Customer Submitted Case Studies

CaseStudy:FunctionalOverviewonLetterofCredit
Author:DeepakSeeruwani,Consultant Contributors:NaveenRangineni,Consultant SkillLevelRatingforthisCaseStudy:Intermediate

AboutOracleCustomerSubmittedCaseStudies

OracleCustomerSubmittedCaseStudiesareintendedaslearningtoolsandforsharing informationorknowledgerelatedtoacomplexevent,process,procedure,ortoaseriesof relatedevents.Eachcasestudyiswrittenbasedupontheexperiencethatthewriter/s encountered. Customersshouldnotinterpretoruseinformationinthesecasestudiesassolutionsor recommendationswithoutfirstcontactingOracleSupport. EachCaseStudycontainsaskilllevelrating.Theratingprovidesanindicationofwhatskilllevel thereadershouldhaveasitrelatestotheinformationinthecasestudy.Ratingsare: Expert:significantexperiencewiththesubjectmatter Intermediate:someexperiencewiththesubjectmatter Beginner:littleexperiencewiththesubjectmatter

CaseStudyAbstract

Thiscasestudywillprovideapracticalguidetolettersofcreditandasthereisnofunctionality asofnowtouseLetterofCreditasameansofpaymentwhichisincreasinglybeingused,a workaroundinOraclePayablestohandlepaymentsthroughLettersofCredit. Withinitslimitationsitishopedthat: Thispaperwillserveasabasictoolinunderstandinglettersofcreditand ThesolutiongiveninthiscasestudyisspecifictoLetterofCredittransactionsofour MiddleEastclientandmightnotapplicablegloballytoalltypesofLetterofCredit transactionsbecausethepracticeadoptedinotherregionsofworldmightdifferfrom whatisfollowedinMiddleEast.

CaseHistory

Documentarycredits,commerciallettersofcreditorjustlettersofcredit,playanintegralpartin facilitatinginternationaltradewhileprovidingasecureandreliablemeansofpayment. OneofourclientsinMiddleEastisusinglettersofcreditextensivelyasameansofpaymentto theirSuppliers.TomappaymentsusingLettersofcreditinOraclePayablesmodulewe suggestedthegivensolutionwithoutanycustomization.

Analysis

LetterofCreditdefined
Insimpleterms,aletterofcreditisabankundertakingofpaymentseparatefromthesalesor othercontractsonwhichitisbased.Itisawayofreducingthepaymentrisksassociatedwith themovementofgoods. Expressedmorefully,itisawrittenundertakingbyanissuingbanktothebeneficiarytomake paymentwithinaspecifiedtime,againstthepresentationofdocumentswhichcomplystrictly withthetermsofthecredit.Therefore,therisktothesellerofnonpaymentbythebuyeris transferredtotheissuingbank(andtheconfirmingbankiftheletterofcreditisconfirmed)as longastheexporterpresentsthedocumentsinstrictcompliancewiththecredit.Itisimportant torememberthatallpartiesintheletterofcredittransactiondealwithdocuments,notgoods. Otherthancashinadvance,aletterofcreditisthemostsecuremethodofpaymentin internationaltrade,withthepaymentundertakingofthebank,aslongasthetermsofthecredit aremet.Theletterofcreditalsoprovidessecurityfortheimporterwhocanensureall contractualdocumentaryrequirementsaremetbymakingthemconditionsoftheletterof credit.

WhyLetterofCreditisused?
Whenthesellerhasdoubtsaboutthecreditworthinessofthebuyerandwishestoensure promptpayment,thesellercaninsistthatthesalescontractprovidesforpaymentby irrevocableletterofcredit.Furthermore,ifthebankissuingtheletterofcredit(issuingbank)is unknowntothesellerorifthesellerisshippingtoaforeigncountryandisuncertainofthe issuingbanksabilitytohonouritsobligation,thesellercan,withtheapprovaloftheissuing bank,requestitsownbankorabankofinternationalreputetoassumetheriskoftheissuing bankbyconfirmingtheletterofcredit.

BenefitsofLetterofCredit
TotheExporter/Seller Lettersofcreditopendoorstointernationaltradebyprovidingasecuremechanismfor paymentuponfulfillmentofcontractualobligations. Abankissubstitutedforthebuyerasthesourceofpaymentforgoodsorservices exported.

