end. On 27 June, goods costing $48,000 are shipped to a customer, free on board (FOB) shipping point, and the customer takes legal title at dispatch. The freight invoice for $3,600 arrives on 4 July and is paid on 9 July. The accountant records the freight as a July expense, arguing the invoice was not received until July. The sales invoice for $72,000 was recorded in June. On 30 June a stocktake reveals goods costing $5,200 held on consignment from a supplier and included in closing inventory. The draft profit before these items is $96,000. The business reports under accrual accounting and the conceptual framework definitions of assets, liabilities, income and expenses.
1. Determine the correct June profit treatment for the freight and the consignment goods, and calculate the adjusted profit.
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Freight: Under accrual accounting, expenses are recognised when the obligation is incurred, not when the invoice arrives or cash moves. The freight relates to a June sale and was incurred in June, so $3,600 belongs in June as a selling/distribution expense. Recording it in July overstates June profit and understates July profit.
Consignment goods: Goods held on consignment remain the property of the supplier; Kestrel Bay does not control them. They fail the asset definition and must be excluded from closing inventory. Including $5,200 overstates inventory and understates cost of goods sold, thereby overstating profit.
Adjustment:
- Draft profit: $96,000
- Less freight expense: ($3,600)
- Less inventory overstatement (increase COGS): ($5,200)
- Adjusted June profit: $87,200
Both errors overstate June profit; the net overstatement is $8,800.
2. Explain why the accountant's 'invoice date' reasoning is inconsistent with the conceptual framework, and state one consequence for the financial statements if uncorrected.
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The framework defines an expense as a decrease in economic benefits through outflows or depletion of assets, or incurrence of liabilities, that reduce equity. The freight obligation was incurred on 27 June when the goods were dispatched, creating a liability (accrued freight) and reducing equity then. The invoice is merely documentary evidence; it does not create the expense. Waiting for the invoice is cash-basis thinking.
Consequence: June profit and equity are overstated by $3,600, liabilities are understated (no accrual recognised), and the July period bears an expense with no related revenue, distorting comparability and any profit-based ratios or performance bonuses. The matching of the sale with its directly attributable freight cost is also broken.