Accounting treatment of Letter of Credit

The LC Accountant must be aware of all journal entries and accounting treatment of letters of credit. The accounting treatment varies by type of letter of credit and depending on the nature of the dealing with the supplier and the bank. The accounting treatment of the types of letters of credit is one of the common important things an accountant should be aware of how to recording and monitoring them. 

First, Cash Against Document

In other words, when the exporter's bank sends the documents to the importer's bank, in this case, should be paid by the importer’s bank immediately to the exporter's bank because this condition of letter of credit is that cash against documents if the company doesn't have facilities, of course, the bank will only open the letter of credit when the company deposits the full letter of credit amount +10% extra in the event of the dollar's rise

If the company has a bank facility, in this case, the bank transfers the value of the goods to the supplier's bank

The company will then paid to the bank under conditions of the facility agreement and we will cover both cases where there are banking facilities or that the company would cover its values with the full letter of credit from its current account at the bank

First, if there is no Banking Facilities Agreement

When the letter of credit is opened, the bank deducts the opening of the letter of credit commission and all bank charges vary from bank to another

Certainly, there are expenses of Form (4) for LC opening; it is almost a specific amount by the amount of each letter of credit. That is, if for example, from $10,000 to $20,000, the expenses of Form (4) amounting to XXXXX. If the letter of credit is of $20,000 to $50,000, the expenses of Form (4) amounting to XXXXX. The Accounting treatment is as follows:

Account	Debit	Credit
Letter of Credit	XXXXX
Bank Account		XXXXX

 (Recording SWIFT payments and LC opening commission No. ***** Bank ****)

The bank accountant must review the value of the commission that the bank has deducted, it is mostly of a specific rate of letter of credit amount, for example, LC opening commission with a fixed percentage mostly 75% or 1.25%, each period increases, by bank and by the terms of LC opening and are calculated, for example, assuming that the letter of credit amount is one million pounds and the exchange rate at the date of LC opening 15 EGP to USD 

The LC opening commission = 1000000×15×1.255

The commission and letter of credit charges are deducted by the bank when it opens the letter of credit regardless of the type of letter of credit, the payment date for the supplier, and whether the payment will be made from the company's current account or the payment via the facilities

When the LC documents delivered at the importer's bank, it transfers the letter of credit amount and assuming that the letter of credit is $300.000 and the exchange rate at that time was 15.50 pounds

The amount transferred to the supplier = $300,000 and the equivalent in Egyptian Pound 300000× 15.50 = 4650,000

The accounting treatment is as follows

Account	Debit	Credit
Accounts Payable	4650000
Bank Account/ Loan (According to the Payment Method)		4650000

Certainly, the supplier is transferred to it in dollars or foreign currency, but in the company books, recording in local currency

Assuming that there is trust with the customs broker as a result of the old dealings with him, and instead of the company writing checks and paying high bank commissions, it transfers to the customs broker an amount in the amount of all the costs of the customs release and an account is opened to the clearance company and it is monitored and the journal entry is as follows:

Account	Debit	Credit
Al-Salam Clearance Company	XXXXX
Cash/ Bank		XXXXX

When the goods reach the company's port, the customs broker makes the procedure of customs clearance, and goods entered the company warehouse

The accounts payable accountant reviews the customs release form in which he taxes are shown, whether it is VAT, customs duty, or withholding and some other charges

The customs duty is added to the cost of a letter of credit if the commodity is subject to customs duties and the rest of the other fees such as offloading, freight, storage fees, receiving, and other expenses in the customs are added to the letter of credit amount, and the cost of the letter of credit, and for VAT not added to the letter of credit amount and the cost of the letter of credit because it is considered a refundable tax that the company pays currently, it is deducted from the tax return, and there is the withholding tax, which is that the customs deduct 1% of the letter of credit amount and at the end of the year the company benefits from it by deducting it from the income tax 

The accounting treatment is as follows:

Account	Debit	Credit
Letter of Credit  (The value of the customs duty and all customs clearance fees)	XXXXX
VAT Account (the tax that the company paid at customs, which is either paid by check or given the value to the customs broker to pay it)	XXXXX
Withholding Tax Account (the value of the tax deducted by customs from the company and the company will benefit from it at the end of the year)	XXXXX
Al-Salam Clearance Company		XXXXX
Withholding Tax Account		XXXXX

