Letter of credit

The emergence of documentary credits dates back to the last century, when banks interfered in international trade exchange operations by opening documentary credits, and the rules governing documentary credits were established in the United States of America in 1920, and the great importance of documentary credits appeared in foreign trade financing operations, whether for import or export; It guarantees for both the exporter and the importer the implementation of the conditions and contracts mentioned in the accreditation, which gives all parties the reliability and seriousness in implementing each of the parties with the obligations required of him, and the implementation of contracts through the banks subject of the contract, gives the deal its weight and seriousness of implementation, as documentary credits are prepared ( L / C) is commonly used in business life especially in import operations

Definition of documentary credit

According to Article No. 359 of the Egyptian Commercial Law, it is a contract whereby the bank undertakes to open a credit at the request of one of its clients (the order to open the credit) in favor of another person (the beneficiary) with the guarantee of documents representing transported goods or prepared for transportation, the documentary credit is considered independent from the contract for which the credit was opened.

In other word, the documentary credit is opened by the banks (the importer's bank) according to the request of one of the customers (the importer / buyer) for the benefit of another person (the beneficiary / the exporter) upon receiving and viewing the shipping documents in accordance with the conditions contained in the contract, with the guarantee of the issuer's bank.

In other words, the documentary credit is opened by banks (Bank importer) according to the request of one customer (importer / buyer) for the benefit of another person (the beneficiary / source) Once you receive and see shipping documents in accordance with the terms of the contract, ensuring that the source bank.

Parties to the documentary credit

First: The importer: It is the buyer's party requesting accreditation

Second: The importer's bank: It is the bank that opens the credit and undertakes to cover the value of the goods

Third: The exporter: It is the external party (the seller) and responsible for supplying the goods according to the terms agreed upon in advance

Fourth: The exporter's bank: It is the bank that guarantees the supply of the goods to the importer in accordance with the terms of the contract.

Divisions of documentary credits

The first division: in terms of the strength of the banking commitment

Revocable accreditation: It authorizes any of its parties to cancel the accreditation unilaterally, and it usually takes place only between a company and its branches, or between a multinational company and its affiliated companies, or between parties among whom there is no boundary trust, and the party requesting accreditation (the importer) can cancel the accreditation by notifying the bank, The bank that opens the credit can also cancel the credit voluntarily, and this type of credit is not commonly used in working life.

Peremptory credit (non-cancellable): It is the binding credit to the customer (the importer) before the bank that opened the credit (the importer's bank) and also binding on the bank towards the beneficiary (the exporter). It may not be modified either in the same way, but this type is considered the most common and used in practical life.

supportive credit: It is basically a definitive credit to which another foreign bank has joined the name of the supportive bank, and the meaning of this type of credit is that it is based on the request of the beneficiary in order to reach the shortest methods that enable him to obtain the value of the credit from the shortest possible way.

The second division: in terms of the purpose of accreditation

Import documentary credit: Banks open an import credit when a local importer wants to import goods from abroad and finance these goods through open credit.

Documentary credit for export: Upon entering the exporter's bank to confirm this credit, as we have previously explained, the credit is considered from the point of view of the supporting bank (the exporter's bank) as

adocumentary credit for export, and the purpose of this type of credit is that it gives the source reliability to the commitment of the two banks, whether the importer's bank or the exporter's bank, to pay the value of the deal.

The third division: Sales letters of credit and guarantee letters of credit

The familiar image of the credit is the existence of a sale contract for which a documentary credit is opened for the presentation of documents for the goods purchased through it and the payment of its value through the bank, but there is another image in which the credit appears not related to a sale contract and there is no commodity in it, but the credit is related to ensuring the implementation of certain obligations, and it is closer to a letter Collateral This type of credit is called conditional credit.

Fourth division: in terms of transferability

Transferable credit: the credit is transferable only once, but this time it may be split between a number of suppliers or producers (exporters).

Non-transferable credit: The principle is that the credit is not transferable unless it is explicitly stated in it.

Fifth division: the indivisible and indivisible appropriation

The credit is divisible when the goods are allowed to be shipped partially, that is, in batches, provided that the value of the credit is fulfilled in the same percentage that was shipped from the goods, and it is indivisible if the recipient (the exporter) must present the goods in one payment, and the division may be local as The supply takes place on board more than one vessel, and it may be split in time, such as if the supply takes place over more than one period of time.

