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AP Let of Cre PDF
AP Let of Cre PDF
CaseStudy:FunctionalOverviewonLetterofCredit
Author:DeepakSeeruwani,Consultant
Contributors:NaveenRangineni,Consultant
SkillLevelRatingforthisCaseStudy:Intermediate
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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.
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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
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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
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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
ForPaymentoftheabovePrepaymentInvoice
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XXXX
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
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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
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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.
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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.
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