Customer Submitted Case Studies

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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