The withholding tax, which is other liabilities, which is the value of what the company deducts as a withholding tax from the customs clearance company because is a service provider in the sense that the customs broker sends the clearance bill

5% is deducted from the service and 3% to the transport bill and provided to the Tax Authority

In other cases, the company deals with checks and pays customs duty and VAT with checks, and the customs broker pays other clearance fees and settles them with the company, so the accounting treatment is as follows:

Account	Debit	Credit
VAT Account	XXXXX
Customs Duty	XXXXX
Bank Account		XXXXX

When the customs broker makes all the customs clearance procedures and brings all the receipts, the journal entry is as follows:

Account	Debit	Credit
Letter of Credit  (The value of the customs duty and all customs clearance fees)	XXXXX
Withholding Tax Account (the value of the tax deducted by customs from the company and the company will benefit from it at the end of the year)	XXXXX
Al-Salam Clearance Company (the value of the customs duties paid by the clearance company, except for the customs duty)		XXXXX
Withholding Tax Account		XXXXX

Upon the receipt of the goods at the company's warehouses, it is preferable to create an adjusting entry to the supplier at the same price shown in the customs release that was transferred to the supplier, and assuming that it is the same price at which the transfer was made to the supplier, the journal entry is as follows:

Account	Debit	Credit
Letter of Credit (Letter of Credit No. ****)	4650000
Accounts Payable		4650000

Assuming that the dollar exchange rate at that time was 15.50 and today it is 15.30, and therefore there is a decrease in the exchange rate

The journal entry is as follows:

Account	Debit	Credit
Letter of Credit  (300,000 × 15.30)	4590000
Currency Exchange Gain/Losses		60000
Accounts Payable		4650000

In the event that the price at the customs release and the arrival of the goods to the company’s warehouses is higher than the price at which the transfer was made to the supplier, assuming that the dollar exchange rate at that time was 15.50, and today it became 15.75, and therefore there is an increase in the exchange rate

Account	Debit	Credit
Letter of Credit  (300,000 × 15.75)	4,725,000
Currency Exchange Gain/Losses		75,000
Accounts Payable		4650000

The LC account is finally closed at all expenses and costs incurred by the company (excluding VAT) in the inventory account if the goods received are raw materials and products and are closed in the asset account if the goods received are machinery, equipment, and the journal entry is as follows:

Account	Debit	Credit
Inventory/ Fixed Asset	XXXX
Letter of Credit  (Letter of Credit No. **** Al-Ahly Bank  To**** ("Beneficiary"))		XXXX

Second, if there is a Banking Facilities Agreement

In this case, the bank will pay the amount of letter of credit to the supplier, whether its value is full or the company pays a portion of it (LC cash collateral) the bank pays the rest of the letter of credit and this is a relationship between the bank and the company, and the supplier or supplier's bank has no relationship to the payment  method and the bank pay from the company's facilities at the bank and of course, the facility will have a credit limit in the sense of a certain balance that the company cannot exceed, of course, each amount that is paid to the supplier from the facility shall increase the debit balance for the company and therefore the bank interest of the company are to be calculated the interest of the company in this method: Debit Balance × Interest Rate × Number of Days/360

Certainly, in the facilities, every amount that the company withdraws to pay the letter of credit amount that is considered a loan to the company and there is a credit period granted to the company by the bank should through which the loan payment otherwise the company has arrears of interest

Here is a very important point in the practical reality

It is it the bank requires the company the cash collateral let say 10% and the bank will fund 90% of the letter of credit amount as a banking facility, assuming that the letter of credit amount was $50,000 and the dollar exchange rate at that time was 20 EGP

In other words, the letter of credit amount in Egyptian Pound, one million pounds

First, 10% of the letter of credit amount is transferred $50,000 at an exchange rate of 20 EGP

Account	Debit	Credit
Accounts Payable (50000x20 x10%)	$100000
Bank Account		$100000

