Understanding the Importance of FOB Shipping Point

Understanding the Importance of FOB Shipping Point

According to the International Chamber of Commerce (ICC):

FOB means that the seller delivers the goods on board the vessel nominated by the buyer at the named port of shipment or procures the goods already so delivered.

However there are two types that can’t be mixed up: the FOB shipping point (or the FOB origin) and the FOB destination. In this article we will disclose the following:

1. What is FOB?

2. Chances of getting an IRS tax audit letter

3. How to record FOB shipping point

4. FOB alternatives

It’s important that you have a clear understanding of this term so that you know what your rights and obligations are from the start of your contract. 

What is FOB?

Freight shipping has been a fundamental part of the global economy. More and more small businesses are now relying on freight to transport their goods from one region to another.

What does FOB stand for? FOB means the shipping process when the seller is responsible for the delivery of the products on board the vessel that was chosen by the buyer at the named port of shipment.

📌 Note: the legal FOB definition may differ from country to country so make sure to consult the local attorney before using it to avoid misunderstanding and misuse of the term in the contract. 

What does FOB destination mean?

The FOB destination means that the seller is at risk to pay for the damage until the buyer receives the products. 

The FOB destination is often used in international sales contracts but can also be used to be more specific about when or where the seller must deliver. To find out if your FOB destination is different from your FOB origin, you should always check with your supplier and make sure you have all of your contracts in order.

What does FOB shipping point mean?

The FOB shipping point means the buyer is responsible for the products they ordered once the seller ships the items. It means that the buyer takes complete control over the delivery. 

The FOB shipping point (or the FOB origin) is an important term to understand in a contract, as it can significantly affect how much you pay for packing materials and insurance.

FOB: shipping point vs destination

As mentioned above, there are two FOB types: the FOB destination and the FOB shipping point. This can be confusing because they sound exactly the same. So let’s focus on the differences:

Difference #1. Responsibility. With the FOB shipping point the buyer takes the responsibility for lost or damaged goods. Under the FOB destination — the seller. 

Difference #2. Accounting. Under the FOB shipping point the buyer can record an increase in their inventory as soon as the products were placed on the ship. Under the FOB destination — the seller completes the sale in its records only when the goods arrive at the receiving dock. And only after that the buyer can record the increase. 

Difference #3. Division of costs. When it comes to the FOB shipping point, the transport cost and fees are the responsibility of the seller until the products are delivered to the port from where they will be sent to the buyer. Once they are on board — the buyer becomes a financially responsible figure. For the FOB destination the seller assumes all costs and fees associated with the transportation until the goods reach the port of destination. 

FOB cost

The costs associated with FOB include:

  • Transportation of the goods to the port of shipment;
  • Loading them onto the shipping vessel;
  • Freight transport;
  • Insurance;
  • Unloading and transporting the goods from the port of origin to the final destination.

Under the terms of FOB responsibilities for covering costs, losses or damages are divided between both the seller and the buyer.

📌 Note: FOB status does not determine the ownership of the products. It is determined in the bill of sale or agreement between the two parties: the seller and the buyer. 

FOB shipping point: who pays?

Under the FOB shipping point the buyer pays the shipping cost from the factory and becomes responsible for the goods in case of any damages during the shipment. 

In general the flow of the FOB shipping point is the following:

The seller assumes the transport cost and fees until the products are delivered to the port from where the goods will be shipped to the customer (the port of origin). After they are on the ship, the buyer becomes financially responsible for the costs associated with:

  • Transport
  • Customs
  • Taxes
  • Other fees

FOB shipping point: Insurance

If under the FOB shipping point the goods are damaged during the transportation, the buyer should file a claim with the insurance carrier since the buyer has the title to the goods during the period when the products were damaged.

📌 Note: if an item is lost/damaged in shipment, the buyer must file any claims for reimbursement (not the seller) since under the FOB shipping point the shipment became the buyer’s responsibility immediately. 

How to record FOB shipping point?

📌 Note: FOB establishes when the goods become an asset on the buyer’s balance sheet. This becomes especially important at the end of a calendar or fiscal year — if a transaction occurs close to the transaction from one accounting period to the next.

The accounting treatment for the FOB shipping point is important since adding costs to inventory means the buyer does not immediately have an expense. This delay in recognizing the expense and changes in the buyer’s inventory affects the net income.

So it is important to understand the accounting under the terms of the FOB shipping point: the sale is typically recorded when the shipment leaves the seller’s facility and the receipt is recorded when it arrives at the buyer’s facility. 

📌 Note: As the seller, you have to record any shipping costs in the Delivery Expense account as a debit.

FOB alternatives

The FOB shipping point and the FOB destination are the most common terms in international trade. A total of 98% of cargo is shipped with the FOB shipping points. However, many traders are looking for more flexible terms and have turned to other modes of shipping:

  • FAS (Free Alongside Ship). This means that when you receive your goods, they will be on board a vessel next to your ship. 
  • CIF (Cost, Insurance, and Freight). This means that when you receive your goods, they will already be delivered to your destination port. 
  • DDP (Delivered Duty Paid). This means that when you receive your goods, they will be delivered to your door without any additional fees.
  • CPT (Carriage Paid To). This means that the seller pays for carrying costs until he places the goods at your disposal anywhere on your premises including storage areas, loading ramps and any connecting parts of your premises.
  • EXW (Ex Works). The seller fulfills all obligations up until the goods are placed at the buyer’s disposal at their premises. This includes loading goods onto the vehicle that will deliver them to the purchaser’s premises. It does not include any obligation on behalf of the seller to load goods onto a carrier or even to provide them with transport over public roads.

While each one of these options has its benefits and drawbacks, it’s important to note that there are certain circumstances in which one option might be more suitable than another depending on what you’re importing and exporting. For example, if you import high-value items like electronics or jewelry, DDP may not be an ideal option because it can leave you with large customs duties to pay when you cross borders.

Anastasia Su

Anastasia Su

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