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Free On Board (FOB)



Definition

Free On Board (FOB) is a term used in international trade to specify at which point the seller’s responsibilities, including cost and risk of transport, are transferred to the buyer. Under FOB shipping terms, the seller is responsible for all costs and risks up until the goods are loaded on board the shipping vessel. From that point on, the buyer assumes all responsibility for the goods.

Phonetic

The phonetics of the keyword: Free On Board (FOB) is /friː ɑn bɔːrd/.

Key Takeaways

  1. Definition: Free On Board (FOB) is a shipping term used in international trade, indicating who is responsible for the shipment of goods at what point during the delivery process. The party designated as FOB is responsible for the costs and risks associated with the transportation.
  2. Two Types: There are two types of FOB – FOB destination and FOB shipping point. In FOB destination, the seller retains the responsibility and costs of transportation until the goods reach the buyer’s location. On the other hand, with FOB shipping point, the buyer takes on the responsibility and costs of shipping when the goods leave the seller’s premises.
  3. Risk and Ownership Transfer: FOB also determines when the ownership and risk of the goods transfers from the seller to the buyer. For FOB destination, ownership transfers when the goods are received by the buyer, and for FOB shipping point, ownership transfers when the goods are shipped by the seller.

Importance

The business/finance term Free On Board (FOB) is important because it is a crucial part of trade agreements and contracts, identifying the point at which the costs and risks associated with shipping goods shift from the seller to the buyer. By stipulating that goods are FOB, the seller is responsible for the condition, cost, and delivery of goods to a specific location, usually a shipping port. After the goods are ‘free on board’ , liability and costs transfer to the buyer, who is responsible for insurance, transportation, and risks of damage or loss. Underscoring the terms and conditions of shipping transactions, FOB also affects the accounting of such transactions, helping to avoid disputes around the timing of revenue or expense recognition. Thus, FOB plays a vital role in international trade, logistics, accounting, and risk management.

Explanation

The primary purpose of Free on Board (FOB), a term used in international trade, is to set clear guidelines for the division of shipping obligations, costs, and risk between the seller and buyer of goods. The term identifies when the responsibility and risk of goods is transferred from the sellers to the buyers. This is an essential component of international trade as it prevents disagreements between the two parties involved regarding who is responsible for paying the costs associated with shipping, transportation, insurance, and other related expenses.FOB is frequently used in contracts for the sale and purchase of tangible goods to determine when the risk of loss shifts from the seller to the buyer. For example, if a contract stipulates “FOB destination,” it means the seller retains risk and costs until the goods are received at the buyer’s location. Conversely, “FOB shipping point” or “FOB origin” indicates that the buyer takes over risk and costs of transportation as soon as the goods leave the seller’s location. Therefore, FOB plays a critical role in establishing a transparent and fair allocation of costs and risks between the seller and the buyer in global trade transactions.

Examples

1. Electronics Manufacturing: Assume a U.S. electronics company orders parts from a Japanese company, and the agreed terms are FOB at the Japanese company’s warehouse. This means the responsibility and risk of transporting these goods across international lines falls on the U.S. company once they leave the Japanese warehouse. From loading the goods onto a truck, ensuring they safely arrive at the port, get loaded onto a ship and finally make it to the U.S., all liability lies with the buyer.2. Wine Importing: Let’s take a wine retailer in New York importing wines from a vineyard in France with FOB terms from the French vineyard. It simply means the French vineyard would cover the costs of transportation of the wine to the nearest port, including all the legalities and paper work within France. Once the wine reaches the port and is loaded on the ship, the New York retailer takes up the costs from there.3. Raw Materials for Furniture: A furniture manufacturer in Canada buys lumber from a US supplier. If the agreed upon terms are FOB at the supplier’s sawmill, once the lumber is loaded onto the shipping vehicle at the sawmill, the Canadian manufacturer takes on the responsibility. It must be ensured the goods arrive safely at their factory including dealing with the customs at the Canada-US border. If any damage occurs during transit or there are issues at customs, the Canadian company bears that risk.

Frequently Asked Questions(FAQ)

What does Free On Board (FOB) mean in finance and business terms?

Free On Board (FOB) is a trade term that indicates whether the seller or the buyer is liable for goods that are damaged or destroyed during shipping. If an item is shipped FOB, the seller retains responsibility of the goods until it reaches its destination.

Who is responsible for the shipping and handling costs in Free On Board (FOB)?

In FOB shipping, the seller is responsible for costs associated with transporting the goods to the port of shipment. However, once the goods are ‘free on board’ , the buyer is responsible for all costs thereafter.

Can risks associated with FOB be mitigated?

Yes, risks can be mitigated through the use of shipping insurance. Buyers can opt to purchase this insurance to protect against loss or damage during transport.

What is the difference between FOB destination and FOB shipping point?

When a shipment is designated FOB destination, the seller retains ownership and liability of the goods until they reach the buyer’s location. FOB shipping point implies that ownership and liability transfer to the buyer when the goods leave the seller’s premises.

Where is FOB typically used?

FOB terms are most commonly used with larger physical shipments that are transported by sea or inland waterways. It can also apply to shipments transported by air or road.

How is FOB related to Incoterms?

Free On Board (FOB) is part of the International Commercial Terms (Incoterms), a set of pre-defined commercial terms established by the International Chamber of Commerce (ICC) to clarify terms of delivery of goods between buyer and seller.

Does FOB always favor the seller?

No, FOB does not always favor the seller. In an FOB shipping point agreement, risk transfers to the buyer as soon as the shipment leaves the seller’s location. Meanwhile, in FOB destination, the seller carries the risk until delivery is accomplished.

What is the relevance of FOB in accounting?

FOB not only determines who pays for transportation and insurance costs, but also the point at which ownership of goods is transferred. This is critical for accounting purposes as it affects when a business can record a sale or purchase in their books.

Related Finance Terms

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