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 terms in shipping that can’t be mixed up: the FOB shipping point (or the FOB origin) and the FOB destination. In this article we’ll disclose the intricacies of international shipping and the ways to manage it in your reports:
1. What is FOB?
3. FOB costs
It’s important that you have a clear understanding of FOB shipping 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 is one of the internationally accepted incoterms and may stand for ‘free on board’ or ‘freight on board’ and means the shipping process when the seller is responsible for the delivery of products on board the vessel that was chosen by the buyer to a named port of shipment.
📌 Note: To ensure smooth shipping of items globally, the International Chamber of Commerce (ICC) publishes a set of 11 Incoterms (international commercial terms) that specify the responsibilities of sellers and buyers. Incoterms 2020 is the latest edition that is still in effect.
However, the legal ‘free on board’ definition may differ from country to country so it’s better to consult the local attorney before using it to avoid misunderstanding and misuse of incoterms in the contract, as well as ensure that you’re shipping goods in accordance with a local law.
What does FOB destination mean?
FOB destination, or FOB destination point, means that the seller is at risk to pay for the damage until the buyer receives the products. The seller selects the freight carrier and is responsible for shipping the goods to the final destination point.
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.
📌 Note: The terms ‘Freight Collect’ and ‘Freight Prepaid’ are used to indicate who’s responsible for the freight and any additional expenses incurred while shipping the goods.
If ‘FOB Destination, freight collect’ is specified, it means that the buyer is the one to pay for the freight.
‘FOB Destination, Freight Prepaid’ is the opposite of ‘FOB Destination, Freight Collect’ and is used to indicate that the seller assumes the cost of freight.
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. Basically, the buyer takes complete control over the delivery once a freight carrier picks the goods.
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.
📌 Note: The terms ‘FOB shipping point’ or ‘FOB origin’ indicate the opposite of ‘FOB Destination, freight collect / freight prepaid’ — the buyer is responsible for the freight charges.
FOB: shipping point vs destination
As mentioned above, there are two FOB types: the FOB destination and FOB shipping point. Let’s focus on their differences to avoid confusions:
Difference #1. Responsibility. With the FOB shipping point, the buyer takes the responsibility for lost or damaged goods and freight. Under the FOB destination — it’s the seller’s responsibility.
Difference #2. Accounting. Under the FOB shipping point, the buyer can record an increase in their inventory as soon as the products are placed on the ship. Under the FOB destination, the seller completes the sale in their 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 who will incur any additional costs related to shipping. With the FOB destination, the seller assumes all costs and fees associated with the transportation until the goods reach the port of destination.
The costs associated with FOB include:
- Transportation of the goods to the port of shipment;
- Loading them onto the shipping vessel;
- Freight transport;
- Unloading and transporting the goods from the port of origin to the final destination.
Under the terms of FOB, responsibilities for covering freight costs, losses or damages are divided between both the seller and the buyer and are defined in the sale contract or purchase order of a freight shipment.
📌 Note: FOB status doesn’t determine the ownership of the products. It’s determined in the bill of sale or agreement between the two parties: the seller and the buyer.
FOB shipping point terms: Who pays for freight?
Under the FOB shipping point terms, 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 freight 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:
- Freight transport;
- Other fees.
FOB shipping point terms: Insurance
If under the FOB shipping point terms the goods are lost/damaged during transportation, the buyer should file a claim with the insurance carrier since the buyer has the title to the goods during the period and therefore the shipment is the buyer’s responsibility.
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 of the FOB shipping point is important since adding costs to inventory means the buyer doesn’t immediately recognize an expense. This delay in recognizing the expense and changes in the buyer’s inventory affects the net income.
That’s why it’s 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 point of destination.
📌 Note: As the seller, you have to record any shipping or freight costs in the Delivery Expense account as a debit.
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 the seller is responsible for clearing the goods for export and their delivery alongside a ship at a named port of destination.
- CIF (Cost, Insurance, and Freight). The seller pays for shipping, but isn’t responsible for insurance or freight. The risks transfer to the buyer only when the goods are delivered to a port of destination.
- DDP (Delivered Duty Paid). This means that the shipment will be delivered to your point of destination without any additional fees as the seller covers taxes and/or import duty.
- CPT (Carriage Paid To). This means that the seller pays for delivery until they place 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 doesn’t 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 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 the others depending on what you’re importing and exporting. For example, if you’re importing 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.
If you’re shipping items internationally, it’s essential to understand the terms and conditions of FOB. What’s even more important, you must record your shipping costs correctly. With Synder, you’ll be able to keep track of your shipping amounts and record them into your books flawlessly. And that’s far from all! The Smart Rules engine may help you to calculate VAT for your sales based on the shipping address country or region.
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