All About the Wholesale Business in Cost Accounting: Accounting

The accounting activity is a facility-level activity that is essential to the ongoing operation of any wholesaling company. Accounting for customer orders, warehouse activities, and payroll demands is a multifaceted operation which will require a dynamic cost driver. We considered the following: labor hours of warehouse workers, number of radio-frequency identification (RFID) tags, and dollar value of customer order.

The activities of physically sorting and delivering goods to customers are very labor-intensive. The number of hours that warehouse workers must spend on these activities is directly traceable to individual customer orders. More time spent on these activities implies either more quantity of goods, more miles driven, or both. In the case of driver labor hours, planned overnighters and unpredictable events like traffic jams can boost labor costs in ways that wouldn’t require much extra accounting. For this reason, ‘driver direct labor hours’ is not a good choice for cost driver.

An RFID tag is attached to each customer pallet after it has been prepared, so that goods shipped to customers can be tracked. The number of RFID tags a customer’s order accumulates is merely a count of the number of pallets that the order occupies. This count, unfortunately, does not pay attention to the variety of goods that were loaded onto the pallets. As goods are pulled from the shelves during the sorting process, a larger variety of goods would require more time to collect. With warehouses consisting of several hundred thousand square feet, two orders with the same number of pallets will take considerably different times to compile if one of the orders requests a greater variety of goods.

Using warehouse direct labor hours from the sorting activity as a cost driver is much wiser than using a simple count of RFID tags. Given the number of RFID tags for a particular order, the count of direct labor hours required to physically sort that order will give a good indication as to the variety of goods in that order. More labor hours incurred will imply a level of complication that undoubtedly requires more accounting. As orders gain variety, more time must be spent collecting different items from around the warehouse, and that means more entries to the inventory ledger. An order which uses more of the resources of the company’s accounting computer system should logically accumulate an equally greater share of the overhead costs associated with the accounting activity cost pool, including software, salary, and utilities expenses. Therefore, the number of direct labor hours incurred by the warehouse staff during the sorting function should be used as the cost driver for the accounting activity.

All About the Wholesale Business in Cost Accounting: Logistics (External)

The activity of external logistics is a little more straightforward than that of internal. Internal logistics involves moving goods from manufacturer locations to wholesaler warehouses. The external logistics activity is a service provided for customers whereby the wholesaling company determines the most efficient and logical way to deliver customer orders. Essentially, external logistics is the organization of the movement of goods from the wholesaler’s warehouse to the client’s destination site.
Our team gave the most consideration of cost drivers to these three possibilities: number of pallets in a customer’s order, dollar amount of the customer’s order, and consultant direct labor hours. External logistics involves the incurrence of overhead costs such as EDI software, logistics software, and IT equipment, which are aimed at fulfilling the service-providing cost object. Consultants work with these softwares and equipment in order to service the needs of individual customers. The consultants work on one client at a time, and therefore their labor hours are directly traceable to the cost object, which is a customer’s order for services.
First of all, the size of a customer’s order, in terms of dollar amount, does not necessarily dictate the physical size of the goods that fulfilling that order will require. For this reason, an order with a larger dollar amount could actually require fewer pallets to fulfill than an order of a lesser dollar amount. What this means, is that the dollar value of an order can’t really tell a consultant how physically grand the order is, and so no actionable information is delivered that would allow the consultant to plan logistics surrounding the order. Thus, ‘dollar amount of a customer’s order’ cannot accurately enough drive the allocation of external logistics overhead costs.
To say that the number of pallets in an order could drive the application of overhead costs is actually reasonable. So far, the number of pallets in an order has proved a useful cost driver in other activities, and it could be used here as well. Although possible, it is our belief that the number of consultant direct labor hours would be the best cost driver for this activity. External logistics is a matter of working with customers to plan the delivery of goods with very specific details in mind, including the time, place, and frequency of delivery. How precise a customer wants to get about these details will determine the amount of time a consultant must spend with him or her. The consultant’s hours are directly billable to the customer, and increased interaction with a customer will require greater usage of the software and computer products that consultants have available. In essence, customers who engage the logistics services of a wholesaling company pay a fixed rate per hour that includes not only the consultant’s time, but the overhead costs (softwares/computers) associated with making the consultant’s job feasible. With consultant direct labor hours driving the level of external logistics activity that is performed, the best cost driver for this activity is clearly direct labor hours for consultants. ‘Consultant direct labor hours’ is a duration cost driver.

All About the Wholesale Business in Cost Accounting: Logistics (Internal)

Internal logistics as a service that is internal to the company. External logistics services are offered to customers, and they will be covered in the next section. Logistics activities internal to the firm involve organizing the transportation of goods from manufacturer locations to the wholesaler’s warehouse. When wholesale companies purchase goods from manufacturers, they are responsible for picking up the goods at the manufacturer’s facility and bringing them back to the warehouse all on their own. This requirement poses its own challenges, so a large company in the wholesale business employs consultants to arrange these exchanges.

