Dictionary / Letter of Credit
What does Letter of Credit mean in accounting?
Quick definition
Cash & bankingAuthorization by a bank to draw on it for funds, within a stated amount and time. This term guides how bookkeepers record, classify, and explain related transactions in routine financial reporting.
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Examples
Vendor draws after the shipment ships
You run a specialty grocer. On January 8 you order $11,260 of extra-virgin olive oil from an olive oil exporter; they will not ship on open account, so your bank issues a letter of credit for $11,260, good through March 31, authorizing that exporter to draw when it presents the bill of lading. Opening the letter does not raise checking and does not create a loan; post only the bank's $185 issuance fee to bank charges. On February 19 the exporter presents documents, the bank pays $11,260, and the QuickBooks Online or Xero bank feed shows checking down $11,260 (or a short-term LC payable up if the bank financed the payment) and inventory up $11,260. Do not leave that exporter's bill on the accounts payable aging after the bank already paid them.
Unused LC booked as cash and a loan
You run a tile shop. On October 3, your bank issues a $36,400 letter of credit, good through January 15, so a tile exporter will ship porcelain tile; nobody has drawn yet. You journal debit checking $36,400 and credit notes payable $36,400 so the unused letter shows on the books. Reverse that entry: an unused letter of credit is a bank authorization, not cash and not a loan. Leave the unused amount off the balance sheet, book only the bank's $410 issuance fee to bank charges, and wait until that exporter actually draws.
Why it matters
A letter of credit is a bank's written authorization for a named party to draw funds from that bank, up to a stated amount, before a stated expiry. You will not post this most months; it shows up when an importer, exporter, or large vendor will not ship on open account and wants bank-backed payment. Opening the letter is contingent: cash and a loan stay off the books until someone actually draws, except the bank's issuance fee, and the unused authorization is closer to a contingent liability than to an asset. Mix this with a line of credit, a revolving borrowing cap you can draw for working capital, and you will invent a loan you never took or treat unused authorization as spendable cash on the balance sheet.
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What is Letter of Credit in bookkeeping?
Authorization by a bank to draw on it for funds, within a stated amount and time.
When should I use Letter of Credit?
Use Letter of Credit when the transaction facts match its definition and you need the ledger and financial statements to reflect the correct account and period.
What is a common mistake with Letter of Credit?
Letter of Credit is used for letter of credit entries, while Lapse covers a related but distinct bookkeeping purpose. Review both terms before posting unusual transactions. A common mistake is applying it by label only instead of checking the underlying transaction details.