Fig: 4
Fig: 5
Fig: 7 (Standard SAP Workflow can be used for settling the contract)
Fig: 8
Fig:10
Fig: 11
Fig:12
Fig:13
Fig:14 (Issuing bank is CITIBANK and Advising/Recipient bank is JP Morgan considered as example in this blog)
Fig:15 (Counterparty CITIBANK is linked with customer 5000010099)
Fig:16 (Vendor payment accounting based on the bank statement received on next day of payment processing to Recipient bank)
Fig:17
Fig:18
Fig:19
Fig:20 (Sample used for this blog, Prior initiation to bank for entering into a LC contract)
Fig:21
Fig:22
Fig:23 (Counterparty CITIBANK linked with customer 5000010099. LC Sales is against ABC Forwarder)
Fig:24 (Payment credited to Customer based on the bank statement, LC payment received by issuing bank)
Background
A letter of credit, or "credit letter" is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. If the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It may be offered as a facility.
Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.
(Source Investopedia)
This blog explains the Letter of Credit (Buy and Sell) process in SAP and accounting in SAP using SAP Treasury & Risk Management process. SAP has standard solution for letter of credit “Trade Finance”. SAP Trade Finance is available from SAP 6.0 EHP8 onward. In this blog the scenario used is Commercial letter of credit directly paid by banks.
User Story
Lee is procurement manager responsible for placing Purchase Order for raw material involved in manufacturing of Copper insulated wires. At times Lee had to raise purchase order for procuring raw material Copper from distant vendor. As copper is a commodity which is traded in commodity markets such as LME (London Metal Exchange), COMEX and Shangai Futures Exchange. As the rates of copper is driven by market rates, Lee has to ensure that the rate and quantity of purchase is fixed. As the vendor is from another country, to avoid the vendor payment risk and vendor country’s legal requirements, Lee enters into a Letter of Credit agreement with the business partner.
Lee approached his finance counter part (Rohan). Rohan explain Lee the IFRS standard requirement
Business Requirement
As per business requirement, Lee raises a purchase order against an LC payment and approaches Rohan to negotiate and process the Letter of credit with CITIBANK. The payment against the purchase order will be done based on the delivery of goods at Munich port.
On receipt of bill of lading and Invoice, payment will be released (LC payment). Payment will be done to the issuing/obligatory bank which will forward the payment to recipient bank. Recipient bank pays the vendor. On next bank statement, CITIBANK debits (payment against LC to the receiving bank). Vendor should be credited once the LC payment is debited on bank statement.
Letter of credit details to be sent to bank and confirmation to be sent via SWIFT message.
Fig: 1 Source: - International Chamber of Commerce
LC accounting process should compile as per IFRS accounting standards
SAP Solution
Fig: 2
Letter of Credit Process in SAP Trade Finance
Fig: 3
Contract with Issuing Bank – Issue of LC
Credit limit check of counterparty (CITIBANK)
Fig: 6
Presentation of LC with Issuing bank
Contingent Liability is created
Dr 194200 – TR-TM Clearing A/c
Cr 159100 - Contingent Liability
Presentation of LC with Issuing bank
Fig:9
Presentation of LC
LC Presentation to bank (Payment obligation)
LC Presentation to bank (Acceptant Payment)
LC Presentation to bank (Acceptant Payment)
On Due date LC payments
Note: - All the dates represented only for demonstration purpose.
On Due date Vendor payment
Letter of Credit (Sales Process)
Presentation of LC with bank
Presentation of LC with Advising bank
Intimation to issuing bank
PDF document can be generated and automatically send the email address maintained on Business partner master data.
LC Accounting in Treasury system
LC Presentation to bank (Acceptant Payment)
On Due date LC payments
Additional Information
Disclaimer:
Accounting entries might change based on the client requirements. All the accounting entries depicted in the blog are for representation to align with LC standard process.
Conclusion
SAP Trade Finance covers the complete solutions for Letter of Credit process both Buy & Sell. Entire process is automated using standard SAP workflow process, automatic matching of contracts using SWIFT MT format for communication with the banks to avoid risk of manipulation using workflow and with full automation of Letter of Credit Process.
