International commercial laws have been in place for decades and were established to standardize the rules and regulations surrounding the shipment and transportation of goods. Having special contracts in place has been important because international trade can be complicated and because trade laws differ between countries.
These international contracts outline provisions, including the time and place of delivery as well as the terms of payment agreed upon by the two parties. When the risk of loss shifts from the seller to the buyer and determining who foots the bill for freight and insurance, all depend on the nature of the contract. Europe
Free on board (FOB) shipping point and free on board (FOB) destination are two of several international commercial terms (Incoterms) published by the International Chamber of Commerce (ICC).
FOB shipping point and FOB destination indicate the point at which the title of goods transfers from the seller to the buyer. The distinction is important in specifying who is liable for goods lost or damaged during shipping. The primary difference between the two contracts is in the timing of the transfer of the title for the goods.
Free on board, also referred to as freight on board, only refers to shipments made via waterways, and does not apply to any goods transported by vehicle or by air.
FOB shipping point, also known as FOB origin, indicates that the title and responsibility of goods transfer from the seller to the buyer when the goods are placed on a delivery vehicle.
Since FOB shipping point transfers the title of the shipment of goods when the goods are placed at the shipping point, the legal title of those goods is transferred to the buyer. Therefore, the seller is not responsible for the goods during delivery. FOB shipping point is a further limitation or condition to FOB, as responsibility changes hands at the seller’s shipping dock.
For example, assume Company ABC in the United States buys electronic devices from its supplier in China, and the company signs a FOB shipping point agreement. If the designated carrier damages the package during delivery, Company ABC assumes full responsibility and cannot ask the supplier to reimburse the company for the losses or damages. The supplier is only responsible for bringing the electronic devices to the carrier.
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.
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.
For example, assume Company XYZ in the U.S. buys computers from a supplier in China and signs a FOB destination agreement. Assume the computers were never delivered to Company XYZ’s destination, for whatever reason. The supplier takes full responsibility for the computers and must reimburse Company XYZ or reship the computers.
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.
A primary difference between these two terms is how they are accounted for. Since the buyer assumes liability after the goods are placed on the ship for transport, the company can record an increase in its inventory at that point. Similarly, the seller records the sale at the same time.
The accounting rules change for FOB destination. In this case, the seller completes the sale in its records once the goods arrive at the receiving dock. That’s when the buyer records the increase in its inventory. In general, the accounting entries are often performed earlier for an FOB shipping point transaction than an FOB destination transaction.
Though in line with the accounting treatment mentioned above, it’s worth explicitly calling out that FOB shipping point and FOB destination transfer ownership at different times. In an FOB shipping point agreement, ownership is transferred from the seller to the buyer once goods have been delivered to the point of origin. Once at this shipping point, the buyer is the owner of the goods and is at risk during transit.
Alternatively, FOB destination places the burden of delivery on the seller. The seller maintains ownership of the goods until they are delivered. Once they’re delivered, the buyer assumes ownership.
There is also a difference in the division of costs. 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.
Once the goods are on the ship, the buyer is financially responsible for all costs associated with transport as well as customs, taxes, and other fees. For FOB destination, the seller assumes all costs and fees until the goods reach their destination. Upon entry into the port, all fees—including duties, customs, taxes, and other fees—are borne by the buyer.
The sale is recorded in the general ledger when the goods have arrived at the point of origin.
Transfer of ownership occurs when the goods have been delivered to the point of origin (the shipping point).
Costs of shipment often reside with the buyer, as they are now considered owners during transit.
The sale is recorded in the general ledger when the goods have been delivered to the buyer.
Transfer of ownership occurs when the goods have been delivered to the buyer (often the final destination).
Costs of shipment often reside with the seller, as they are considered owners during transit.
There are also a range of different FOB shipment options, including but not limited to:
Although FOB shipping point and FOB destination are among the most common terms, there are other agreements that vary from these two.
Incoterms define the international shipping rules that delegate responsibility of buyers and sellers. These terms are reviewed and updated once every decade.
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.
The fitness equipment manufacturer is responsible for ensuring the goods are delivered to the point of origin. This is the 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 that the manufacturer would record an entry for accounts receivable and reduce its inventory balance.
At the same time, even though the treadmills have not yet been delivered, the buyer has now officially taken responsibility for the goods. When at the shipping point, the buyer now has an open accounts payable balance though it also should now carry the treadmill on their financial records. The fact that the treadmills may take two weeks to arrive is irrelevant to this shipping agreement; the buyer will already possess ownership while the goods are in transit.
Imagine the same situation as above, except the terms of the agreement called for FOB destination. Instead of ownership transferring at the shipping point, the manufacturer retains ownership of the equipment until it is delivered to the buyer. Both parties do not enter the sale transaction into their general ledger until the goods have arrived to the buyer, and the seller retains the risk of the goods while they are in transit.
In FOB shipping point agreements, the seller pays all transportation costs and fees to get the goods to the port of origin. Once the goods are at the point of origin and on the transportation vessel, the buyer is financially responsible for costs to transport the goods, such as customs, taxes, and fees.
The seller is at-risk until the goods reach the shipping point. Once goods are shipped, the buyer is at-risk. If the goods are damaged in transit, the loss is the responsibility of the buyer.
FOB destination is more favorable for a buyer. The buyer is not responsible for the goods during transit; therefore, the buyer often is not responsible for paying for shipping costs. The buyer is also able to delay ownership until the goods have been delivered to them, allowing them to do an initial inspection prior to physically accepting the goods to note any damages or concerns.
FOB stands for either “free on board” or “freight on board.” The term is used to designate ownership between the buyer and the seller as goods are transported. FOB does not explicitly mean the transportation of goods is free.
When shipping goods to a customer, FOB shipping point or FOB destination may be two primary options to choose from. FOB shipping point holds the seller liable for the goods until the goods begin their transport to the customer, while FOB destination holds the seller liable for the goods until they have reached the customer.
International Chamber of Commerce. “Incoterms® 2020.”
Air Freight International Chamber of Commerce. “The Incoterms® Rules 2010.”