Page2of9

Theissuingbankundertakestomakepayment,providedallthetermsandconditions stipulatedintheletterofcreditarecompliedwith. Financingopportunities,suchaspreshipmentfinancesecuredbyaletterofcredit and/ordiscountingofaccepteddraftsdrawnunderlettersofcredit,areavailablein manycountries. Bankexpertiseismadeavailabletohelpcompletetradetransactionssuccessfully. Paymentforthegoodsshippedcanberemittedtoyourownbankorabankofyour choice.

TotheImporter/Buyer Paymentwillonlybemadetothesellerwhenthetermsandconditionsoftheletterof creditarecompliedwith. Theimportercancontroltheshippingdatesforthegoodsbeingpurchased. Cashresourcesarenottiedup

StepsinLetterofCreditTransaction
1. SalesContract Thesalescontractistheformalagreementbetweenthebuyerandsellerspecifyingthetermsof salethatbothpartieshaveagreedupon.Thecontractshouldinclude:adescriptionofthe goods;theamount;theunitprice;thetermsofdelivery;thetimeallowedforshipmentand presentationofdocuments;thecurrency;andthemethodofpayment. 2. Application&Agreement Thebanksletterofcreditapplicationandagreementforms,whenexecuted,constitutea paymentandreimbursementcontractbetweentheissuingbankanditscustomer.Itisalsothe customersinstructiontotheissuingbank.Theagreementconstitutesanundertakingbythe customertoreimbursetheissuingbankfordrawingspaidinaccordancewiththetermsofthe letterofcredit,andnormallytakestheformofanauthorizationtodebitthecustomers account. 3. IssuanceoftheLetterofCredit Theissuingbankpreparestheletterofcreditasspecifiedintheapplicationandforwardsitto theadvisingbank,(abranchorcorrespondentoftheissuingbank).Theissuingbankinstructs theadvisingbankastowhetherornottoadditsconfirmation,aspertheircustomers instructions. 4. Advising Theadvisingbankforwardstheletterofcredittothebeneficiary(seller)statingthatno commitmentisconveyedonitspart.However,iftheadvisingbankhasbeenaskedtoconfirm theletterofcreditandagreestodoso,itwillincorporateaclauseundertakingtohonourthe

Page3of9

beneficiarysdrafts,providedthedocumentsevidencethatalltermsandconditionsoftheletter ofcredithavebeencompliedwith. 5. ShipmentofGoods Uponreceivingtheletterofcredit,thebeneficiaryshouldexamineitcarefullyandbesatisfied thatallthetermsandconditionscanbecompliedwith.Ifthisisnotpossible,thebeneficiary shouldrequesttheapplicanttoarrangeanamendmenttotheletterofcredit.Oncecompletely satisfied,thebeneficiarywillthenbeinapositiontoassembleandshipthegoods. 6. PresentationofDocumentsbyBeneficiary Thebeneficiarypreparesaninvoiceinthenumberofcopiesrequired,withthedescriptionof goodsshownexactlyasstipulatedintheletterofcredit.Thebeneficiaryobtainsthebilloflading and/orothertransportdocumentsfromthecarrierandpreparesand/orobtainsallother documentsrequiredbytheletterofcredit.Theseareattachedtothedraft,drawnonthebank indicatedandatthetermstipulatedintheletterofcredit,andarepresentedtothe advising/confirming/negotiatingbank. 7. SendingDocumentstotheIssuingBank Theadvising/confirming/negotiatingbankchecksthedocumentspresentedbytheselleragainst theletterofcredit.Ifthedocumentsmeettherequirementsoftheletterofcredit,thatbank willsendthemtotheissuingbank,claimingreimbursementandpayingtheseller. 8. DeliveringDocumentstotheApplicant Theissuingbankwillalsocheckthedocumentsforcomplianceandthendeliverthemtothe applicanteitheragainstpaymentorasanundertakingtopayonmaturityofthedrawingunder theletterofcredit

Page4of9

Results,ConclusionandLearnings
WeconcludedthatwecouldprovideasolutionthatcouldbeadoptedinOracle ApplicationstorecordLetterofCredittransactions.Thefunctionalprocessweusedis shownbelow.

