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Accounting entries for letter of credit

sri.student (student) (144 Points)

25 January 2015

1. what is the procedure to obtain letter of credit from a bank?

2. What are the accounting entries for issue and obtaining of Letter of Credit ?

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CA Final Student (and Trainee Accountant) (373 Points)
Replied 25 January 2015

Hi sri.

For Question 1: Letter of credit : A document of belief/trust that buyer (his bank) will give to seller (bank), safeguarding his payment.

Why LC? Ans: No immediate cash flow required. By paying LC commission you can postpone your fund outflow for substantial period of time. E.g. 90 days.

Example: L&T is buying steel pipes from Jindal. In return, L&T has to pay Rs. 10 Crores to Jindal as consideration. But, L&T having only Rs. 5 crores in bank (say)

It will ask for time of 90 days from Jindal. But, Jindal is in doubt, whether L&T will honour payment or not. Also, doesnt want to lose customer like L&T. So, Jindal asks L&T to produce L.C.(Letter of credit) and take material.

Procedure:

Say you (Sri) are representing L&T

Obtain the following documents and go to bank:-

1. Letter of Intent given by you to Jindal. (Details of Qty of steel, etc to be mentioned)

2. Purcahse order issued by you and their acceptance.

3. Proforma Invoice issued by Jindal (Proforma Invoice will be issued when material is ready with Jindal)

Say You have went to StateBank of India.

Banker will examine 1,2, 3 above and ask you to deposit say 25% of Invoice value (Rs. 2.5 Crores) to make margin (They'll call it as Margin Money). SBI will give you interest on that money. Not to worry.

Now SBI (Address him as Issuing Bank) will give LC to L&T(Applicant) in favour of Jindal (Benificiary) to Jindal's Bank (Say Punjab National Bank, We call this as Advising bank).

Appropriate charges will be collected by SBI and PNB from respective Customers (L&T and Jindal respectively)

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CA Final Student (and Trainee Accountant) (373 Points)
Replied 25 January 2015

Regarding Accounting,

You have to

a. pass bank payment entry for Margin money deposit made (Rs. 2.5 Cr) in your books

b. Disclose Rs. 10 Crore as contingent liability till the amount is paid off and LC is cancelled

c.On receipt of material, book the cost and create liability for Rs. 10 Cr against Jindal)

Any other .views from experts are always welcome

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sri.student (student) (144 Points)
Replied 25 January 2015

thanks for the reply

eshi5198 (Article Assistant) (72 Points)
Replied 27 January 2015

Many thanks..

chandra sekar (Manager-Accounts) (387 Points)
Replied 27 April 2015

excellent way or presentation of the subject.

1 Like

Rajesh Kumar K (Finance Manager) (50 Points)
Replied 27 April 2015

You have explained in a way that a any layman can understand it. Great presentation

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chandra sekar (Manager-Accounts) (387 Points)
Replied 06 January 2016

a doubt on the LC . is it a must condition in LC , that, if a buyer has to insist the terms that, some amt has to be borned by the seller, if the LC is to discounted within 30 days, i.e. 10% of the BE value.