The sixth division: local accreditation and external accreditation

If the buyer and seller reside in the same country, the accreditation is local, but if the two countries are different, it is considered external credit.

Seventh Division: Appropriations provided, completed and deferred

Accomplished credits: The value of the goods is paid upon presentation of shipping documents and their conformity with the conditions.

Appropriations provided: the value of the credit is paid in advance.

Deferred credits: Payment of the credit value is postponed until the importer discharges part of the goods.

Other divisions:

- Circular or renewed credit: This credit is automatically renewed and the bank’s commitment to the beneficiary is renewed. The renewed credit differs from the concept of extending the credit deadline, as extending the credit deadline does not entail the bank’s commitment.

- Approval of a single payment: This credit is opened for fulfillment of the value of one transaction only.

- Guaranteed credit: All documents issued by the source are submitted in the name of the bank.

- Unsecured credit: All documents submitted are in the name of the buyer or the importer.

- Covered credit: the bank obtains from its client a cover for credit, and the cover may be in cash or in kind. Usually, the bank’s commission for this type of credit is lower than the rest of the other types.

- Uncovered credit: Here, the customer does not provide any amounts or in-kind guarantees to the bank in exchange for opening the credit.

- Cash credits: the value of the credit is transferred to the beneficiary in cash

- Swap credits: It is used in the case of bartering the goods. The credit guarantees only the differences resulting from the difference in the value of the goods.

The difference between documentary credits and borrowing

Some people may confuse  between the process of borrowing and opening credits, but there are big differences between them, in terms of mechanism and purpose, as the borrowing process expresses granting  the customer a financial facility over time periods at an interest rate that may be high As for the documentary credit, it is opened mainly with the aim of supporting confidence in the buyer towards the seller, in exchange for a commission charged by the bank,  the accreditation is considered to be pending on the condition that the goods are received by the dealer or the viewing of shipping documents in accordance with the terms of the credit

The difference between a credit and a hedge contract

Hedging contracts are mainly concluded with the aim of facing fluctuations in exchange rates. As for the credit, as we have previously explained, it is about supporting the position of the customer (importer) towards the seller (the beneficiary) more than it being a financial facility, but in most cases hedging contracts are concluded (forward exchange contracts simultaneously with the opening of the credit, especially in the case of long-term credits.

Accounting guidance for documentary credits

Practical example: On March 1, the national company opened a documentary credit with bank Misr (Egypt bank) for the purpose of importing goods from the American company at an amount of 1,000,000 Egyptian pounds. The bank charges a 12% commission on the amount of the credit, and the coverage rate was 25%, and against the credit expenses 2%, and at 25- March The bank received the shipping documents and the amount was transferred to the beneficiary, and on that date the bank deducted the remaining value of the credit from the current account of the national company, and the national company received the shipment in its warehouse.

Accounting treatment

Credit value = 1000,000 EGP

Bank commission = 1000,000 x 12% = 120,000 EGP

Bank fees = 1000,000 x 2% = 10,000 pounds

Cover Value = 1000,000 x 25% = 250,000

Accounting guidance on 1-March

Of account / documentary credits (the American company) 1000,000

To those mentioned

250,000accounts / cash in the bank (Egypt bank)

750,000 account / documentary registration fees (Egypt bank)

Proof of opening a documentary credit at (Egypt bank)

Of those mentioned

 120,000 bank accounts / commissions (Documentary Credit No. XXXX)

Bank accounts / expenses 10,000

To the bank account / cash (Egypt bank) 130,000

Proof of payment of bank commission and bank expenses.

Accounting guidance on 25-March

From account / inventory 1,000,000

 (to the supplier account (the American company 1000,000

Proof of receipt of the goods

1000,000 accounts / suppliers (American company)

1000,000( to the account / documentary credits (the American company 1000,000

Proof of transferring the transaction value to the supplier

From account / documentary credit commitments (Egypt bank) 750.000

To the account / cash in the bank (Egypt bank) 750,000

Steps to register on Accflex ERP

Opening an account for documentary credits within the current assets in the accounts directory.

Branching of the documentary credit account according to the bank and the customer.

Opening an account of documentary credits obligations within the obligations circulated in the accounts directory and sub-branching it according to the bank

Bank commissions account registration as well as bank expenses included under expenses General and administrative evidence accounts.

Print follow-up reports on the accounts of commitments and credits, as well as accounts of external suppliers, and show their movements and balances during the period.

Settlement of current assets, and liabilities upon payment.