Trade Finance Letter of Credit (Buy & Sell) in
SAP Treasury
684,385
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
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
1. 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
Fig: 4
Fig: 5
Credit limit check of counterparty (CITIBANK)
Fig: 6
Presentation of LC with Issuing bank
Fig: 7 (Standard SAP Workflow can be used for settling the contract)
Contingent Liability is created
Dr 194200 – TR-TM Clearing A/c
Cr 159100 – Contingent Liability
Fig: 8
Presentation of LC with Issuing bank
Fig:9
Presentation of LC
Fig:10
LC Presentation to bank (Payment obligation)
Fig: 11
Fig:12
LC Presentation to bank (Acceptant Payment)
Fig:13
LC Presentation to bank (Acceptant Payment)
Fig:14 (Issuing bank is CITIBANK and Advising/Recipient bank is JP Morgan considered as example in
this blog)
On Due date LC payments
Note: – All the dates represented only for demonstration purpose.
Fig:15 (Counterparty CITIBANK is linked with customer 5000010099)
On Due date Vendor payment
Fig:16 (Vendor payment accounting based on the bank statement received on next day of payment
processing to Recipient bank)
Letter of Credit (Sales Process)
Fig:17
Presentation of LC with bank
Fig:18
Presentation of LC with Advising bank
Fig:19
Intimation to issuing bank
PDF document can be generated and automatically send the email address maintained on Business partner
master data.
Fig:20 (Sample used for this blog, Prior initiation to bank for entering into a LC contract)
LC Accounting in Treasury system
Fig:21
LC Presentation to bank (Acceptant Payment)
Fig:22
On Due date LC payments
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)
Additional Information
Integration with SWIFT/Open Text/Block Chain for communication with Counterparty
Correspondence (MT700* as per ISO standards) for following can be triggered
o LC Contract
o Settlement
o Presentation
o 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.
