Standard Cost Baseline Setting and Purchase Price Variance Tracking
Standard cost baselines set full landed charges while purchase price variance tracking prevents distorted stock valuations and credit covenant breaches.
Freight Absorption
Meaning
Pricing strategies involve a seller paying the transportation costs of goods instead of charging the customer. Utilizing freight absorption allows a company to remain competitive in distant markets where shipping fees would otherwise make their products too expensive. This practice applies to the delivery of finished goods but does not include the cost of bringing raw materials into the plant.
Cost Distribution
Internal accounts record the shipping expense as a marketing or sales cost rather than a production charge. When freight absorption is used, the profit margin per unit decreases by the exact amount of the transport bill. A business must have high enough production efficiency to offset these extra fees.
Market Strategy
Geographic expansion depends on being able to offer uniform pricing to all buyers regardless of their location. Implementing freight absorption helps a manufacturer win contracts against local competitors who have lower logistics costs. This method is effective for high value items where the shipping cost is a small percentage of the total price.
Margin Erosion
Continuous monitoring of transport rates is required to ensure that the seller does not lose money on a transaction. If fuel prices rise rapidly, freight absorption can turn a profitable order into a financial loss. A firm that fails to set limits on this practice will see its net income disappear even as its sales volume grows.
Limiting the distance or the weight of orders eligible for this treatment protects the bottom line.