This document summarizes a case study on using letters of credit for international payments. It provides background on letters of credit, explaining that they transfer payment risk from the buyer to the issuing bank. The document then outlines the typical steps in a letter of credit transaction and proposes a solution to record letter of credit payments in Oracle Payables by raising a purchase order and recording a prepayment invoice against the vendor. The summary concludes that this functional process could be adopted to handle letter of credit transactions within Oracle Applications.

1. Customer Submitted Case Studies
Case Study: Functional Overview on Letter of Credit
Author: Deepak Seeruwani, Consultant
Contributors: Naveen Rangineni, Consultant
Skill Level Rating for this Case Study: Intermediate
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Case Study Abstract
This case study will provide a practical guide to letters of credit and as there is no functionality
as of now to use Letter of Credit as a means of payment which is increasingly being used, a
workaround in Oracle Payables to handle payments through Letters of Credit.
Within its limitations it is hoped that:
• This paper will serve as a basic tool in understanding letters of credit and
• The solution given in this case study is specific to Letter of Credit transactions of our
Middle East client and might not applicable globally to all types of Letter of Credit
transactions because the practice adopted in other regions of world might differ from
what is followed in Middle East.

2. Case History
Documentary credits, commercial letters of credit or just letters of credit, play an integral part in
facilitating international trade while providing a secure and reliable means of payment.
One of our clients in Middle East is using letters of credit extensively as a means of payment to
their Suppliers. To map payments using Letters of credit in Oracle Payables module we
suggested the given solution without any customization.
Analysis
Letter of Credit defined
In simple terms, a letter of credit is a bank undertaking of payment separate from the sales or
other contracts on which it is based. It is a way of reducing the payment risks associated with
the movement of goods.
Expressed more fully, it is a written undertaking by an issuing bank to the beneficiary to make
payment within a specified time, against the presentation of documents which comply strictly
with the terms of the credit. Therefore, the risk to the seller of nonpayment by the buyer is
transferred to the issuing bank (and the confirming bank if the letter of credit is confirmed) as
long as the exporter presents the documents in strict compliance with the credit. It is important
to remember that all parties in the letter of credit transaction deal with documents, not goods.
Other than cash in advance, a letter of credit is the most secure method of payment in
international trade, with the payment undertaking of the bank, as long as the terms of the credit
are met. The letter of credit also provides security for the importer who can ensure all
contractual documentary requirements are met by making them conditions of the letter of
credit.
Why Letter of Credit is used?
When the seller has doubts about the credit‐worthiness of the buyer and wishes to ensure
prompt payment, the seller can insist that the sales contract provides for payment by
irrevocable letter of credit. Furthermore, if the bank issuing the letter of credit (issuing bank) is
unknown to the seller or if the seller is shipping to a foreign country and is uncertain of the
issuing bank’s ability to honour its obligation, the seller can, with the approval of the issuing
bank, request its own bank or a bank of international repute to assume the risk of the issuing
bank by confirming the letter of credit.
Benefits of Letter of Credit
To the Exporter/Seller
• Letters of credit open doors to international trade by providing a secure mechanism for
payment upon fulfillment of contractual obligations.
• A bank is substituted for the buyer as the source of payment for goods or services
exported.
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3. • The issuing bank undertakes to make payment, provided all the terms and conditions
stipulated in the letter of credit are complied with.
• Financing opportunities, such as pre‐shipment finance secured by a letter of credit
and/or discounting of accepted drafts drawn under letters of credit, are available in
many countries.
• Bank expertise is made available to help complete trade transactions successfully.
• Payment for the goods shipped can be remitted to your own bank or a bank of your
choice.
To the Importer/Buyer
• Payment will only be made to the seller when the terms and conditions of the letter of
credit are complied with.
• The importer can control the shipping dates for the goods being purchased.
• Cash resources are not tied up
Steps in Letter of Credit Transaction
1. Sales Contract
The sales contract is the formal agreement between the buyer and seller specifying the terms of
sale that both parties have agreed upon. The contract should include: a description of the
goods; the amount; the unit price; the terms of delivery; the time allowed for shipment and
presentation of documents; the currency; and the method of payment.
2. Application & Agreement
The bank’s letter of credit application and agreement forms, when executed, constitute a
payment and reimbursement contract between the issuing bank and its customer. It is also the
customer’s instruction to the issuing bank. The agreement constitutes an undertaking by the
customer to reimburse the issuing bank for drawings paid in accordance with the terms of the
letter of credit, and normally takes the form of an authorization to debit the customer’s
account.
3. Issuance of the Letter of Credit
The issuing bank prepares the letter of credit as specified in the application and forwards it to
the advising bank, (a branch or correspondent of the issuing bank). The issuing bank instructs
the advising bank as to whether or not to add its confirmation, as per their customer’s
instructions.
