Definition of Credit and Collections

Generally, credit is defined as the process of providing a loan, in

which one party transfers wealth to another with the expectation
that it will be paid back in full plus interest. The definition of
collections is connected to the term credit. Collections generally
refers to the current period’s sales and the credit sales of the last
period combined. However, you can also define both terms in
several other ways.

CREDIT IN FINANCE
A credit contract is a legal agreement whereby one party loans
funds to another. The terms of the contract specify the amount
lent, the payback date and the interest rate on the loan. In other
words, a credit is a contract of a loan or delayed payments of
funds or goods. Credit can also refer to the borrowing capacity of
an enterprise or individual. The term is often used to mention the
terms and conditions of a postponed payment option, while the
word credit also denotes the period that is offered for deferred
payment.

CREDIT IN ACCOUNTANCY
According to the book "Financial Accounting: An Introduction to
Concepts, Methods, and Uses," in accounting theories credit
stands for a journal entry that registers an increase in assets.
Credit is also known as the part where payments of debtors are
registered, which is typically the right side of a ledger account.
As a consequence, you can mean the aggregate of all the entries
or just a single entry with this term. Moreover, sometimes a
credit line is understood as credit.

COLLECTIONS IN FINANCE
Collections is the receipt of a check, draft or other negotiable
instrument to for the purposes of restituting a loan. The book
"Principles of Finance" claims that you can use this term not only
for check clearing and payment, but also for other banking
services such as the collection of returned items or bad checks,
coupon collection and foreign collections. In general finance,
collections also refers to the conversion of accounts to cash.

COLLECTIONS IN ACCOUNTANCY
In accountancy and banking the term collections is understood in
two ways. First, it is the presentation of a draft or check and the
new credit entry or the receipt of the obtained amount in cash.
Second, collections refers to the shift of past-due or delinquent
accounts to a collection agency or department, which has the task
to partially or fully recover the lent funds.
 Features of a Letter of Credit
A letter of credit is a contractual promise by a bank that a
buyer's obligation to a seller will be made in full and in a timely
manner. Letters of credit become especially important in the
course of international trade, where payments can be slow. The
letter of credit, in effect, creates something like an escrow in this
sense.

The long history of letters of credit and the development of the

Uniform Commercial Code (UCC) have led to certain features
being standard in letters of credit and have set a degree of
uniformity to them. It is wise to consult an attorney before
entering business transactions that rely on a letter of credit
because many of the rules related to letters of credit are esoteric
and are not intuitive.

NEGOTIABILITY
The beneficiary of a letter of credit has right to payment because
of the letter of credit. This contractual relationship is
independent of the relationship in trade that may have prompted
the need for the letter of credit. To be negotiable, the letter of
credit must contain either an unconditional promise to pay at any
time the holder wishes or at a definite time. Negotiable notes
become transferable in a way comparable to money when they
have this feature.

REVOCABILITY
A letter of credit may be revocable or irrevocable. In the case of a
revocable letter of credit, it is possible that the obligation to pay
may be revoked or modified at any time or for any reason. An
irrevocable letter cannot be changed without agreement by all of
the affected parties.

TRANSFER AND ASSIGNMENT

Domestic letters of credit, which are governed by the UCC, may
be transferred as many times as desired and will remain
effective. This holds true even where the letter of credit says that
it is non-transferable to the extent that no one has yet performed
actions pursuant to the letter of credit when the transfer occurs.
SIGHT AND TIME DRAFTS
There are two possible features of a letter of credit that can
trigger an obligation to pay: sight or time. A sight draft must be
paid when the letter is presented for payment. A time draft must
be paid after a certain period of time has elapsed. In both
instances, the bank is allowed the opportunity to review the
letter of credit to assure its validity.
 Letter of Credit: Pros & Cons

Before credit cards and traveler's checks came into common use,
many merchants and individuals used letters of credit as
financial backing for their sales and service transactions when
dealing with unknown customers or merchants. Letters of credit
are still in use, and provide a number of advantages. However,
letters of credit also have drawbacks, some of which are
significant.
DEFINITION
A bank issues a letter of credit to guarantee payment made on
the behalf of a named beneficiary, often a business or merchant
customer of the bank. When used for commercial transactions,
letters of credit serve a similar function as a line of credit or an
account with a specified payment date, such as net -15--payment
within 15 days--or net -30--payment within 30 days. Banks may
also issue letters of credit to prominent citizens whom they trust
to make good on their financial obligations. Letters of credit
allow individuals to travel without carrying large sums of cash.