The selection of a cost driver for the internal logistics activity is more difficult to pinpoint because linking the costs incurred in this product-level activity to the goods-delivery cost object is not so clear. The three cost drivers to consider are: number of truck miles, consultant labor hours, and number of pallets in order. The number of miles a wholesaler’s truck must drive to fetch goods from manufacturers and return with them to the warehouse is not important. Different quantities of goods can be loaded onto trucks, and trucks may stop at multiple manufacturer plants as is the case when picking up specialty goods. Therefore, number of truck miles is not a good candidate for cost driver.

Consultants who perform the internal logistics activity incur labor hours that are not directly traceable to customer orders. Because the wholesale company starts with bulk quantities of goods and breaks/sorts them to create specific customer orders, it is not possible to link costs associated with those products before the break/sorting action to those after it. For this reason, ‘consultant labor hours’ is not a compatible cost driver.

Logisticians arrange to have goods brought in to wholesaling warehouses. The purpose of bringing the goods in is to arrange customer orders and send the goods back out, but this time to customers. Assuming a full warehouse, as goods come in, more will leave. Even if this activity happens sporadically with warehouse inventory levels climbing and falling, over time the aggregate amount of goods that come in will be equal to that which leaves. Accordingly, the number of pallets that a customer’s order is comprised of can be matched to the number of pallets that entered the warehouse to make that sale possible, on an aggregate basis. This is how we bridge the gap between direct and indirect labor costs incurred in the breaking/sorting and stocking activities. As a very basic example, 100 pallets of manufacturer goods enter a warehouse where they are rearranged, and two orders of 50 pallets with mixed goods are sent out to Customers A and B. In this most basic example, the input is equal to the aggregate output. Internal logistics costs like consultant salaries (indirect labor), software, and supplies should be allocated to the goods-delivery cost object on the basis of the number of pallets in a customer’s order. The number of pallets in an order is a transaction cost driver.

All About the Wholesale Business in Cost Accounting: Stocking

The stocking activity occurs after purchasing, but before sorting. When the purchasers place orders with manufacturers, the goods must be picked up and brought to the warehouse. This process of transporting goods to the wholesaler’s warehouse and stocking them on the shelves therein is called “stocking.” Once goods are stocked, the sorting function can be undertaken to assemble customer orders. In real wholesaler warehouses, the stocking and sorting functions happen simultaneously as goods are constantly being moved in and out to meet customer needs in a hurry.

We identified three possible cost drivers for the stocking activity: number of pallets stocked, labor hours of warehouse stocking workers, and number of pallets in individual customer orders. Pallets that are stocked in the warehouse have arrived straight from manufacturers, and therefore have not yet undergone any bulk-breaking or sorting service activity yet. Because of this, the pallets of incoming goods have no relationship with any customer order yet, and it is likely that many pallets of goods will be disassembled to provide the bulk-breaking service to customers who order smaller quantities. The incoming pallets of goods, which bear no relation to the outgoing pallets of customer orders, cannot be connected to the goods-purchasing cost object. Therefore, the number of pallets stocked is not a suitable cost driver.

It takes a considerable amount of time for warehouse workers to stock the shelves with incoming goods. While wages paid to warehouse workers who sort goods and assemble customer orders is directly traceable to orders, the labor wages paid to warehouse stockers is an indirect labor cost. Labor hours put toward stocking shelves only involves placing whole pallets onto racks inside the warehouse. The sorting activity, on the contrary, involves handling smaller quantities of goods. Because the two separate activities involve a different level of goods-handling, they are not linkable enough to use warehouse labor hours as a cost driver.
In theory, the number of pallets that come into the warehouse should be the same as that which leaves. Although both the stocking and sorting functions are occurring simultaneously in a real-life warehouse, the aggregate number of pallets that come in versus go out should be equal. As an example, if 500 pallets come into the warehouse, and Customer A gets 300 pallets delivered containing a mix of goods from the 500 original pallets, that customer order should be allocated 60% (300/500) of the stocking cost incurred. Operating under these conditions, the number of pallets in a customer’s order should dictate what proportion of stocking overhead costs their order gets assigned. Overhead costs for the stocking activity include forklifts, software, industrial equipment, tools, and safety materials. All these items receive use by the pallets that enter the warehouse and the workers that move them. For the frozen food industry, goods do not vary greatly in size and shape, and therefore will not incur wildly different handling costs during the stocking process. For this reason, the number of pallets in a customer’s order should be used as the cost driver for the stocking activity, as the aggregate number of pallets stocked and prepared is in relative equilibrium. This is a transaction cost driver.