4. Advising
The advising bank forwards the letter of credit to the beneficiary (seller) stating that no
commitment is conveyed on its part. However, if the advising bank has been asked to confirm
the letter of credit and agrees to do so, it will incorporate a clause undertaking to honour the
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4. beneficiary’s drafts, provided the documents evidence that all terms and conditions of the letter
of credit have been complied with.
5. Shipment of Goods
Upon receiving the letter of credit, the beneficiary should examine it carefully and be satisfied
that all the terms and conditions can be complied with. If this is not possible, the beneficiary
should request the applicant to arrange an amendment to the letter of credit. Once completely
satisfied, the beneficiary will then be in a position to assemble and ship the goods.
6. Presentation of Documents by Beneficiary
The beneficiary prepares an invoice in the number of copies required, with the description of
goods shown exactly as stipulated in the letter of credit. The beneficiary obtains the bill of lading
and/or other transport documents from the carrier and prepares and/or obtains all other
documents required by the letter of credit. These are attached to the draft, drawn on the bank
indicated and at the term stipulated in the letter of credit, and are presented to the
advising/confirming/negotiating bank.
7. Sending Documents to the Issuing Bank
The advising/confirming/negotiating bank checks the documents presented by the seller against
the letter of credit. If the documents meet the requirements of the letter of credit, that bank
will send them to the issuing bank, claiming reimbursement and paying the seller.
8. Delivering Documents to the Applicant
The issuing bank will also check the documents for compliance and then deliver them to the
applicant either against payment or as an undertaking to pay on maturity of the drawing under
the letter of credit
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5. Results, Conclusion and Learnings
We concluded that we could provide a solution that could be adopted in Oracle
Applications to record Letter of Credit transactions. The functional process we used is
shown below.
In case of Sight letter of credit:
Sight letter of credit can permit the beneficiary to be paid immediately upon presentation of
specified documents.
1. Raise a Purchase Order
Raise a Purchase Order in Oracle Purchasing stating the description of goods, quantity, unit
price, and terms of delivery. Purchase order would be issued after beneficiary examined that all
the terms and conditions of letter of credit are/can be complied with.
Letter of Credit number and/or other details can be tracked on Purchase Order with the help of
DFF.
2. Record a Prepayment Invoice against Vendor
In case of confirmed sight letter of credit the confirming bank is obliged to honour the drawing
without recourse to the beneficiary. Beneficiary (Seller) should present following documents to
Advising / Confirming Bank:
• Invoice with description of goods shown exactly in LC
• Bill of lading and/or other transport documents
• Draft (Bill of exchange)
• Other documents as required by letter of credit
The advising/confirming/negotiating bank will claim reimbursement from the issuing bank and
issuing bank in turn from buyer by debiting his account. On receipt of the debit advice from
Bank enter a Prepayment Invoice in Oracle Payables against Vendor:
In cases where seller bears Debit Credit In cases where title of goods Debit Credit
the risk – (Trade term is are deemed to be
DAF/DES/DDU/ DDP) transferred to Buyer (Trade
term is EXW/ FOB/CFR/CIF)
Dr Advance to Supplier XXXX Dr Goods in Transit XXXX
Cr Liability XXXX Cr Liability XXXX
3. For Payment of the above Prepayment Invoice
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6.
Record a dummy payment against the above Prepayment Invoice. For making this dummy
payment, a Dummy LC Bank or Dummy LC Bank Account (under a Bank through which Letter of
Credit has been processed) can be created.
Account Debit Credit
Dr Liability XXXX
Cr LC Payment Clearing Account XXXX
4. Simultaneously, raise an Invoice against Bank to record the liability towards payment
made by Bank to Vendor.
Account Debit Credit
Dr LC Payment Clearing Account XXXX
Cr Bank Liability XXXX
5. Payment to Bank
Account Debit Credit
Dr Bank Liability Account XXXX
Cr Bank / Bank Clearing Account XXXX
6. Receipt of Goods
On receipt of goods record a receipt transaction in Inventory
Account Debit Credit
Dr Material Account XXXX
Cr AP Accrual Account XXXX
7. On receipt of Invoice from Vendor
Enter an Invoice in Oracle Payables & match it with Purchase order:
Account Debit Credit
Dr AP Accrual Account XXXX
Cr Liability Account XXXX
8. Apply the prepayment against above Invoice
Account Debit Credit
Dr Liability Account XXXX
Cr Advance to Supplier / Goods in XXXX
transit
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7.
In case of Usance letter of credit:
Term/Usance Letters of credit can permit the beneficiary to be paid at a future date as
established in the sales contract.
1. Raise a Purchase Order
Raise a Purchase Order in Oracle Purchasing stating the description of goods, quantity, unit
price, and terms of delivery. Purchase order would be issued after beneficiary examined that all
the terms and conditions of letter of credit are/can be complied with.