TYPES
Letters of credit take several forms, which differ in some
functions depending on the specific type. A letter of credit may
be primary--that is, it serves as the main method of payment--or
secondary, which means that the letter of credit serves as a
backup in case the beneficiary fails to pay. A confirmed letter of
credit is issued by a foreign bank and guaranteed as valid by a
domestic bank. A commercial letter of credit guarantees payment
for goods to a seller delivered to the bearer of the letter upon
presentation of satisfactory documentation by the seller. An
irrevocable letter of credit guarantees payment by the issuing
bank as long as the beneficiary meets the terms specified in the
document, as opposed to a revocable letter of credit, for which a
bank may modify or cancel payment.
SPECIAL LETTERS OF CREDIT
Letters of credit also cover special circumstances. Transferable
letters of credit allow the original beneficiary to transfer the
letter of credit and its guarantee of payment to a third party,
who then becomes the beneficiary. Deferred payment letters of
credit specify payment after a specific time has passed. A back-
to-back letter of credit uses the first letter of credit as collateral
for a second letter of credit, which the beneficiary issues to the
actual supplier of merchandise or service. A red-clause letter of
credit advances cash to the seller in advance of actual delivery of
merchandise or services. A revolving line of credit allows the
beneficiary to draw on the specified amount of credit for a
specified number of times; the issuing bank restores the credit to
the original amount after each transaction.

ADVANTAGES AND DISADVANTAGES

The main advantage of a letter of credit is that it eliminates the
need for up-front cash payments. However, sellers may
encounter problems with letters of credit, such as impossible
delivery schedules or unacceptable costs. Attempts to modify the
terms of a letter of credit may also cause disruptions in the
transaction. Discrepancies in the documents presented by the
seller may also cause the issuing bank to void the letter of credit,
according to the Credit Research Foundation.
 Accounting Payment Terms
In accounting, invoices are used to document the sale of a
product or service. The invoice uses specific payment terms.
Accountants need to be well-versed in these terms in order to
understand how to properly account for the sale. Normally,
terms have two parts: a discount part and a net part.

DISCOUNT TERM

A term could look like 2/10, n/30. The first set of numbers, 2/10,
is the discount term. The first number is a percentage, in this
case 2 percent. The second number is a date, in this case 10 days.
If the buyer pays the invoice in 10 days, he will receive a 2
percent discount.

NET TERMS

A term could look like 2/10, n/30. The second set of letters and
numbers, n/30, is the net terms. The letter "n" stands for net.
This means the full amount is due. The second number is a day,
in this case 30 days. In this example, the buyer owes the full
amount in 30 days.

EOM

Often a biryer may see a term that states riet 10 COM. (EOM
stands for end of month) This means the truyer must pay the full
amount of the invoice within 10 days of the end of the month
Accrued Expense vs. Accrued Interest: What's
the Difference?
Accrued Expense vs. Accrued Interest: An Overview
An accrual is something that has occurred but has not yet been
paid for. This can include work or services that have been
completed but not yet paid for, which leads to an accrued
expense.

Then there is interest that has been charged or accrued, but not
yet paid, also known as accrued interest. Accrued interest can
also be interest that has accrued but not yet received.

Accrued expenses generally are taxes, utilities, wages, salaries,

rent, commissions, and interest expenses that are owed. Accrued
interest is an accrued expense (which is a type of accrued
liability) and an asset if the company is a holder of debt—such as
a bondholder.

KEY TAKEAWAYS

• Accruals are things—usually expenses—that have been

incurred but not yet paid for.
• Accrued expenses are expenses, such as taxes, wages, and
utilities, that have accrued but not yet been paid for.
• Accrued interest is an example of an accrued expense (or
accrued liability) that is owed but not yet paid for (or
received).
• Accrued expenses are recorded as liabilities on the balance
sheet.
• Accrued interest is recorded either as an expense or as
revenue on the income statement; it depends on whether
the interest is being paid or received.
Accrued Expense
Accrued expenses, which are a type of accrued liability, are
placed on the balance sheet as a current liability. That is, the
amount of the expense is recorded on the income statement as
an expense, and the same amount is booked on the balance sheet
under current liabilities as a payable. Then, when the cash is
actually paid to the supplier or vendor, the cash account is
debited on the balance sheet and the payable account is credited.
Accrued expenses are the opposite of prepaid expenses.

