FOB also determines when a business will record a sale for accounting purposes. If a shipment is designated as FOB Shipping Point, the sale will be recorded in the accounting system as soon as the shipment leaves the seller’s dock. At the same time, the buyer will record in its accounting system that inventory is on route. That inventory then becomes an asset eight processes of accounting in the buyer’s accounting books even though the shipment hasn’t yet arrived. FOB is an acronym for Free on Board, and indicates whether the supplier or the customer will pay shipping expenses. Also, the type of FOB shows which party takes legal responsibility for the goods being shipped, and at what point during transport that responsibility is transferred.
They can include the physical handling and loading of the goods, the cost of transporting them to the vessel, shipping and insurance. If the shipment is FOB Destination, the buyer can credit them to inventory costs, then to cost of goods sold when he disposes of them. FOB Shipping Point means that the seller transfers ownership of the goods sold at the point of origin, when the items leave the seller’s warehouse. Under FOB Shipping Point, the seller would record the sale as soon as the goods leave the seller’s premises. The buyer then owns the products as soon as they leave the warehouse and therefore must pay any delivery and customs fees.
What Is EXW or FOB Unit Prices?
Unlike EXW, when a buyer and a seller enter a Free on Board (FOB) trade agreement, the seller is obligated to deliver the goods to a destination for transfer to a carrier designated by the buyer. The location designation in the FOB trade agreement is the point at which ownership is transferred from the seller to the buyer. The buyer owns the product en route to its warehouse and must pay any delivery charges. FOB is only used in non-containerized sea freight or inland waterway transport. As with all Incoterms, FOB does not define the point at which ownership of the goods is transferred.
- FOB, or Free on Board, instead shifts the responsibility of the goods to the buyer as soon as they are loaded onboard the ship.
- There are two types of FOB, which are FOB destination and FOB shipping point.
- The income statement shows whether your business is profitable; the cash flow statement shows whether you have enough cash on hand to pay employees and creditors.
Say the buyer defaulted on a $3,000 toy shipment after you entered it in your ledgers. 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. If you’re shipping items internationally, it’s essential to understand the terms and conditions of FOB. What’s even more important, you must record your shipping costs correctly.
FOB accounting deals with the treatment of freight charges and how they are recorded in the accounting system. FOB shipping point might let us find rates cheaper than our printer charged. We were a small shop in Texas, however, so we weren’t in Southern California to deal with U.S. customs and had no expertise in that area. The two major FOB types are FOB shipping point and FOB destination, which we’ll discuss in depth below. In the wake of the COVID-19 pandemic and escalating tensions with China, American companies are actively seeking alternatives to mitigate their supply chain risks and reduce dependence on Chinese manufacturing. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before.
Indicating “FOB port” means that the seller pays for transportation of the goods to the port of shipment, plus loading costs. The buyer pays the cost of marine freight transport, insurance, unloading, and transportation from the arrival port to the final destination. The passing of risks occurs when the goods are loaded on board at the port of shipment. Responsibility for the goods is with the seller until the goods are loaded on board the ship. Since the buyer takes ownership at the point of departure from the supplier’s shipping dock, the supplier should record a sale at that point.
Freight on Board Destination
They need to update the records even if they are yet to receive the shipment. A variation on FOB shipping point is were the seller for convenience prepays the shipping cost and recovers this from the buyer at a later date. For example, if you’re importing high-value items like electronics or jewelry, DDP may not be an ideal option because it can leave you with large customs duties to pay when you cross borders. The FOB destination is often used in international sales contracts but can also be used to be more specific about when or where the seller must deliver. Sure, you want to keep costs low by making your own shipping arrangements, but can you afford the liability if something goes wrong?
Besides, they also need to pay for the shipping costs and insurance charges. As we already have seen with FOB, sellers do not assume much responsibility unless it is the FOB destination. Even when sellers pay for the shipment charges, they can get reimbursed by buyers based on mutual agreement. The shipment ownership from the buyer to the seller gets transferred at different times at the FOB shipping point and FOB destination. FOB shipping point involves ownership transfer when the seller delivers the goods at the origin point. Buyers need to assume responsibility for the shipment from this point and need to bear risks during the transportation.