A letter of credit, or "credit letter" is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. If the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It may be offered as a facility.
Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.
(Source Investopedia)
This blog explains the Letter of Credit (Buy and Sell) process in SAP and accounting in SAP using SAP Treasury & Risk Management process. SAP has standard solution for letter of credit “Trade Finance”. SAP Trade Finance is available from SAP 6.0 EHP8 onward. In this blog the scenario used is Commercial letter of credit directly paid by banks.
User Story
Lee is procurement manager responsible for placing Purchase Order for raw material involved in manufacturing of Copper insulated wires. At times Lee had to raise purchase order for procuring raw material Copper from distant vendor. As copper is a commodity which is traded in commodity markets such as LME (London Metal Exchange), COMEX and Shangai Futures Exchange. As the rates of copper is driven by market rates, Lee has to ensure that the rate and quantity of purchase is fixed. As the vendor is from another country, to avoid the vendor payment risk and vendor country’s legal requirements, Lee enters into a Letter of Credit agreement with the business partner.
Lee approached his finance counter part (Rohan). Rohan explain Lee the IFRS standard requirement
- Disclosure of Letter Credit as Contingent Liability (IFRS 4-Financial guarantee contracts and credit insurance)
Business Requirement
As per business requirement, Lee raises a purchase order against an LC payment and approaches Rohan to negotiate and process the Letter of credit with CITIBANK. The payment against the purchase order will be done based on the delivery of goods at Munich port.
On receipt of bill of lading and Invoice, payment will be released (LC payment). Payment will be done to the issuing/obligatory bank which will forward the payment to recipient bank. Recipient bank pays the vendor. On next bank statement, CITIBANK debits (payment against LC to the receiving bank). Vendor should be credited once the LC payment is debited on bank statement.
Letter of credit details to be sent to bank and confirmation to be sent via SWIFT message.
Fig: 1 Source: - International Chamber of Commerce
LC accounting process should compile as per IFRS accounting standards
- Disclosure of Letter Credit as Contingent Liability (IFRS 4-Financial guarantee contracts and credit insurance)
SAP Solution
Fig: 2
Letter of Credit Process in SAP Trade Finance
Fig: 3
Contract with Issuing Bank – Issue of LC
Credit limit check of counterparty (CITIBANK)
Fig: 6Presentation of LC with Issuing bank
Contingent Liability is created
Dr 194200 – TR-TM Clearing A/c
Cr 159100 - Contingent Liability
Presentation of LC with Issuing bank
Fig:9
Presentation of LC
LC Presentation to bank (Payment obligation)
LC Presentation to bank (Acceptant Payment)
LC Presentation to bank (Acceptant Payment)
On Due date LC payments
Note: - All the dates represented only for demonstration purpose.
On Due date Vendor payment
Letter of Credit (Sales Process)
Presentation of LC with bank
Presentation of LC with Advising bank
Intimation to issuing bank
PDF document can be generated and automatically send the email address maintained on Business partner master data.
LC Accounting in Treasury system
LC Presentation to bank (Acceptant Payment)
On Due date LC payments
Additional Information
- Integration with SWIFT/Open Text/Block Chain for communication with Counterparty
- Correspondence (MT700* as per ISO standards) for following can be triggered
- LC Contract
- Settlement
- Presentation
- Presentation acceptance
- Payments via SWIFT
- Full automation of accounting entries (Bank statements/Treasury module)
- LC Fee accounting can be integrated
- Limit Management of SAP can be extended to counterparty limits
Disclaimer:
Accounting entries might change based on the client requirements. All the accounting entries depicted in the blog are for representation to align with LC standard process.
Conclusion
SAP Trade Finance covers the complete solutions for Letter of Credit process both Buy & Sell. Entire process is automated using standard SAP workflow process, automatic matching of contracts using SWIFT MT format for communication with the banks to avoid risk of manipulation using workflow and with full automation of Letter of Credit Process.
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