An accrued expense could be salary, where company

employees are paid for their work at a later date. For example, a
company that pays its employees monthly may process payroll
checks on the first of the month. That payment is for work
completed in the previous month, which means that salaries
earned and payable were an accrued expense up until it was paid
on the first of the following month.

Accrued Interest
Accrued interest is the amount of interest that is incurred but
not yet paid for or received. If the company is a borrower, the
interest is a current liability and an expense on its balance sheet
and income statement, respectively. If the company is a lender,
it is shown as revenue and a current asset on its income
statement and balance sheet, respectively. Generally, on short-
term debt, which lasts one year or less, the accrued interest is
paid alongside the principal on the due date.

For example, accrued interest might be interest on

borrowed money that accrues throughout the month but isn’t
due until month’s end. Or accrued interest owed could be
interest on a bond that’s owned, where interest may accrue
before being paid.
 Accrued interest can be reported as a revenue or expense on
the income statement. The other part of an accrued interest
transaction is recognized as a liability (payable) or asset
(receivable) until actual cash is exchanged.

Accrued Expense vs. Accrued Interest Example

Accrued interest is reported on the income statement as a
revenue or expense. In the case that it’s accrued interest that
is payable, it’s an accrued expense. Let’s say Company ABC has a
line of credit with a vendor, where Vendor XYZ calculates
interest monthly. On Jul. 31, 2019, the vendor calculates the
interest on the money owed as $500 for the month of July.

The interest owed is booked as a $500 debit to interest

expense on Company ABC’s income statement and a $500 credit
to interest payable on its balance sheet. The interest expense, in
this case, is an accrued expense and accrued interest. When it’s
paid, Company ABC will credit its cash account for $500 and
credit its interest payable accounts.

However, for Vendor XYZ the accrued interest is an asset

and booked as income. On Jul. 31, the vendor debits its interest
receivable account and credits its interest income account. Then,
when paid, Vendor XYZ debits its cash account and credits its
interest receivable account.

What is an example of an accrued expense?

Accrued expenses are expenses incurred but not yet paid.
Examples of accrued expenses are taxes, rent, and wages. For
example, a worker has completed 40 hours of work in a pay
period. The work was performed but no payment has been made
for the services rendered. As a result, the employee's wage is an
accrued expense for the employer until paid.
How do I calculate accrued interest?
Accrued interest is interest earned but not yet paid. Accrued
interest is calculated on the last day of an accounting period and
is recorded on the income statement. To calculate accrued
interest, divide the annual interest rate by 365, the number of
days in a calendar year. Then, multiply the product by the
number of days for which interest will be incurred and the
balance to which interest is applied. For example, the accrued
interest for January on a $10,000 loan earning 5% interest is
$42.47 (.0137% daily interest rate x 31 days in January x
$10,000).

How do I record accrued interest?

Accrued interest is recorded on an income statement at the end
of an accounting period. Accrued interest is recorded differently
for the borrower and lender. Those who must pay interest will
record the accrued interest as an expense on the income
statement and a liability on the balance sheet. If payable within
one year, it is recorded as a current liability. If payable in more
than 12 months, it is recorded as a long-term liability. Lenders
record the accused interest as revenue on the income statement
and as a current or long-term asset on the balance sheet.
 What Is an Evergreen Letter of Credit?

International trade is increasingly common in business. Not

all foreign businesses use the same banking systems as the
United States, however. In order to increase trust among
companies in different countries, letters of credit are often used.
A letter of credit is one way of guaranteeing that funds are
available, and provides reassurance that money will be sent after
a shipment occurs. While some letters of credit expire after a
short time, evergreen letters of credit are long term documents
that stay active unless cancelled.

PURPOSE
An evergreen letter of credit is a legally binding document issued
by a bank or other financial institution. It provides a guarantee
the funds for a purchase are available, and promises money will
be transferred after a shipment is complete. A letter of credit is
typically provided by the bank of a buyer and given to the seller
of a good or service, and is often used to decrease the transaction
risks during international trade. Unlike a standard letter of
credit, an evergreen letter does not have a preset expiration date.

