Free on Board – FOB 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 have been important since 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 who foots the bill for freight and insurance all depends on the nature of the contract.
Free on board (FOB) shipping point and free on board 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.
An update to the ICC's Incoterms is due in 2020.
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.
According to the U.S. Department of Transportation's Bureau of Transportation Statistics (BTS), 884 million tons of product moved by water in 2015. Of this total, 95 million tons were export goods, 246 million tons were imported goods, and the remaining 544 million tons were moved by water within the United States. BTS projects the amount of cargo transport will increase each year at around 1.4% until 2045.
Free on Board – FOB Shipping Point
FOB shipping point, also known as FOR 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.
The ICC was established in 1919.
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.
Another key difference between these two terms is the way in which they are accounted. 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. If there is any damage or loss of goods during transport, the buyer may file a claim since the company holds title during delivery.
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.
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 customs, taxes and other fees—are borne by the buyer.
- Free on Board 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 contracts have become more sophisticated in response to the increasing complexities of international shipping.