What it means
When your business buys or sells products, there is often a gap between the moment the items leave the warehouse and the moment they arrive at the destination. This period creates a puzzle for accountants because the stock physically exists, but nobody can touch it yet.
Tracking goods in transit matters greatly when the financial year-end approaches. If you run your inventory counts on the final day of the financial year, you must decide whether to include items currently sitting in the back of a delivery truck.
To solve this, businesses rely on shipping terms such as FOB, which stands for Free On Board. If terms are FOB shipping point, the buyer owns the stock the moment it leaves the supplier, so it counts as the buyer's inventory immediately, even while rolling down the motorway.
If terms are FOB destination, the supplier retains ownership until the delivery truck pulls up to your loading dock. Getting this right is vital for accurate financial statements.
If a growing company forgets to record goods in transit, its balance sheet will understate both inventory and accounts payable. This oversight distorts key financial ratios, such as the current ratio, which lenders examine closely, and mismanaging transit stock can also ruin cost of goods sold calculations, leading to surprise tax bills or misleading profit reports.
In daily operations, warehouse managers and finance teams must communicate closely about shipping schedules. By reviewing bills of lading and dispatch notices at month-end, finance staff can make adjusting journal entries.
This ensures that assets match liabilities properly, giving managers a true picture of business performance without nasty surprises. Imagine ordering a pizza for delivery.
The pizza is yours the moment it leaves the shop counter, even though it is still inside the delivery driver's warming bag on your street.
In practice
Real-world examples
Example 1
A boutique clothing brand orders winter coats worth $15,000. The shipment leaves the factory on the 28th of March under FOB shipping point terms. Although the coats do not arrive until the 3rd of April, the brand must record them as inventory on its March 31st balance sheet.
Example 2
A regional hardware store orders $8,000 of power tools with FOB destination terms. A massive snowstorm delays the delivery truck across the county border. Because the supplier retains risk during transit, the store does not record these tools as assets until they actually arrive.
Example 3
An online furniture retailer imports chairs from overseas. The cargo ship is in international waters on audit day. Under the agreed shipping contract, the retailer took title at the foreign port, so the $45,000 of inventory must appear on their financial statement as transit stock.
Think of it
Imagine ordering a pizza for delivery. The pizza is yours the moment it leaves the shop counter, even though it is still inside the delivery driver's warming bag on your street.
Formula
Calculation
Total Inventory = Physical Stock on Premises + Goods in Transit (where the terms make you the owner)
Example: If your warehouse holds $50,000 of stock, and you have valid FOB shipping point goods in transit worth $10,000, your total recorded inventory is 50,000 + 10,000 = $60,000. The adjusting journal entry is a debit to Inventory of $10,000 and a credit to Accounts Payable of $10,000.
Both sides of the balance sheet grow, which can change ratios. If current assets were $100,000 and current liabilities $80,000, the current ratio was 100,000 / 80,000 = 1.25. After recording the transit stock it becomes 110,000 / 90,000 = 1.22, a more accurate picture of what the business owns and owes.Case study
Seen in the real world
This is a fictional, illustrative scenario. Oakwood Supplies, a mid-sized office furniture distributor, faced a stock audit puzzle at the end of their financial year on December 31st. Their physical warehouse count showed $120,000 of inventory. However, the finance manager discovered two major shipments on the ledger.
Shipment A, valued at $15,000, was shipped from the manufacturer on December 28th under FOB shipping point terms. Shipment B, valued at $25,000, was shipped under FOB destination terms and was still two days away. Following accounting rules, the finance team added Shipment A to the year-end inventory balance because Oakwood already held legal title and the associated risk. Shipment B was left off the balance sheet because ownership remained with the supplier until physical delivery in the new year.
The correct year-end inventory was therefore $120,000 + $15,000 = $135,000, with a matching $15,000 added to accounts payable. By correctly accounting for Shipment A as goods in transit, Oakwood avoided understating its assets. This precise adjustment ensured their year-end financial statements satisfied bank covenants and provided an accurate valuation for tax reporting.
Watch out
Common mistakes
- Counting the same inventory twice by including items that have already arrived and been logged in the warehouse.
- Failing to check shipping terms, leading to goods being left off the balance sheet when the company actually holds legal ownership.
- Forgetting to record the corresponding accounts payable liability when logging goods in transit as inventory.
Questions
People also ask
Who pays for goods in transit if they get damaged?
Whoever holds the risk of loss under the agreed shipping terms is responsible for filing insurance claims or absorbing the cost.
Do goods in transit affect my profit and loss statement?
Not directly until they are sold. They sit on the balance sheet as an asset until the customer purchases them, at which point they become the cost of goods sold.
How often should I review goods in transit?
You should review them at the end of every reporting period, especially at financial year-end, to ensure your balance sheet is accurate.