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 can also be used for domestic (regular) purchases in certain cases.

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: 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:

plaintext

Dr. Purchases / Inventory / Fixed Asset (Amount of LC) Cr. LC Payable / Accounts Payable (Amount of LC)

If the bank directly debits the buyer’s account:

plaintext

Dr. 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

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