Free on board (FOB), sometimes known as "freight on board," is a common agreement for international shipping. It indicates the point when the costs and risks of shipping shifts from the seller to the buyer. FOB shipping point (aka FOB origin) means that the title and responsibility of goods transfer from the seller to the buyer at the point of shipping. FOB destination means that the title and responsibility are transferred at the final shipping destination.
The difference between the two designations can be a big deal for businesses because it indicates which party is responsible for the costs if a shipment is lost, stolen, or damaged. There are also FOB accounting implications for a company.
In this guide, we’ll walk you through the ins and outs of FOB accounting and what it might mean for your business.
The History of FOB Shipping
The term "FOB" goes back to the time of sailing ships when freight was "passed over the rail by hand." Once the goods were over the ship’s rail, they shifted from the owner’s to the buyer’s responsibility. If the goods fell overboard at that point or were damaged, they became the buyer’s loss, not the seller’s.
In modern terms, if a seller of widgets in Thailand signs an FOB shipping point agreement with a United States-based retail chain, it’s the retailer who would need insurance and be liable if the shipment was lost or damaged.
FOB shipping point terms and FOB destination terms are two of several international commercial terms ("Incoterms") published by the International Chamber of Commerce (ICC). FOB shipping usually refers to goods shipped by waterways, although uses of the term can vary from country to country.
Sometimes, "shipping point" and "destination" can be replaced by a place name in a contract. So, if goods are shipping from New York to Miami, and the invoice says "FOB New York," that means the buyer in Miami has ownership of the goods when they leave New York. But if the invoice says "FOB Miami," the responsibility stays with the seller until they arrive at their destination.
Why Is FOB Important to Small Business Accounting?
As far as FOB accounting for small businesses, the designation matters because it determines when a sale is recorded, and it also dictates shipping terms. So, with an FOB shipping point agreement for $50,000 worth of goods, the seller would put $50,000 in their accounts receivable when the goods were shipped and deduct $50,000 from their inventory. The buyer would be in the opposite position. As the goods shipped from the seller, the buyer would have to add $50,000 to their inventory and $50,000 to their accounts payable. So, the inventory would be an asset in their books even though the goods hadn’t arrived yet.
Whether the buyer or seller pays for shipping, they will also have to enter those transportation costs in their account ledger. These freight costs can include the labor needed to handle and load the goods at the shipping dock, the cost of transporting them to the vessel, shipping, and insurance.
With an accrual accounting system, income and expenses are reported as soon as cash is earned or debt is incurred. So, an FOB transaction could muddy your financial picture as you make a quarterly financial statement. In the case of the FOB shipping point, the seller would record $50,000 as coming in, even though they haven’t been paid yet. But their cash flow statement would record the income when it comes in. So, there’s a disparity in the amount of money you’ve recorded as having and how much cash is actually there.
It’s possible to turn into a cash-only business model, only recording the transaction in the ledger when the buyer pays. But this makes it harder to judge your true profitability since you don’t have a clear picture of how much money you owe, how much money you anticipate coming in, the number of sales that have closed, and other essential data.
How Do I Record FOB Shipping Point?
In looking at the scenario above, the seller of the $50,000 worth of goods would have to invoice the seller for this amount. They can expedite this process and maintain a professional look with Skynova’s invoice template. The template allows for easy customization, including adding a logo, adding a point of origin or a specific address for the seller’s warehouse, and the address for the receiving dock.
Then, you would simply fill out the form fields, including:
- Your name and address
- The buyer’s name and address
- The invoice number
- The invoice date
- The due date
- The item/description/unit price/quantity/amount
The invoice automatically does the math, including the subtotal, total, and amount due (you can also specify if some part of the amount has already been paid). There is also a field where you can include notes, such as shipping instructions and dates.
The invoice can be sent directly from the Skynova platform (notifying you when it’s opened by the buyer).
With accounting and FOB shipping arrangements, other options may need to be considered. The freight could be prepaid by the seller or paid collect by the buyer. Or under "freight collect and allowed," the buyer would pay for the shipping but deduct the cost from the seller’s payment.
How to Factor in Inventory Costs
FOB shipping costs are important to a buyer because they affect their inventory costs. These include all the costs to prepare inventory for sale. For example, if the goods shipped from New York to Miami were under an FOB shipping destination contract, the buyer would have to pay the, say, $100,000 price for the cost of goods sold upfront, plus insurance costs against loss or damage.
Other costs related to inventory would also have to be included, such as:
- Renting a warehouse for the goods
- Paying for warehouse utilities
- Hiring labor to unload the goods
Adding costs to the inventory means that the buyer doesn’t expense the costs right away, and this delay affects net income.
What’s the Difference Between FOB Shipping Point and FOB Destination?
With an FOB shipping point (or FOB origin), the sale of the goods is made as soon as the seller ships them out. In essence, this means the sale is finalized the moment the shipping carrier takes the goods away. So, the buyer pays for the goods before they are received and usually bears the cost of shipping and liabilities of transportations, including loss, damage, or theft.
With FOB destination, the sale of goods is finalized once they arrive at the buyer’s destination. In this case, the seller may take care of the shipping costs and be responsible for any transportation liabilities. When the goods reach the buyer’s location, the title of ownership is shifted from the seller to the buyer.
The main differences between FOB shipping point and FOB destination include:
- FOB accounting regulations: With an FOB shipping point, the buyer records the purchase at the point of sale, increasing their inventory. On the other hand, the seller records the sale at the time of shipment and within their accounts receivable.
- Shipping costs: With FOB destination, the seller usually assumes any shipping costs until the goods arrive at the buyer’s destination. With FOB shipping point, the buyer is usually responsible for the full cost of shipment, including any additional insurance or liability costs, since they are legally in full ownership of the goods the moment they are picked up by the shipping carrier.
- Transfer of title: With FOB shipping point, the seller transfers the title of ownership to the buyer when the goods are shipped from the seller’s location. Under an FOB destination sales contract, the buyer does not receive the title of ownership until the goods reach the buyer’s location.
What Is the Difference Between CIF and FOB?
Cost in freight (CIF) and free on board (FOB) are international shipping agreements used when shipping goods between a seller and a buyer. CIF is an expense paid by the seller to cover the freight costs, insurance, and shipping of a buyer’s order while being transported to the buyer’s destination.
CIF tends to be more expensive for buyers than FOB. Many times, sellers will invoice buyers for the cost of shipping and insurance, adding extra fees to increase their profit. Even so, buyers sometimes prefer CIF contracts because of the convenience of not dealing with any risks, claims, or freight issues while the goods are transported.
On the flip side, FOB arrangements tend to be more cost-effective for buyers and give them more control over the timing and price of shipments. Sellers like FOB shipping point arrangements because they relieve them of the responsibility of the cost and liability of shipping goods.
Create a Customized Invoice With Skynova’s Sales Invoice Template
Anyone who ships goods or provides services can benefit from using Skynova’s invoice template. The free, easy-to-use template enables you to quickly create sales invoices, giving you more time to spend on crucial aspects of running and growing your business.
In fact, we cover many crucial software needs of running a small business, including handy templates for estimates, quotes, bids, purchase orders, deposit requests, business proposals, balance sheets, and much more. Skynova also has software products to help ease tasks, such as accounting, creating worker orders, producing credit notes, and requesting retainers.
Use Skynova’s proven software solutions for small business and free templates to simplify and expedite the process of earning customers’ business and getting paid.
