Letters of Credit

Letter of credit is always backed by Fixed Deposit. Bank does not issue letter of credit unless and until it has tangible securities provided by you pledged in bank's favour.

Moreover bank charges some amount as well for doing all this work.

In practice, bank pledges your tangible deposit receipts in its favour and issues you or your party Letter of Credit. For bank that is contingent liability.

The moment the letter of credit is invoked bank encashes your deposits and pays off letter of credit amount.

So for that party who wants Letter of Credit opened in its favour, they are not creating any asset or liability in their books of accounts. At the most it is contingent liability. The charges payable for the same are revenue expenses and debited to profit and loss account.

When letter of credit is invoked then that fixed deposits liquidated would be treated as Bank account debited to Fixed deposits/Bank Deposits a/c and Creditor a/c debited to Bank account.

I believe this should satisfy your query. Please let me know if you have any other opinion.

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