What is freight on board (FOB)?
Freight on Board (FOB) is an international commercial term (Incoterm®) indicating the point where costs of shipping and liability of goods transfers from the seller to the buyer. The term, which was defined as part of the International Chamber of Commerce’s (ICC), is the most common agreement when shipping internationally.
The FOB, also known as “Free on Board,” is used when referring to shipments made via the sea or waterways and is determined in the terms of the sale contract or purchase order of a freight shipment. A FOB only defines the responsibility of the shipping and costs and not the owner of the goods en route. Ownership is always defined by the bill of lading.
Does FOB only refer to maritime shipping?
Freight on Board was originally used as a term to describe the shipment of goods transported by sea, as maritime shipping was always the main method of transporting cargo internationally. FOB has evolved to include all modes of shipping transport, including air and land. However, Free on Board is specific to shipping over the sea.
Who pays for the freight cost in a FOB?
Usually, in Free on Board shipping, the seller is responsible for the goods and transport costs until their delivery to the shipping ports. Subsequently, the buyer takes responsibility from the port until the goods’ final destination. However, depending on the terms outlined in the sale contract, there can be two types of FOBs that affect the seller and buyer differently, with the primary difference between the two types being the point of transfer.
What is the difference between FOB shipping and FOB destination?
The two types of FOB shipping are termed FOB Shipping Point and FOB Destination. At the time of sale negotiations, a sales contract is brought forth outlining all the details of the shipping sale and determines if a FOB Shipping Point or FOB Destination will be used during a shipping agreement.
Free on Board Shipping Point
Also called the FOB Origin, the FOB shipping point is used when the title of the goods and shipping costs are legally assumed by the buyer from the origin pick-up location, or the shipping point, at the start of cargo loading and the bill of lading (BOL), is signed. The seller bears no responsibility for the goods during delivery and any damages, loss, or theft is handled by the buyer. Fuel charges, insurance, customs tax, and all other shipping fees are also under the buyer’s financial responsibility.
Free on Board Destination
A FOB Destination, also known as FOB Delivered, is when the transfer of title of the goods between seller and buyer occurs at the buyer’s loading dock, and the seller is therefore responsible for the costs and liability of the freight during the shipping process. If goods do not reach the buyer or are damaged upon arrival, it is the seller’s responsibility and the buyer is entitled to reimbursement or a reshipment from the seller. All costs included in a shipment, including insurance and custom taxare accounted for by the seller in a FOB Destination.
What risks are involved for FOB Shipping Point vs FOB Destination?
The differences between a FOB Shipping Point and FOB destination could have specific impacts on shipping risks and therefore, companies should take caution when entering a FOB agreement, ensuring they have as much understanding as they need to mitigate counterparty risk.
FOB determines recorded inventory costs
Businesses record their inventory costs as a liability or shareholder equity until the inventory is sold, whereupon it becomes reported as the cost of goods sold. The cost of goods sold is one of the largest expenses on a company’s balance sheet, therefore choosing a FOB Shipping Point vs FOB Destination has specific implications on inventory costs.
FOB Shipping Inventory Costs
Since the buyer assumes liability as soon freight is on board or loaded onto a carrier ship, the buyer can record an increase in its inventory at that moment. All costs thereafter go into preparing the inventory for sale, which means that the buyer doesn’t immediately need to expense the costs. This delay in paying costs affects a company’s net income during a shipping cycle.
FOB Destination Inventory Costs
In a FOB Destination contract, the seller completes the sale only when goods arrive at a buyer’s dock. At this point, the freight is all prepaid by the seller. A company buying goods can only record an increase in its inventory costs at the time of delivery.
FOB determines when goods become an asset
The terms of the FOB can establish when goods become a company’s asset on its balance sheet. This can become acutely relevant if a shipping contract occurs close to the end of an accounting period, like the end of a fiscal year or yearly quarter. Only inventory within a company’s FOB responsibility is included in a company’s financial statements. Companies could use a FOB shipping point or a FOB destination contract depending on the FOB’s favorability or not for their yearly reported revenue and tax implications. The timing of the transfer of title of goods can also affect insurance costs, therefore assessing the risks of a FOB are critical in shipping negotiations and sale contract.
Concerns of FOB
While upholding ICC’s international standards, every country has its own FOB regulations and documentation slightly differing from other nations. Researchers have criticized these variations of FOB procedures as complex and the cause for misunderstandings in a FOB agreement between international partners. This can be quite critical in maritime shipping, where lengthy shipping periods, port regulations, and many players are involved in one shipping sale contract. Therefore, companies should carefully choose the best FOB for them and clarify the type of FOB used so the risks and liabilities are concise for a smooth shipment process.