Second, the bank pays the remaining 90% to the supplier 

Account	Debit	Credit
Accounts Payable	900,000
Loan		900,000

An important point to focus on, which is that letter of credit, its type, cash against documents meaning that the supplier is paid the same day that the documents were delivered, and the payment is therefore made on this day since the agreement between the company and the bank is that it will be the company 10% of the letter of credit amount and the bank 90% of letter of credit amount

For the LC cash collateral, certainly, before the bank opens the letter of credit, it must have the cash collateral amount in the sense that the company should be its account in dollar the value of 10% or it has in Egyptian Pound in the current account, equivalent to 10% and the bank in return for it dollar transaction fee by deduction its value from the Egyptian account

When the bank opens the letter of credit, it freezes the LC cash collateral amount because when it opens the letter of credit, it has become obligated according to banking norms that it pays the letter of credit amount to the supplier through the exporter's bank once the bank sends the documents, it immediately transfers the letter of credit amount, whatever the payment method, is in full, partial, or the company to cover its full value

Certainly, the letter of credit amount is converted in dollars, meaning that the letter of credit amount is deducted in the pound at the dollar exchange rate on the day the letter of credit amount will be transferred 

When the goods enter the warehouse, an adjusting entry is created

Account	Debit	Credit
Letter of Credit	1,000,000
Accounts Payable		1,000,000

Certainly, the 900,000 that the bank paid to the supplier will start calculating interest rates until they are paid to the bank during the loan maturity date

Second, Red Clause Letters of Credit

Other types of letters of credit, which are the foreign buyer is required to make an advance payment of the letter of credit amount before to send any documents or to transfer the goods to the importer, and assuming that the amount of the letter of credit was $500,000 and the advance payment was 25%, the amount to be transferred as an advance payment is 500,000×25% = $1250,000 and the dollar exchange rate was $15 at that time. Thus, the accounting treatment would be

Account	Debit	Credit
Accounts Payable	1875000
Bank Account		1875000

When the goods reach and receive the importer, it is transferred the rest of the amount from the importer's bank to the exporter's bank and the rest of the amount is 75% of the value of the letter of credit and the dollar exchange rate was 15.30

Therefore, the amount paid to the supplier is 500,000×75%×15.30 = 5737500

The Journal entry is as follows: 

Account	Debit	Credit
Bank Account	5737500
Accounts Payable		5737500

The rest of the journal entries for letters of credit charges, customs clearance fees, and closing letters of credit are the same in all letters of credit

There are banks that require the customers of importers who are provided to them by the bank the credit facilities before opening any letter of credit to pay a portion of the letter of credit amount, it’s called LC Cash Collateral meaning if the letter of credit amount is $300,000 the bank requires the company (importer) to pay 10% of the letter of credit amount from his/her current account and the rest of the 90% of the letter of credit amount will be paid at the loan maturity date with the bank is in accordance with the terms of the facilities contract and this is a relationship between the importer and his/her bank and the nature of the payment to the supplier is different by type of letter of credit

The remaining 90% of the letter of credit amount will be paid by the bank to the supplier from the open account, and the company after a period will pay it to the bank if we assume that the company will pay to the bank every 90 days in the sense of the bank will pay the foreign buyer on 1/7/2019 for that the company is paying the bank 90 days after the date of payment to the foreign buyer means that it will be on 1/10/2019

There is an important point for the LC accountant is that there are two dates in the letters of credit: The payment date to the supplier according to the terms of the letter of credit and payment to the supplier and the loan maturity date to the bank in case that, of course, it is paid through the bank's facilities

SWIFT Code 

First, SWIFT code is a notice from the recipient’s bank to the sender's bank confirms the money transfer to it in the sense of the transfer interbank network each other globally, meaning that, to be transferred from bank to bank must be using SWIFT codes

Certainly, each bank receives certain expenses, SWIFT and mail, and these are different from one bank to other and when the company contracts with the bank, it has data on all fees, commissions and bank charges that will be the bank receives and there are expenses of Form (4) and the bank keeps a copy and gives a copy to the importer for customs release and the release of goods only if all data fulfill and was sealed by the bank