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.

All About the Wholesale Business in Cost Accounting: Physical Sorting

The physical sorting activity takes place after a customer’s order has been transmitted to the wholesaler, and the date of delivery for that order comes near. The warehouse workers review the customer order, and begin to move around the warehouse collecting a variety of goods. Since products come in bulk from manufacturers, that is how they are stored on the warehouse shelves. Therefore, when customers request pallet-size or smaller quantities of these items, the warehouse workers must collect the appropriate quantities of many different goods from around the warehouse. Once a customer’s order contents have been collected, the workers place the goods onto wooden pallets and sometimes wrap them in plastic. At this point, the sorting activity has been completed, and the customer’s order is ready to be loaded onto trucks for delivery.

There are four cost drivers that should be reviewed for the sorting activity: direct labor hours of warehouse staff, amount of packaging, dollar amount of an order, and number of pallets prepared. Warehouse workers in the wholesaling industry work to fill orders in a fast and directed manner. It is not difficult for managers to record the amount of time it takes to assemble a particular customer’s order. For this reason, the wages paid to warehouse workers are a direct labor cost.
Wooden pallets and plastic wrap gets used in the process of preparing customer orders. These costs, it turns out, are directly traceable to individual orders because it is quite clear how much packaging is used in assembling an order, and the quantity used can be recorded before orders are loaded onto trucks. Regardless, customer orders are different sizes, and different types of products may require a number of alternative packaging materials which can range in cost. For these reasons, the amount of packaging used is not a suitable cost driver.

The dollar amount of a customer’s order is also negligible. In the frozen food industry, often there are not many products of varying sizes with radically different prices. However, a premium microwave meal could cost double a simple microwave meal, even though these two items occupy the same space. Accordingly, twice as many pallets would be used in a $1m order of simple meals versus premium ones. It follows, therefore, that ‘dollar amount of order’ would be a bad cost driver to use.

A customer’s order, if large, will require the warehouse staff to prepare more pallets during sorting. Pallets are roughly the same size, meaning that a very similar level of expense will be incurred in the preparation of each one. Overhead costs related to the physical sorting activity include the use of forklifts and safety materials, and these costs will not vary per pallet. This means that the overhead costs related to the physical sorting activity can be most accurately assigned to customer orders based on the number of pallets that are prepared to meet that order. This is a transaction cost driver.

All About the Wholesale Business in Cost Accounting: Delivery

For the Delivery activity cost pool, we considered three cost drivers: number of pallets delivered, number of miles driven, and direct labor hours for drivers. The delivery activity begins once a customer’s order has been assembled. In the warehouse, pallets of goods that have been assembled to meet a specific customer’s order are loaded onto delivery trucks. Drivers employed by the wholesaling company will then drive these trucks to the customers’ place of business to make the delivery.
There are several activities that will affect the cost of delivering goods to customers. First, the number of pallets that comprise the order will determine the number of trucks that must make the delivery. Using the number of pallets as a cost driver, however, could be misleading. There could be an instance when a truck is not completely full. In this case, a truck will travel the same number of miles, use almost as much gas, and require drivers to be paid just as much as a truck that leaves the warehouse completely full. Thus, a full truck with 20 pallets will be allocated twice as much overhead as a half-full truck with 10 pallets, even though all the aforementioned expenses will be the same. For this reason, we dismissed ‘number of pallets’ as a potential cost driver.
Second, how far away the customer is geographically located from the wholesaler’s warehouse will determine the number of miles those trucks need to drive. There are several highly probable scenarios which make ‘number of miles driven’ also a less than ideal cost driver. For far-away deliveries, drivers may need to sleep overnight at their destination locations in order to meet legal requirements. For suburban and city deliveries, drivers will likely face slow-moving traffic other causes for delay. In either of these cases, the number of miles driven is negligible because the warehousing company will have incurred a significantly increased labor expense due to the delays.

The number of miles driven is not the only determinant of the amount of time required to make a delivery. A number of factors, including those mentioned above, will affect the number of direct labor hours that drivers must contribute to make deliveries. If a large delivery requires two trucks, then two drivers would be needed to complete the delivery. In a situation like this, the number of direct labor hours is doubled and reflects the extra cost required to complete that delivery. The direct labor cost for each order is directly traceable, based on which customer’s order is on the truck and how long it takes to get to them. There are various overhead costs associated with the delivery activity, however, that are indirect. Costs like cell phones, computers, mechanics, lodging, and insurance will all generally increase as drivers incur more hours on the job using these benefits. The fact that these indirect costs will rise with an increase in driver hours on the job, makes the number of direct labor hours for drivers the most accurate cost driver for the delivery activity. This is a duration cost driver.