How to account for a letter of credit on the balance sheet

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How to account for a letter of credit on the balance sheet
A traveller's letter of credit is usually used to cover business expenses while abroad. (Jupiterimages/Comstock/Getty Images)

A letter of credit, usually abbreviated as “L/C”, is a pledge by a bank to make a payment to one of its account holders’ customers on presentation of confirming documents. It is usually used in international trade where a seller in a foreign country needs a firm commitment to payment by the buyer before goods are shipped. In UK accounting practice a letter of credit is regarded as an “Off Balance Sheet” device, and so should not be entered into the accounts. However, there is one type of L/C that is saleable, and so, accountable. This is the “traveller’s letter of credit.”

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  1. 1

    Enter the details of the traveller’s L/C in the Cash ledger of your accounts. The amount of the L/C should appear in the debit column. A quirk of accountancy practices leads them to define anything that increases in value as a debit.

  2. 2

    Reduce the “Cash at bank” by the same amount. The overall effect of these two entries will cancel each other out and leave the overall Cash account total the same.

  3. 3

    Report the traveller’s L/C on the balance sheet as part of “Cash and Cash Equivalent.” Do not itemise the L/C as a separate item. As a traveller’s L/C is regarded as “cash” (see Tips for explanation) it will not impact the balance sheet at all.

Tips and warnings

  • Standard L/Cs are non-funded and so should be mentioned in the notes accompanying the accounts. Here, they should be listed as “contingent liabilities.”
  • Traveller’s L/Cs are saleable, and so accountable. However, they merely offer an equivalent expression of cash as money and so, in accountancy terms they are just as much “cash” as legal tender. A key difference between commercial L/Cs and traveller’s L/Cs is that the later is “sold for cash” and so has intrinsic monetary value. For account ting purposes, a traveller’s L/C is the same as a traveller’s cheque.

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