A Letter of Credit (LC) is a financial instrument issued by a bank that guarantees payment to a seller (exporter) on behalf of a buyer (importer), provided that the seller meets specific terms and submits the required documents. It is primarily used for import transactions, but it can also be used for domestic (regular) purchases in certain cases.
It is commonly used in international trade to reduce risks for both parties:
- For the Seller: Ensures they receive payment as long as they meet the conditions.
- For the Buyer: Ensures goods are shipped as agreed before payment is made.
Step 1: Record the Invoice received for the Inventory Purchase
When you receive an invoice from a supplier, you must record the purchase in FirstBit ERP in the Invoice received document
Entry:
- Debit: Inventory (or Purchases) → This records the cost of goods purchased.
- Credit: Creditors (Accounts Payable) → This records the supplier's obligation to pay.
Example:
If the invoice amount is AED 10,000:
- Dr. Inventory/Purchases AED 10,000
- Cr Creditors AED10,000
Step 2: Record Payment Using the LC Bank Account
Since the payment is made via an LC, a Dummy Bank account (representing the LC Bank Account) is created to track the LC-related transactions. The amount is transferred from Creditors to the LC Bank Account.
Entry:
- Debit: Creditors → This reduces the liability, as the payment is initiated.
- Credit: LC Bank Account → This represents the LC obligation in the books.
Example:
- Dr Creditors AED10,000
- Cr Bank LC Account AED10,000
Step 3: Transferring Funds from LC Bank to Actual Bank
Entry:
- Debit: Creditors → This reduces the liability, as the payment is initiated.
- Credit: LC Bank Account → This represents the LC obligation in the books.
Example:
- Dr Creditors AED 10,000
- Cr Bank LC Account AED 10,000