IncaseofSightletterofcredit:
Sightletterofcreditcanpermitthebeneficiarytobepaidimmediatelyuponpresentationof specifieddocuments. 1. RaiseaPurchaseOrder RaiseaPurchaseOrderinOraclePurchasingstatingthedescriptionofgoods,quantity,unit price,andtermsofdelivery.Purchaseorderwouldbeissuedafterbeneficiaryexaminedthatall thetermsandconditionsofletterofcreditare/canbecompliedwith. LetterofCreditnumberand/orotherdetailscanbetrackedonPurchaseOrderwiththehelpof DFF. 2. RecordaPrepaymentInvoiceagainstVendor Incaseofconfirmedsightletterofcredittheconfirmingbankisobligedtohonourthedrawing withoutrecoursetothebeneficiary.Beneficiary(Seller)shouldpresentfollowingdocumentsto Advising/ConfirmingBank: InvoicewithdescriptionofgoodsshownexactlyinLC Billofladingand/orothertransportdocuments Draft(Billofexchange) Otherdocumentsasrequiredbyletterofcredit Theadvising/confirming/negotiatingbankwillclaimreimbursementfromtheissuingbankand issuingbankinturnfrombuyerbydebitinghisaccount.Onreceiptofthedebitadvicefrom BankenteraPrepaymentInvoiceinOraclePayablesagainstVendor: Incaseswheresellerbears Debit Credit Incaseswheretitleofgoods Debit Credit therisk(Tradetermis aredeemedtobe DAF/DES/DDU/DDP) transferredtoBuyer(Trade termisEXW/FOB/CFR/CIF) DrAdvancetoSupplier XXXX DrGoodsinTransit XXXX CrLiability 3. XXXX CrLiability XXXX

ForPaymentoftheabovePrepaymentInvoice

Page5of9

 RecordadummypaymentagainsttheabovePrepaymentInvoice.Formakingthisdummy payment,aDummyLCBankorDummyLCBankAccount(underaBankthroughwhichLetterof Credithasbeenprocessed)canbecreated. Account Debit Credit DrLiability XXXX CrLCPaymentClearingAccount XXXX 4. Simultaneously,raiseanInvoiceagainstBanktorecordtheliabilitytowardspayment madebyBanktoVendor. Account Debit Credit DrLCPaymentClearingAccount XXXX CrBankLiability XXXX 5. PaymenttoBank Account Debit Credit DrBankLiabilityAccount XXXX CrBank/BankClearingAccount XXXX 6. ReceiptofGoods OnreceiptofgoodsrecordareceipttransactioninInventory Account Debit Credit DrMaterialAccount XXXX CrAPAccrualAccount XXXX 7. OnreceiptofInvoicefromVendor EnteranInvoiceinOraclePayables&matchitwithPurchaseorder: Account Debit Credit DrAPAccrualAccount XXXX CrLiabilityAccount XXXX 8. ApplytheprepaymentagainstaboveInvoice Account Debit Credit DrLiabilityAccount XXXX CrAdvancetoSupplier/Goodsin XXXX transit

Page6of9

IncaseofUsanceletterofcredit:
Term/UsanceLettersofcreditcanpermitthebeneficiarytobepaidatafuturedateas establishedinthesalescontract. 1. RaiseaPurchaseOrder RaiseaPurchaseOrderinOraclePurchasingstatingthedescriptionofgoods,quantity,unit price,andtermsofdelivery.Purchaseorderwouldbeissuedafterbeneficiaryexaminedthatall thetermsandconditionsofletterofcreditare/canbecompliedwith. LetterofCreditnumberand/orotherdetailscanbetrackedonPurchaseOrderwiththehelpof DFF. 2. ReceiptofGoods OnreceiptofgoodsrecordareceipttransactioninInventory Account Debit Credit DrMaterialAccount XXXX CrAPAccrualAccount XXXX 3. OnreceiptofInvoicefromVendor EnteranInvoiceinOraclePayables&matchitwithPurchaseorder: Account Debit Credit DrAPAccrualAccount XXXX CrLiabilityAccount XXXX 4. ForPayment RecordadummypaymentagainsttheaboveInvoice.Formakingthisdummypayment,a DummyLCBankorDummyLCBankAccount(underaBankthroughwhichLetterofCredithas beenprocessed)canbecreated. Account Debit Credit DrLiability XXXX CrLCPaymentClearingAccount XXXX

Page7of9

5. Simultaneously,raiseanInvoiceagainstBanktorecordtheliabilitytowardspayment madebybanktoVendorwiththePaymenttermattached(SayDuein30days) Account Debit Credit DrLCPaymentClearingAccount XXXX CrBankLiability XXXX 6. PaymenttoBank PaytheaboveInvoiceasandwheninstallmentsaredue Account Debit Credit DrBankLiabilityAccount XXXX CrBank/BankClearingAccount XXXX

