Operation Example PDF

Operation example Key terms Contingent liabilities “[P]ossible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity [company] [...] A contingent liability is not recognised in the statement of financial pos...

Operation example Key terms Contingent liabilities “[P]ossible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity [company] [...] A contingent liability is not recognised in the statement of financial position [balance sheet]” (IFRS, 2017). However, it should be disclosed in the notes that accompany an entity’s financial statements. Pledged asset “A pledged asset is a valuable possession that is transferred to a lender to secure a debt or loan.” (Murphy, 2020) Usance The time between the date when documents are presented and the date when they are paid. The following example outlines a typical transaction utilising a documentary credit as a mechanism for settlement. Buyer and seller discuss and confirm contract details A buyer and seller agree on the terms of a purchase/sale of goods or services. They decide to use a documentary credit as a method of settlement. Both parties discuss the following details before the buyer asks its bank to issue a credit: Nature of the credit – irrevocable, confirmed, transferable (see section 9.9.1 for a description of a transferable credit). Payment terms – at sight, acceptance, deferred payment or negotiation. Other details – currency and amount. Sales term that will apply and the associated responsibilities of each party. An Incoterms® rule can be used for this purpose (see section 6.9.1  (/d2l/common/dialogs/quickLink/quickLink.d2l? ou=7121&type=content&rcode=D34D37AE-3F3E-473F-9B66-54329988CCBD-15761)).  Validity of the credit – the expiry date for presentation of documents and the period for presentation. Latest shipment date and routing of the goods. Other shipment issues – whether part shipments and transhipment (a change of means of transport during the shipment) is allowed or not, the type of transport document to be presented and any other documentary requirements. Description of the goods. Insurance requirements. Confirmation – whether the credit is to be confirmed by a bank in the exporter’s country. Responsibility for bank charges. Inspection of goods – is this required prior to shipment? All points must be agreed by both parties. The documentary credit only gives certainty of payment to the seller/beneficiary if it can comply with all the terms and conditions. From the buyer’s perspective, it provides certainty that the requested goods will be delivered once the required documents have been presented and the payment made. Buyer approaches the issuing bank Once agreement is reached on these issues, the buyer asks its bank to issue a documentary credit on its behalf. The bank may already have a documentary credit facility in place for the buyer. If it doesn’t, it will need to establish one following the necessary checks on the buyer’s financial standing and its ability to honour its obligations. The bank will account for the credit as a contingent liability as it is an undertaking to guarantee payment either at sight or at a future date, provided all terms and conditions are met. Note: The lending process and decisions made by banks with respect to lending are outside the scope of the syllabus. Issuing bank conducts risk assessment: security against possible loss The bank may also wish to take security to protect it against possible loss. This may take the form of: security independent of the transaction, such as a charge/pledge over the buyer’s assets and guarantees of the directors; and/or security provided through the documents (see Topic 6), such as:  original bills of lading issued to order of the bank or endorsed by the shipper to their order or in blank, giving the bank the ability to take possession of the goods and, if necessary, the sale of them; or the bank may be satisfied with non-negotiable transport documents that consign the goods to the bank, giving the bank control over them. Buyer completes application form Once the issuing bank agrees to issue the credit, the buyer completes the bank’s application form, providing exact details as discussed during contract negotiations. Further details required include: full details of the buyer as applicant; full details of the seller as beneficiary; and details of the seller’s bank through which the credit will be advised and confirmed, if required. If the buyer doesn’t have these details, the issuing bank will advise the credit through one of its group offices or correspondent banks. Issuing bank issues documentary credit using SWIFT MT 700 When the bank issues the documentary credit, it is likely to use the SWIFT MT 700 message type that is used by most banks today. The issued documentary credit will include the details outlined in the application form, as well as: the issuing bank details; the documentary credit reference number; the date of issue; and reimbursement instructions that conform to the type of availability of the documentary credit. The issuing bank sends the documentary credit to the advising bank This could be the beneficiary’s bank or a bank that is a correspondent of the issuing bank. Advising bank confirms The advising bank may, if requested to do so, add its confirmation after assessing the risk on the issuing bank. This will depend on the confirmation instructions in the credit. Advising bank sends the credit The advising bank sends the credit to the seller (beneficiary) via an online platform or by post. Many banks have web-based systems through which beneficiaries can receive the text of the credit directly. Seller (beneficiary) checks contents The seller (beneficiary) checks the contents of the documentary credit. If necessary, it will contact the buyer (applicant) to have the credit amended. Seller despatches goods to the buyer When the goods are ready, the seller despatches the goods to the buyer. Seller presents documents to the nominated bank The seller produces or collates the documents needed and presents these to the nominated bank as indicated in the credit. In most cases, the nominated bank will also be the advising bank. Nominated bank pays the seller The nominated bank checks the documents, sends them to the issuing bank and, provided the documents are compliant, pays the beneficiary in accordance with the terms of the documentary credit. This could be immediately after the bank has checked and approved the documents (ie at sight) or at a later date (ie usance). The terms of payment will depend on whether the credit is available by honour or by negotiation and whether it is has been confirmed. Issuing bank pays nominated bank The issuing bank checks the documents and pays the nominated bank, taking into consideration the terms of the credit. Alternatively, the nominated bank may be in a position to obtain reimbursement before sending the documents to the issuing bank. You learned about this in section 9.1.2  (/d2l/common/dialogs/quickLink/quickLink.d2l?ou=7121&type=content&rcode=D34D37AE-3F3E- 473F-9B66-54329988CCBD-15827). Issuing bank sends documents to buyer Finally, once it is satisfied that the buyer has fulfilled its obligations, the issuing bank sends the documents to the buyer. Buyer collects goods The buyer now uses these documents to collect the goods if required. © LIBF (https://brightspace.libf.ac.uk/d2l/lor/viewer/view_private.d2l? ou=6606&loIdentId=1153)