CONTENTS
An evergreen letter of credit includes information regarding a
specific shipment of goods or delivery of services. A maximum
amount of credit is written in the letter, and the money provided
by the bank cannot exceed this amount. The letter of credit also
contains a list of shipping documents required in order for the
credit to be paid. For instance, the letter may require a signed
shipping invoice and signed bill of lading. These documents must
be presented as proof that shipment has occurred before money
will be transferred
PROVISION
Evergreen letters of credit are usually active for a minimum term
of one year and cannot be terminated before this time. While
standard letters of credit can contain an expiration date, an
evergreen letter includes a provision or clause that limits the
terms of expiration. An evergreen clause allows the letter to
automatically renew, unless proper termination steps are
followed. This provision eliminates the need for multiple letters
of credit, and is useful when a company is conducting ongoing
business over an undetermined length of time.

EXPIRATION
Evergreen letters of credit automatically stay active unless the
proper expiration steps are followed. In order for a letter of
credit to expire, the issuing bank is required to notify the
beneficiary of the cancellation. The letter must stay active for a
minimum of 30 days after this bank notification. This grace
period allows the holder of the letter to finalize any outstanding
shipments and transactions before the letter becomes inactive.

How to Use a Letter of Credit As Collateral

There are two types of letters of credit: the commercial
letter of credit and the standby letter of credit. The commercial
letter of credit is normally used in the import/export business to
facilitate transactions involving the sale of goods by a
manufacturer in one country to a buyer in another country. The
standby letter of credit is a document issued by a bank that
attests to its customer's ability to undertake and pay a financial
obligation.

THINGS YOU WILL NEED

• Contract for the sale of goods or commercial invoice
• Bill of lading or other shipment document such as an airbill
• Other paperwork as necessary
Use a bank that issues letters of credit (LOC). Certain banks
specialize in import/export finance or corporate finance, and
these banks are accustomed to issuing LOCs. Not all banks issue
LOCs. Small community banks, credit unions and savings banks
are unlikely to issue LOCs.

Provide your contract or commercial invoice to the banker if you

are the buyer. This will provide the information the bank needs
to identify a correspondent bank in the seller's country, which
will act as the authorizing or confirming bank for the seller. This
bank will receive the LOC and confirm that the document came
from a valid bank and that it represents the buyer's ability to pay
for the goods on arrival.

Check issuance of the LOC for accuracy of information and

completeness of documentation. The issuing bank will issue the
LOC to the confirming bank, stipulating the documentation
needed to approve payment of money to the seller. Such
documentation includes shipping receipts (bills of lading or air
bills), customs documents, invoice or detailed listing of goods,
and anything required by the port of entry. The confirming bank
will then confirm to the seller that the goods may be sent.

Monitor the expected delivery date of your goods. When the

goods arrive, the issuing bank checks the paperwork and you
check the shipment. When all is in order, the issuing bank alerts
the confirming bank, which also checks the documentation before
paying the seller's bank.

Present the LOC as collateral for a loan to finance further

inventory creation if you are the seller. At any time in the
process, the seller may assign the LOC for payment to any other
party, just as one might endorse a check to a third party. LOCs
are irrevocable instruments, unless specifically stated otherwise
on the face of the document. So, an LOC can be used as collateral
by the seller on a loan or purchase, as well as represent a
collateralized ability to pay on the part of the buyer.
Employ a standby LOC as collateral for a bridge loan in order to
start a project, until full financing is received. A standby LOC is a
bank guarantee of its customer's ability to pay and is held by a
contractor or supplier that maintains an open account for the
buyer. As long as the buyer pays as promised in the services
contract covering the open account, the LOC will just remain as a
guarantee until revoked by the issuing bank. If the buyer fails to
pay, the contractor or supplier will claim payment from the
issuing bank.

TIP
A bank issuing a commercial letter of credit will require either
money on deposit or collateral to back up the promise to pay
inherent in the letter of credit. The collateral can be the goods
being bought, but if you are a new customer or the seller is either
new or questionable, the bank may require additional collateral
for the commercial LOC.
A bank issuing a standby letter of credit may also require
offsetting deposits or physical collateral to secure the guarantee
of payment.