Accounting and auditing
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. In this case, the seller completes the sale in its records once the goods arrive at the receiving dock.
These traders have their own forwarding agents and logistic agents in place at the port where the buyer loads the goods to be imported. In FOB trading, the seller is only responsible for taking the goods to the nearest port on his or her end. This location is indicated after FOB, and it is important to accountants, as goods become assets to the buyer on the day they reach that location. The buyer is therefore responsible for paying the ship’s freight and insurance.
A letter of credit from the buyer’s bank can also protect the seller from cheating buyers. It’s not unusual for the sale contract to treat the sale differently from the ledger. FOB in accounting says the buyer in an FOB Shipping Point transaction takes ownership at the supplier’s dock. Actually entering the goods into inventory away from the buyer’s home base is difficult, so the contract may say the buyer receives and takes possession of the goods at the destination point. Usually the name of the actual port – Miami, Los Angeles, New York, Savannah – replaces “destination” or “shipping point” on the labels.
Meaning of FOB
If the same seller issued a price quote of “$5000 FOB Miami”, then the seller would cover shipping to the buyer’s location. To see our product designed specifically for your country, please visit the United States site. An Intelligent Document Processing (IDP) platform like VisionERA can help you automate the processing of FOB shipping documents.
- For FOB origin, after the goods are placed with a carrier for transport, the company records an increase in its inventory and the seller records the sale at the same time.
- Similarly, the buyer needs to update their inventory and make a note of the incoming shipment.
- The Smart Rules engine may help you to calculate VAT for your sales based on the shipping address country or region.
- The term is used to designate ownership between the buyer and seller as goods are transported.
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. In accrual accounting, you report income and expenses at the moment you earn money or incur a debt. In FOB Destination transactions, the sale takes place when the receiving dock accepts the goods even if the buyer won’t pay for the shipment for another 30 days. The buyer still records the inventory purchase and notes the money owed in accounts payable. When they settle the bill, they erase the amount in accounts payable and reduce the amount in their cash account. Whichever party pays for shipping will have to enter those costs in the ledger too.
Free on Board (FOB) Explained: Who’s Liable for What in Shipping?
The most significant advantage of selecting FOB is that the buyer can negotiate for freight services and get the best price. Sellers hold all the responsibility for goods till the time they reach the point of origin. With an automated system, the work can be done more quickly and accurately. It helps lower costs by reducing delays in delivery times, which means customers will receive their shipments faster than they would otherwise. The seller holds a complete charge over the shipment when it is in transit and needs to ensure its safe delivery.
In general, the accounting entries are often performed earlier for an FOB shipping point transaction than an FOB destination transaction. 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.
As the goods were sold FOB shipping point, the seller does not have to pay the freight cost. However, in this case the seller has prepaid the shipping cost on behalf of the buyer and is now owed 5,600. As the goods were sold FOB shipping point, the seller does not have to pay the freight cost and is now owed the 5,000 for the goods. As an example of FOB shipping point accounting, suppose the value of the goods is again 5,000 and the freight expense from the shipping point of 600 is paid in cash by the buyer. As an example of FOB destination accounting, suppose the value of the goods is 5,000 and the freight expense to the buyers destination of 600 is paid in cash by the seller. For new importers, going CIF or FOB Destination often makes excellent sense.
The buyer has to pay for the goods to be transported from the shipping point. As the shipping costs have already been paid, the amount is owed to the seller. Since the customer takes ownership of the goods at its own receiving dock, that is also where the supplier should record a sale. The accounting treatment of the FOB shipping point is important since adding costs to inventory means the buyer doesn’t immediately recognize an expense. This delay in recognizing the expense and changes in the buyer’s inventory affects the net income.