When a shipment ships FOB destination the seller pays the freight and debits?

In accounting, FOB destination means the seller is responsible for the goods until they arrive at the customer’s destination. In this case, the journal entry for FOB destination on the seller’s side will include the delivery cost or freight out that is charged to the income statement as an expense for the period.

Free On Board or FOB destination is a freight term used in shipping. This FOB destination term determines the seller to still has responsibility for goods being shipped until they reach the customer’s destination.

In other words, the point of transfer is when the goods arrive at the customer’s destination. Additionally, the seller also has the responsibility to pay for the delivery cost.

That is why in the journal entry for FOB destination, there will be a freight out account (or delivery expense account) on the seller’s side which represents the delivery expense that the seller needs to pay for delivering goods to the customer. On the other hand, the buyer will just record the purchase transaction as the shipping cost is not their responsibility.

Journal entry for FOB destination

FOB destination on seller’s side

On the seller’s side, we can make the journal entry for FOB destination by debiting the accounts receivable or cash account and crediting the sales revenue account together with the debit of the freight out account and the credit of the accounts payable or cash account.

In this journal entry, the freight out account is an expense account that is charged to the income statement during the period.

The freight out account is usually recorded under the delivery expense on the income statement. That is why some companies may record this transaction in the delivery expense account.

FOB destination on buyer’s side

On the buyer’s side, the journal entry will be the debit of the purchases account and credit of the accounts payable or the cash account since the buyer is not responsible for the delivery cost in the term of the FOB destination.

In this journal entry, the purchases account is a temporary account that will be cleared at the end of the period when we calculate the cost of goods sold.  Likewise, we record this to the purchases account only when the buyer uses the periodic inventory system.

If the buyer uses the perpetual inventory system, the journal entry will be the debit of the inventory account and the credit of the accounts payable or cash account as below instead:

The difference in the perpetual inventory system here is that the balance of the inventory needs to be updated perpetually. Likewise, the debit of the inventory in the this journal entry represents the increase of the inventory balance when the buyer receives the goods from the seller.

On the other hand, the inventory balance in the periodic inventory system only needs to be updated periodically. That is usually at the end of the accounting period when we need to calculate the cost of goods sold in order to conclude the net income on the income statement.

FOB destination example

For example, on June 1, there is a $5,000 credit sale of goods in which the freight terms are stated as the FOB destination on the sale invoice. And there is a delivery cost of $150 that has not been paid yet. (Assuming both seller and buyer use the periodic inventory system.)

What is the journal entry for the FOB destination of the above transactions?

• On the seller’s side and
• On the buyer’s side

Solution:

FOB destination on seller’s side

As the freight term is FOB destination, the seller will have the responsibility to pay for the $150 of the delivery cost. In this case, we can make the journal entry for the FOB shipping point on the seller and buyer’s side as below instead:

FOB Shipping Point or ‘Free on Board Shipping Point’ or ‘FOB Origin’ is a shipping term indicating that a buyer must pay for the delivery of the goods. This means that the title of the goods passes to the buyer as soon as the shipment leaves the seller’s warehouse (or shipping dock). It also means that the seller should record the sale when the goods leave the warehouse.

Here, the buyer owns the goods en route to its warehouse and thus, must bear the delivery charges. So, if the goods get damaged in transit, the buyer must file a claim with the insurance company.

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If you are not familiar with what FOB is, you can read our exclusive post on Free on Board.

Explanation with Example

Let us understand FOB Shipping Point with the help of an example. Suppose Company A (seller) and Company B (buyer) agree on FOB Shipping Point. Company A puts the goods onto a common carrier on December 30, and the same arrives at the buyer’s location on January 2.

In this case, both seller and buyer record the transaction in their accounts on December 30. The seller will record the sale, increase accounts receivable and reduce the inventory. On the other hand, the buyer will record the purchase, increase the account payable, and increase the inventory as well.

Journal Entry

On December 30, the journal entry in the books of the seller will be accounts receivable debit and sales credit. For the buyer, the journal entry will be purchase debit, freight debit and accounts payable, and cash credit.

Reality is Different

In FOB Shipping Point buyer must record the purchase as soon as the goods leave the seller’s warehouse (or shipping dock). In practice, however, it is difficult for the buyer to record the delivery when the goods leave the seller’s warehouse. It requires proper notifications to enter the buyer’s inventory management system. Thus, the receipt of goods completes at the receiving dock of the buyer.

This suggests that there is a difference between what the term implies and its actual accounting implementation.

FOB Shipping Point vs. FOB Destination

In FOB Shipping Point, the ownership transfers when the shipment leaves the seller’s warehouse (or shipping dock). Under FOB Destination, the title of the goods transfers at the buyer’s loading dock or warehouse. Or, the title of the goods transfers once the goods reach the buyer’s specified location. The seller remains the owner of the goods and is also responsible for the goods during the transit.

There is a difference in accounting as well. In FOB Shipping Point, both seller and buyer record the delivery once the shipment leaves the seller’s warehouse (or shipping dock). In FOB Destination, the seller and buyer record the sale (and purchase) only after the shipment reaches the buyer’s dock.

Another difference is in the division of costs. Under the FOB shipping point, the seller bears the cost until the shipment reaches the supplier’s shipping dock. Once the goods are on the ship, the buyer is responsible for all the expenses, including customs, taxes, and other fees. Under FOB Destination, the seller is responsible for all costs until goods reach their destination port. After the entry into the port, all expenses are borne by the buyer.

FOB Shipping Point or FOB Destination – Which is Better?

Buyers must insist on FOB shipping point terms as it gives them complete control over the delivery of goods after they leave the seller’s warehouse (or shipping dock).

On the other hand, FOB Destination allows the buyer to add the inventory only when the purchase shipment reaches perfect condition. So, it is good from an accounting perspective. Also, under FOB Destination, the buyer has to take care of fewer things.

Other Shipping Terms

Though FOB is the most common term in the shipping world, there are other important and must-know terms as well;

FAS

FAS or Free Alongside means the seller must deliver the shipment to a ship that is close to a certain ship, which can then use its lifting devices to bring the goods onboard.

FCA

FCA or Free Carrier means it is the seller’s responsibility to deliver the shipment at the port or airport, or railway terminal where the buyer has an operation.

DES

Under DES or Delivered Ex Ship, the seller has to deliver the shipment to a specific shipping port, where the buyer would take the delivery.

EXW

Under EXW or Ex Works, the seller only has to keep the shipment ready. The buyer makes arrangements for the shipment and also picks up the goods from the seller’s warehouse.

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