Advantages & Disadvantages of Incoterms

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In a contract for the sale and transportation of goods, a buyer’s responsibilities begin at the point where the seller’s responsibilities end. Such responsibilities include the payment of freight costs, insurance charges, taxes and duties. Provisions of a sales contract may require a seller to transfer these responsibilities at the point of sale, source port, destination port or buyer’s premises. However, since company- or country-specific sales contracts are susceptible to misinterpretations, International Commercial Terms, or Incoterms, were introduced to provide standard references for buyers’ and sellers’ freight, insurance and tax responsibilities in cargo transportation.

Basic Facts of Incoterms

Incoterms are formulated, revised and classified by the International Chamber of Commerce. In 2010, the ICC released 11 Incoterms that included Carriage and Insurance Paid to, Carriage Paid to, Cost and Freight, Cost Insurance and Freight, Delivered at Place, Delivered Duty Paid, Delivered at Terminal, Ex Works, Free Alongside Ship, Free Carrier and Free on Board. These Incoterms are abbreviated as CIP, CPT, CFR, CIF, DAP, DDP, DAT, EXW, FAS, FCA and FOB, respectively. However, some of the Incoterms -- that is, CFR, CIF, FAS and FOB -- are strictly used in sea and inland water transportation, while the rest are used across the board.

Meanings of Incoterms

Each of the Incoterms issues specific instructions for departure, payment of costs or delivery of goods. These instructions are classified into four groups of Incoterms -- that is, groups C, D, E and F -- that are identifiable to their first letter alphabets. Group C Incoterms are CIF, CIP, CFR and CPT. They allocate sellers the responsibility of contracting and paying minimum transportation costs, with buyers assuming any extra charges and risks. Sellers assume full costs of freight and insurance under group D Incoterms -- that is, DAP DDP and DAT. The only group E Incoterms rule, EXW, requires buyers to collect goods from sellers’ premises. Under group F Incoterms, comprising FAS, FCA and FOB, sellers deliver goods to buyer-appointed carriers, with the buyer bearing all the charges of transporting and delivering cargo.

Merits of Incoterms

The use of Incoterms eliminates ambiguities or inconsistencies of country-specific sales and shipping contracts. This makes it easy for sellers and buyers to identify and manage the costs and liabilities of transporting cargo between source and delivery destinations. Moreover, sales contracts that are structured along Group F Incoterms afford buyers the leeway for controlling supply chain with respect to the arrival of shipments and subsequent posting of the shipments in inventories. As for sellers, they shoulder minimal liabilities when using Group E Incoterms, which essentially transfer most obligations to buyers.

Demerits of Incoterms

Group C Incoterms generally expose the buyers to inflated costs, because the seller bears the responsibilities for paying freight and insurance costs. This is a disadvantage to the importer, especially if the exporter chooses to quote the final figure without itemizing the individual entries for freight, insurance and currency fluctuation costs. Moreover, a buyer accounting for an inventory of expensive shipments may experience delays as Incoterms do not cover the transfer of titles or ownership. This can be disappointing, because an inventory of expensive goods can help a business push down expenses and report higher income.

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About the Author

Paul Cole-Ingait is a professional accountant and financial advisor. He has been working as a senior accountant for leading multinational firms in Europe and Asia since 2007. Cole-Ingait holds a Bachelor of Science Degree in accounting and finance and Master of Business Administration degree from the University of Birmingham.

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