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:
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When Goods are Received & LC Becomes Payable
The LC obligation becomes a liability once the seller ships the goods and presents documents to the bank.
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:
Entry in Buyer's Books (Importer):
📌 To recognize liability upon acceptance of documents:
plaintextDr. Purchases / Inventory / Fixed Asset (Amount of LC) Cr. LC Payable / Accounts Payable (Amount of LC)
If the bank directly debits the buyer’s account:
plaintextDr. LC Payable / Accounts Payable (Amount) Cr. Bank (Amount)
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
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