FOB is a shortened contractual delivery term for “free on board”, which is based on the orders made by the buyers. It brings to notice the “sale on delivery” buying procedure.
The company that buys the goods makes the order to the seller company, and in this scenario, the FOB brings to notice the fact that the buyer company takes the goods that the seller company delivers after the goods leave their company warehouse or store. The goods’ ownership is now transfered at the point where the goods leave the point of storage in the premises of the supplier. If the goods get damaged, the company they buys the product is responsible for incurring the cost of damages. This is because the owner of goods has been transferred to the buying company. The main question after that is when does a company record its sales under the FOB policy? The accounting principle applied by the selling company is to record sales at the point the goods are dispatched to the customer or buyer premises. The buyer on the other hand records increases in its stock.
A factor to consider is whether the FOB is ethical or not. As far as the accounting principles and concepts are concerned, the FOB is unethical. It fails to exercise and recognize the accruals accounting concept. The concept holds that revenues are recognized when it is received and not when it is earned while accruals are recognized when incurred and not when payments are made (Mostyn, 2007). The selling company, in this case, recognize sales revenue when it is earned and not when it is received. This is revealed when the supplier company ascertains profits before they ship the goods and even forwarded the delivery date. This is very unproductive and irrelevant when buyers default on payments. It can make the company count on losses instead of profits (Weygandt, Kimmel & Kieso, 2014). The FOB policy is again unethical in the sense that once the goods are dispatched to the buyer premises, it is the buyer who is responsible for any risk of losses and damages that may arise in the process of delivery. The buying company causes the risk thus an ethical supplier should share either the cost of damages or the cost to mitigate the risk of damages. They should as well be responsible for the whole cost of damages on the goods as this may act as an after sales service to entice the buyers to maintain a consistent purchase.
The policy is not ethical to the buyer especially if the buyer operates its activities on an annual basis. The supplier company is too strict to make delivery after one week irrespective of the accounting policies applied by the buyer. In cases when the buyer experiences low inventory level, at year end and may wish to increase their stock promptly, they are likely to suffer delays when supply shifts are made. The FOB may also encourage delivery of low-quality goods since it seems to promote the principle of you to let the “buyer beware.” It is the buyer to ascertain the conditions of the goods and not necessarily the supplier. The supplier may even supply goods that have expired, damaged and of low quality and lay blames on the freight owners since the goods are as well unwarranted.
Mostyn, G. (2007). Basic accounting concepts, principles and procedures. Milpitas, CA: Worthy & James Pub.
Weygandt, J., Kimmel, P., & Kieso, D. (2014). Accounting principles. Hoboken, N.J: John Wiley & Sons.