4. FOB Shipping?

Let's talk about FOB. So FOB stands for free on board, and what free on board means, I don't really know. It's an old maritime shipping term, but for accounting, we've got these two things. We've got FOB shipping and FOB destination. And what FOB answers for us is at least three questions. The first is, who pays for shipping costs?

The second is, who counts it in inventory? And the third is, who has the legal title to these goods? And all of these can be summed up as, who owns it? So let's lay out a scenario where a good is purchased. So this is the seller over here, and this is the buyer over here.

A good is purchased. So the seller sells something, then they ship it, then the buyer receives it. And then the buyer sells it, uses it, whatever. The question that we're trying to answer is, who owns that good right here? Between the time it was shipped and the time that it was received, who owns it?

Well, an argument could be made that the buyer doesn't own it until they get it. Or an argument could be made that the seller doesn't have responsibility once they give it to FedEx or whoever the shipping company is.

And that is the very reason we have FOB shipping and FOB destination. So when you see it on your test, do it like this. Draw out a line, and you have the seller over here and the buyer over here. And this is a timeline because the seller owns it before the buyer owns it, obviously. And since we're talking about FOB shipping and FOB destination, we're gonna have time of shipping and time it gets to destination.

Now, I could put received over here, but I wanted to use this word destination. So FOB shipping, FOB destination. There is a point in time when the seller delivers it to the shipping company, and there is a point in time when it gets to the destination. I don't think this is super complicated yet. And this is a timeline, so this goes back to the beginning of time, and this goes forward until the heat death of the universe. So whenever you see an FOB question on your test or a quiz or wherever, this is the mental model that you need to have.

Seller, shipping, destination, buyer. And then here's what you do. So if it says FOB shipping, okay, this word is shipping. This word is shipping. This becomes the important part right here. Seller, buyer. And we just drop out this destination altogether 'cause we don't care about destination. The question is saying it's FOB shipping.

If you see FOB destination, well, then the important part is right here. Buyer, seller. And now, knowing this, there is no question that your teacher can throw at you that you won't be able to figure out. Let's try it.

So the question says, "Goods were shipped on," let's say, "December 28, FOB shipping." Doesn't matter. Making it up as we go. Uh, they were delivered on January 3, let's say. At December 31, who owns them? Well, this is now super easy because what you do is you draw out that timeline like I showed you. You put seller because the seller owns them before the buyer does, and you put buyer. You've got a shipping, and you've got a destination, and in this problem, we actually have dates for those, December 28 and January 3. And so the question is asking, somewhere in the middle here at 12/31, who owns them?

Okay, so we look back at the problem, we see the word shipping. We come down here, we know that this is the important part. And now it's no longer a question because we know that the seller is on the left side and the buyer is on the right side. And if you look, well, the buyer's line goes all the way back to December 28. So obviously, at December 31, the buyer owned it. Don't believe me? Let's do another one. Goods were shipped on December 28. Let's say, shipped December 28, FOB destination. Arrived on January 3. Same question. At December 31, who owns it?

Okay. Well, let's do another one. Draw out your timeline. The buyer is at the end of time, and the seller is at the beginning of time. We've got dates again, so we'll say 12/28 is the shipping point, and 1/3 is the arrived date, the destination point. So, as always, the question is, who owns it on December 31? And this is an important question because the real question that your teacher is asking is, who should include it in inventory? Okay, so we look up to the problem and we see destination. So we know that destination is the point that we actually care about. On the right side of that point, we have buyer, and on the left side, we have seller.

So now it's really a non-question. Well, 12/31 clearly falls on the seller's side of this important point, and so it belongs to the seller. So the seller includes it in his inventory, and the buyer does not include it in his inventory.

So ultimately, the situation is this. You've got a line with two dates on it, and FOB shipping versus FOB destination tells you which date to use. Because if you look, when you've got a line with two, say, buyer, seller, and you've got two of these, well, we know that everything to the right belongs to the buyer, everything to the left belongs to the seller, but we have no idea who this belongs to. And so FOB tells us, "Choose that point," or, "Choose that point." And that's all it is. And then we get to get rid of this confusing second line and say, "Oh, okay. Everything to the left is seller, everything to the right is buyer."

So we have these two points, and we choose the other one, and we say, "Oh, great. Now we just have one point. Everything to the left is seller, everything to the right is buyer." That's it. That's all you have to remember.