References
Glossaryofcommonlyusedterms

Issuingbank:Thebankwhichissuestheletterofcreditontheinstructionsoftheimporter (usually,butnotnecessarily,theimporter'sownbank). Beneficiary:Thepartyinwhosefavourtheletterofcreditisissued. Advisingbank:Thebank,usuallybutnotnecessarilyinthebeneficiary'scountry,throughwhich adviceoftheletterofcreditissentbytheissuingbank. Confirmingbank:Abankusuallyinthecountryofthebeneficiarywhich,attherequestofthe issuingbank,joinsthatbankinundertakingtohonourdrawingsmadebythebeneficiary, providedthetermsandconditionsoftheletterofcredithavebeencompliedwith. Negotiatingbank:Thebankspecificallynominatedintheletterofcredittopurchasethebillof exchange(draft)drawnbythebeneficiaryonadraweeotherthanthenegotiatingbank.(Ifa letterofcreditisfreelynegotiable,anybankwillingtodosocanbethenegotiatingbank).

EXWExworks:"ExWorks"istheminimum/lowestobligationofaseller.Theselleragreesto makethegoodsavailabletothebuyerattheseller'spremises(namedplace).Thesellerunder EXWisnotevenresponsibleforbearingthecostofloadingthegoodsontothevehicleprovided bythebuyer,unlessotherwiseagreedinadvance.Thebuyerbearsthefullcostandrisks involvedinbringingthegoodsfromtheEXWlocationtotheultimatedestination. FOBFreeonboard:GoodsshippedunderFOBtermsareplacedonboardtheshipbytheseller atthespecificportofshipmentnamedinthesalesagreement/purchaseorder/contract.All costsandrisksfromthepointwherethecargo"crossestheship'srail"(i.e.isliftedfromthe quay/pierontothevessel)passestothebuyer.

Page8of9

CFRCost&freight:UnderCFR,thetitleandriskschangeattheship'srail,justasinFOBterms, butthecostallocationisdifferent.ForgoodsshippedunderCFR,thesellerpaysallcoststo deliverthegoodsuptothenamedportofdestination(whileunderFOB,above,thebuyeris responsibleforthosecosts). CIFCost,insurance&freight:Initssimplestform,CIFisCFR+Insurance.Thesellermust procuretransportinsuranceagainsttheriskoflossordamagetothegoods(totheextentthatis mutuallyagreeduponinthesalesagreement).Sellercontractswithinsurancecarrieroragent andpaysthepremiumbutissuesinsuranceinaform/formatthatallowsthebuyertolater makeclaimdirectlytotheinsurancecarrierorsaidcarrier'sagent.(SinceTitle/Riskhaschanged handsatFOBpoint,thesellerisnolongerentitledtomakeclaim,unlessspecificallyonbehalfof thebuyer,who,infact,ownsthegoods.) DAFDeliveredatfrontier:DAFmeansthatthesellerisobligedtomovethegoodstothe namedplaceatthefrontier(bordercrossing).Thisisprimarilyarail/truckterm.Thesellerbears allcosts/risksuptothispoint,butisnotresponsibleforcustomsclearance,duty,ortaxes DESDeliveredexship:UsingDESrequiresthesellertomakethegoodsavailabletothebuyer "onboardtheshipattheplacenamedinthesalescontract".UnlikeCFRandCIFterms,the sellerhasagreedtobearnotjustcost,butalsoRiskandTitleuptothearrivalofthevesselatthe namedport.Costsforunloadingthegoodsandanyduties,taxes,etcarefortheBuyer. DDUDelivereddutyunpaid:DDUtermsrequirethatthesellerdeliversthegoodstothe buyer,UNCLEAREDFORIMPORT,atthepointorplacenamedinthesalesagreement.Theseller bearsallcostsandrisksuptothispoint/place. DDPDelivereddutypaid:JustasEXWrepresentedtheseller'sminimumobligationinan internationaltransaction,DDPwouldrepresenttheseller'sMAXIMUMobligation.UnderDDP, theselleragreestoallcostsandrisks,includingcustomsclearancefeesandpaymentofimport duties,uptothenamedplace/point.

DISCLAIMER: Theinformationinthisdocumentistheopinionoftheauthor,notofOracleCorporation.Anycontent,materials,information orsoftwaredownloadedorotherwiseobtainedthroughtheuseofthesiteisdoneatyourowndiscretionandrisk.Oracleshall havenoresponsibilityforanydamagetoyourcomputersystemorlossofdatathatresultsformthedownloadofanycontent, materials,informationorsoftware.

Page9of9