Freight On Board Understanding How FOB Works in Shipping

“FOB Destination” means that the transfer completes at the buyer’s store and the seller is responsible for all of the freight costs and liability during transport. The determination of who will be charged the freight costs is usually indicated in the terms of sale. If the Freight On Board is indicated as “FOB delivered,” the seller or shipper will be wholly responsible for all the costs involved in transporting the consignment.

1. If the terms include “FOB origin, freight prepaid,” the buyer assumes the responsibility for goods at the point of origin, but the seller pays the cost of shipping.
2. One distributor receives many shipments from various vendors on a daily basis.
3. In that case, the seller wouldn’t record the transaction in the ledger until the buyer pays them.
4. Upon delivery of the goods to the destination, the title for the goods transfers from the supplier to the buyer.
5. FOB suits better for bulk cargo and not containerized cargo (use FCA instead).

Matthew Hudson is the author of three books on retail sales and has nearly three decades of experience in the industry. CIF is a more expensive contract option than FOB, as it demands more effort and expense on the part of the supplier. There are situations where you may be responsible for covering costs before your goods are on board. The phrase passing the ship’s rail is no longer in use, having been dropped from the FOB Incoterm in the 2010 revision.

Assume a fitness equipment manufacturer receives an order for 20 treadmills from a newly opened gym across the country. The terms of the agreement are to deliver the goods FOB shipping point. It may be difficult to record delivery precisely when the goods have arrived at the shipping point. Due to constraints to an information system or delays in communication, it is more realistic that there is a slight timing difference between the legal arrangement and the accounting arrangement. The buyer still pays additional fees like customs clearance, however. Of the 11 different incoterms that are currently used in international freight, Free on Board (FOB) is the one that you will encounter most frequently.

Ownership of a cargo is independent of Incoterms, which relate to delivery and risk. In international trade, ownership of the cargo is defined by the contract of sale and the bill of lading or waybill. The vendor-client transaction defines the FOB terms https://accounting-services.net/ in the purchase order. The cost and risk are divided when the goods are actually on board of the vessel (this rule is new!). The term is applicable for maritime and inland waterway transport only but NOT for multi-modal sea transport in containers.

“Freight collect” refers to the legal fact that the buyer is responsible for the freight charges. Here is more detail about FOB, beginning with common transportation terms you may encounter. We will also explore steps you can take to deal with FOB issues at your business. During a site visit with a prominent shipper a high-level purchasing person called it fob (rhyming with “bob”). That highlights a need to understand how this often-misused term is defined.

Depending on the agreement with your supplier, your goods may be considered delivered at any point between the port of destination and your final delivery address. Cost, Insurance, Freight (CIF) puts the liability of payment for – you guessed it – cost, insurance, and freight on the supplier. An FOB shipping point agreement is signed and the container is handed off to the freight carrier at the shipping point. The term ‘free’ refers to the supplier’s obligation to deliver goods to a specific location, later to be transferred to a carrier. The term FOB is also used in modern domestic shipping within North America to describe the point at which a seller is no longer responsible for shipping costs. For FOB destination, the seller retains ownership of the goods and is responsible for replacing damaged or lost items until the point where the goods have reached their final destination.

Accounting Ratios

Communication may also be problematic if the buyer relies solely on people who act for the seller. The buyer may have to pay additional fees at the port, such as docking fees and customs clearance fees before the goods are cleared. Shipping terms affect the buyer’s inventory cost because inventory costs include all costs to prepare the inventory for sale. This accounting treatment is important because adding costs to inventory means the buyer does not immediately expense the costs and this delay in recognizing the cost as an expense affects net income.

Cost, Insurance, and Freight (CIF) vs. Free on Board (FOB): An Overview

Conversely, with FOB destination, the title of ownership is transferred at the buyer’s loading dock, post office box, or office building. Once the goods are delivered to the buyer’s specified location, the title of ownership of the goods transfers from the seller to the buyer. Consequently, the seller legally owns the goods and is responsible for the goods during the shipping process. A Free on Board contract is much cheaper than a cost, insurance, and freight agreement. That’s because buyers have more control over the shipping logistics, including insurance and transport costs. Buyers are able to sign with the shipper of their choice and take as much coverage as they see fit to insure their shipments.

Example of FOB Shipping

Shipping costs are reduced, but fewer buyers are willing to accept shipping point terms, especially on large or fragile orders. Under CPT, or “carriage paid to,” the seller pays for delivery of goods to a carrier or nominated location and assumes risks until the carrier takes possession. Because of this, misunderstanding FOB shipping point terms can be costly for buyers.

A late shipment, a break down, a shipping slip filled out improperly – no matter what it is—a circumstance can arise to challenge the best working dynamic in logistics. Making sure the FOB terms suit your company’s needs is a powerful way to gain a competitive advantage in your day-to-day when shipping and accepting goods. Consider your options for managing your goods during transit and purchasing cargo insurance. If your items are expensive, unique, or in a category where obtaining insurance is difficult, negotiating for FOB destination may be a better option. ICC Incoterms were last updated in 2020 but remain valid contractual terms. Free on board is one of around a dozen Incoterms, or international commercial terms.

You cut $3,000 from accounts receivable and enter $3,000 in the bad debt expense account. If you know from experience that, say, 7 percent of your accounts receivable won’t be paid, you set up an “allowance for doubtful accounts” entry in your records. Subtracting 7 percent of accounts receivable on your financial statements gives you a more realistic view of how much income to expect. In that case, the seller wouldn’t record the transaction in the ledger until the buyer pays them.

Who Pays for Shipping in FOB Shipping Point?

FOB origin, or shipping point, means that the buyer will receive the title for the goods they purchased when shipment begins. The seller’s responsibility ends when the items are placed with a shipment carrier, and the buyer must ensure their goods reach their final destination on time and undamaged. One worry for sellers shipping overseas, particularly with new customers, is whether the buyer will pay up.

Where the FOB terms of sale are indicated as “FOB Origin,” the buyer is responsible for the costs involved in transporting the goods from the seller’s warehouse to the final destination. The buyer assumes full responsibility for the goods as soon as they reach the destination port under a CIF agreement. This means that the buyer may have to assume liability for any extra costs, such as customs fees, and makes payment once it reaches the port of destination. The transport carrier turns the transfer documentation for the goods over to the buyer upon payment.

Instead of ownership transferring at the shipping point, the manufacturer retains ownership of the equipment until it is delivered to the buyer. Both parties to not enter the sale transaction into their general ledger until the goods have arrived to the buyer, and the seller retains risk of the goods while they are in transit. The fitness equipment manufacturer is responsible for ensuring the goods are delivered to the point of origin. This is the fob meaning point of primary transportation in which the buyer will now assume responsibility for the treadmills. The equipment manufacturer would not record a sale until delivery to the shipping point; it is at this point the manufacturer would record an entry for accounts receivable and reduce its inventory balance. When it comes to the FOB shipping point option, the seller assumes the transport costs and fees until the goods reach the port of origin.