Free on Board Shipping Point vs. Free on Board Destination: An Overview
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.
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.
- Free on board (FOB) is a trade term used to indicate whether the buyer or the seller is liable for goods that are lost, damaged, or destroyed during shipment.
- Free on board shipping point indicates that the buyer takes responsibility for loss or damage the moment the goods get to the shipper.
- Free on board destination indicates that the seller retains liability for loss or damage until the goods are delivered to the buyer.
- FOB shipping point is usually paid for by the buyer, while FOB destination is usually paid for by the seller.
- FOB contracts have become more sophisticated in response to the increasing complexities of international shipping.
Free on Board (FOB) Shipping Point
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.
Free on Board (FOB) Destination
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 United States 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 either 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 between these two terms is the way in which 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.
Transfer of Ownership
Though in line with the accounting treatment mentioned above, it is 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 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 are delivered, the buyer assumes ownership.
Division of Cost
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.
FOB Shipping Options
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.
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.
Other FOB Terms
There are also a range of different FOB shipment options, including but not limited to:
- FOB shipping point, freight prepaid: The buyer assumes risk for the products being shipped once the goods are at the point of origin. However, the buyer may compensated by the seller, or the seller may incur upfront shipment costs on behalf of the buyer. Though the seller paid for shipping, risk still lands with the buyer.
- FOB shipping point, freight prepaid and charged back: The seller may pay for shipping and the buyer retains responsibility for the goods once they are at the point of origin, the seller may intend to bill the customer back for shipment payments. These costs may be added to an existing invoice or a separate invoice.
- FOB destination, freight collect: Although the buyer pays for the shipping costs, the seller still owns the goods through transit and is responsible for the goods while en route.
- FOB destination, freight collect and allowed: The "and allowed" phrase means the seller adds shipping costs to the invoice and the buyer agrees to pay that cost even if the seller coordinates and manages shipment. Even though the buyer ultimately pays for shipment, the seller is still responsible for the goods until they have been delivered.
Although FOB shipping point and FOB destination are among the most common terms, there are other agreements that vary from these two.
- Free Alongside: The seller must deliver goods via ship, meet up with a ship during transport, and the goods must be transported using lifting devices to move the goods from one ship to the other.
- Free Carrier: The seller must ship the goods via aircraft, boat, or railway where the buyer has an operation. The buyer is obligated to take delivery at one of those destinations.
- Delivered Ex Ship: The seller must deliver products to a specific shipping port. When the ship arrives, the buyer is required to take delivery upon arrival.
- Ex Works: The seller must make the goods ready for delivery but is not responsible for actually delivering the goods. The buyer is responsible for making delivery arrangements and for picking the goods up.
Incoterms define the international shipping rules that delegate responsibility of buyers and sellers. These terms are reviewed and updated once every decade.
Example of FOB Shipping
FOB Shipping Point
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 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 the the treadmills may take two weeks to arrive is irrelevant for 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 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.
Who Pays for Shipping in FOB Shipping Point?
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.
Who Retains Risk in FOB Shipping Point?
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.
Is FOB Destination Better for a 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.
Does FOB Mean Free Shipping?
FOB stands for either "free on board" or "freight on board". The term is used to designate ownership between the buyer and seller as goods are transported. FOB does not explicitly mean the transportation of goods is free.
The Bottom Line
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.