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Letter of Credit

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Letter of Credit is a document issued by a bank with a guarantee to pay the beneficiary(for whom the LC is opened) a presecribed amount on successful submission of already agreed documents by the beneficiary.

LC is widely used in international trade where the supplier wants to be sure about getting payments for his delivered products, and the importer wants to be sure that the items are really delivered (documentry evidence, not the physical evidence) before payment is made to the supplier. Here the bank play as an intermediater, on one hand it guaranteed the supplier that the amount will be issued to him on successful submission of required documents (usually invoice, bill of lading, insurance, etc) and on the other hand it assures the importer that the amount will only be paid once there is a documentary prove that the items are really delived (in transit).

the LC account in General Ledger is a temporary account which will eventually become NILL balance. Once an LC is opened, an account (LC) is creaed in Chart of Account. any payment to the bank will be a LC-to-bank transaction. once the bank gets all the amount of the LC, the lc account will become NILL. Then immediatery there will be PO-to-bank transaction for the entire amount of LC. If the items are still in transit, another temporary account item-in-transit is created and instead of PO-to-bank, a item-in-transit--to-bank account is created. and once the items reached the warehouse, the inventory and PO accounts are updated.