Letter of Credit number and/or other details can be tracked on Purchase Order with the help of
DFF.
2. Receipt of Goods
On receipt of goods record a receipt transaction in Inventory
Account Debit Credit
Dr Material Account XXXX
Cr AP Accrual Account XXXX
3. On receipt of Invoice from Vendor
Enter an Invoice in Oracle Payables & match it with Purchase order:
Account Debit Credit
Dr AP Accrual Account XXXX
Cr Liability Account XXXX
4. For Payment
Record a dummy payment against the above Invoice. For making this dummy payment, a
Dummy LC Bank or Dummy LC Bank Account (under a Bank through which Letter of Credit has
been processed) can be created.
Account Debit Credit
Dr Liability XXXX
Cr LC Payment Clearing Account XXXX
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8. 5. Simultaneously, raise an Invoice against Bank to record the liability towards payment
made by bank to Vendor with the Payment term attached (Say ‐ Due in 30 days)
Account Debit Credit
Dr LC Payment Clearing Account XXXX
Cr Bank Liability XXXX
6. Payment to Bank
Pay the above Invoice as and when installments are due
Account Debit Credit
Dr Bank Liability Account XXXX
Cr Bank / Bank Clearing Account XXXX
References
Glossary of commonly used terms
Issuing bank: The bank which issues the letter of credit on the instructions of the importer
(usually, but not necessarily, the importer's own bank).
Beneficiary: The party in whose favour the letter of credit is issued.
Advising bank: The bank, usually but not necessarily in the beneficiary's country, through which
advice of the letter of credit is sent by the issuing bank.
Confirming bank: A bank usually in the country of the beneficiary which, at the request of the
issuing bank, joins that bank in undertaking to honour drawings made by the beneficiary,
provided the terms and conditions of the letter of credit have been complied with.
Negotiating bank: The bank specifically nominated in the letter of credit to purchase the bill of
exchange (draft) drawn by the beneficiary on a drawee other than the negotiating bank. (If a
letter of credit is freely negotiable, any bank willing to do so can be the negotiating bank).
EXW ‐ Ex works: "Ex Works" is the minimum/lowest obligation of a seller. The seller agrees to
make the goods available to the buyer at the seller's premises (named place). The seller under
EXW is not even responsible for bearing the cost of loading the goods onto the vehicle provided
by the buyer, unless otherwise agreed in advance. The buyer bears the full cost and risks
involved in bringing the goods from the EXW location to the ultimate destination.
FOB – Free on board: Goods shipped under FOB terms are placed on board the ship by the seller
at the specific port of shipment named in the sales agreement/purchase order/contract. All
costs and risks from the point where the cargo "crosses the ship's rail" (i.e. is lifted from the
quay/pier onto the vessel) passes to the buyer.
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9. CFR – Cost & freight: Under CFR, the title and risks change at the ship's rail, just as in FOB terms,
but the cost allocation is different. For goods shipped under CFR, the seller pays all costs to
deliver the goods up to the named port of destination (while under FOB, above, the buyer is
responsible for those costs).
CIF – Cost, insurance & freight: In its simplest form, CIF is CFR + Insurance. The seller must
procure transport insurance against the risk of loss or damage to the goods (to the extent that is
mutually agreed upon in the sales agreement). Seller contracts with insurance carrier or agent
and pays the premium ‐ but issues insurance in a form/format that allows the buyer to later
make claim directly to the insurance carrier or said carrier's agent. (Since Title/Risk has changed
hands at FOB point, the seller is no longer entitled to make claim, unless specifically on behalf of
the buyer, who, in fact, owns the goods.)
DAF – Delivered at frontier: DAF means that the seller is obliged to move the goods to the
named place at the frontier (border crossing). This is primarily a rail/truck term. The seller bears
all costs/risks up to this point, but is not responsible for customs clearance, duty, or taxes
DES – Delivered ex ship: Using DES requires the seller to make the goods available to the buyer
"on board the ship at the place named in the sales contract". Unlike CFR and CIF terms, the
seller has agreed to bear not just cost, but also Risk and Title up to the arrival of the vessel at the
named port. Costs for unloading the goods and any duties, taxes, etc… are for the Buyer.
DDU – Delivered duty unpaid: DDU terms require that the seller delivers the goods to the
buyer, UNCLEARED FOR IMPORT, at the point or place named in the sales agreement. The seller
bears all costs and risks up to this point/place.
DDP – Delivered duty paid: Just as EXW represented the seller's minimum obligation in an
international transaction, DDP would represent the seller's MAXI MUM obligation. Under DDP,
the seller agrees to all costs and risks, including customs clearance fees and payment of import
duties, up to the named place/point.
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