All About the Wholesale Business in Cost Accounting: Sorting Service

The sorting service should not be confused with the physical sorting activity. The wholesale company buys goods in bulk from manufacturers, and stocks these goods in its own warehouse. To meet customer orders, warehouse workers take bulk-size or smaller quantities of goods off the warehouse shelves, and combine them on pallets to be shipped out. By purchasing in bulk from manufacturers and passing goods on to customers in less-than-bulk quantities, the wholesaler has done what is known as “breaking bulk.” By breaking bulk, the wholesaler has provided a service of convenience for the customer. The customer is not forced to purchase the goods in such large quantities direct from manufacturers, and the price the customer pays for this service is included implicitly in the price of the goods in the form of a markup. The pallets of goods that get shipped out to customers have a variety of different goods on them, and the act of preparing this variety is called “sorting.” Sorting is both a physical action and a service. By completing the physical action of arranging many different goods in a way that meets specific customer needs, a sorting service has been delivered.

Three cost drivers should be considered for the sorting service: dollar amount of the order, direct labor hours of warehouse workers, and number of pallets in the order. It is wrong to assume that the dollar amount of a customer’s order could indicate fully the level of activity that was required to complete the sorting activity for that order. With the sorting service, what we seek to do is allocate the overhead costs associated with providing the service to the individual customer orders themselves. Two orders could require the same effort to prepare, and occupy the same number of pallets as one another, but be valued at significantly different dollar amounts depending on the contents of them. Scenarios like this are commonplace in the wholesaling industry, and as such, it is not appropriate to use the dollar amounts of orders as a cost driver.
This discussion relates to the sorting service, and not the physical sorting activity. Accordingly, there is no indirect labor cost associated with it, and the direct labor that is required for the physical sorting activity is directly traceable to customer orders. This means that direct labor hours for warehouse workers, because it is direct, cannot be used as a cost driver.

The overhead costs of providing the sorting service are mainly tied up in maintaining a system of Electronic Data Interchange (EDI) between customers and the wholesaler. EDI is a means by which customers can transmit the specifications of their orders to the wholesaler for fulfillment. The EDI system and the warehouse inventory management software system in place work together to determine how goods should best be arranged on pallets and in delivery trucks. For this reason, the size of an order will determine how many pallets it requires. Orders with more pallets use more of the intrinsic and calculation resources that the EDI system provides, and therefore should be allocated more share of the EDI system’s cost. Using this methodology, we determined that the number of pallets in an order should be the cost driver used to allocate sorting service overhead costs.