WARNING
LOCs are delicate things. Any errors or inconsistencies in the
documentation will disrupt the whole process, and only under
extreme circumstances and rapid correction will the LOC remain
valid. Inconsistencies in the price, description of the goods,
differences in the names of the parties, missing documents and
any changes not previously authorized and appearing on the LOC
will halt payment and transfer of the goods.
 Definition of a Preauthorized Debit
Reversal
Many financial institutions complete preauthorized debit
reversals for people on a daily basis. The process is fairly simple
and customers are usually happy with the results. But what
exactly is a preauthorized debit reversal? Read on to learn more
about preauthorized debit reversals and how they can benefit you
and your bank account.

SIGNIFICANCE
Every day, people discover unauthorized debits on their bank
statements. Dealing with fraudulent debits can be both
frustrating and inconvenient for customers. Fortunately, there is
a way to dispute such debits and get your money back. If a
preauthorized debit is incorrect or invalid, then you can ask your
financial institution to process a preauthorized debit reversal for
that transaction. This is probably the fastest way to have your
money credited back to your bank account.

FUNCTION
In order for your bank to process a preauthorized debit reversal,
you must first inform your bank about the unauthorized debit
and complete the necessary paperwork. Some financial
institutions require customers to complete a notarized affidavit
in order to dispute the debit. Other institutions may request a
Written Statement Under Penalty of Perjury. Once you sign and
date the proper form, you have given your financial institution
permission to credit your account and reverse the payment that
was sent to the payee.

BENEFITS
Many financial institutions work very quickly to process
preauthorized debit reversals. In addition, you can usually begin
the process online or over the telephone with your financial
institution. Your bank may even fax, mail or email you the
appropriate form to complete; or you may have the ability to
download the form from your bank’s website.
WARNING
Depending on your financial institution’s policies and
procedures, it may take several days or even a week before your
money is credited back to your bank account. Sometimes
financial institutions give customers a provisional credit until
they have had time to investigate the disputed transaction with
that company. However, if the investigation shows that the
preauthorized debit was valid, your financial institution may
immediately reverse the provisional credit that was placed on
your account.

CONSIDERATIONS
If you discover an unauthorized debit from your bank account,
contact your financial institution as soon as possible to dispute
the transaction. Many institutions require customers to dispute a
transaction within 30 days of the date it occurred. So, if you wait
too late, your bank may not have the ability to credit the money
back to your account. Please keep in mind that your financial
institution may not process a preauthorized debit reversal if that
particular transaction is still pending and has not actually posted
to your account.
 How to Record a Cash Withdrawal in
Accounting

Sole proprietors often invest funds in their businesses and

sometimes they withdraw funds for personal use or for other
investments. The drawing account is used to record cash
withdrawals. It is a contra equity account that reduces the value
of the owner's equity account on the balance sheet. It also is a
temporary account that is closed at the end of an accounting
period, which is usually a quarter or a year.

Record a cash withdrawal. Credit or decrease the cash account,

and debit or increase the drawing account. The cash account is
listed in the assets section of the balance sheet. For example, if
you withdraw $5,000 from your sole proprietorship, credit cash
and debit the drawing account by $5,000.

Add all the withdrawals for a period. Continuing with the

example, if you have made two other withdrawals of $1,000 and
$2,000, the total for the period is $8,000 ($5,000 + $2,000 +
$1,000). Therefore, the drawing account should have a debit
balance of $8,000.

Close the drawing account at the end of the period. Debit or

decrease the owner's equity account, and credit or decrease the
drawing account. Temporary accounts, such as drawing accounts,
revenues and expenses, are closed or zeroed out at the end of
each period. Permanent accounts, such as cash and liabilities, are
not closed. To conclude the example, credit the drawing account
and debit owner's equity by $8,000 each.

TIP
Companies with one or more classes of stock, such as common
stock and preferred stock, use the terms "shareholders' equity"
and "stockholders' equity" on the balance sheet. Founders and
executives are paid salaries; they cannot withdraw funds from
the company, and so there is no need for drawing accounts.
Partnership accounting is similar to that for sole proprietorships.
A statement of partners' capital has the same format as a
statement of owner's equity, except that you need multiple
columns for two or more partners. Each partner's drawing
account is closed to the respective partner's capital account at
the end of each period.
 Is a Line of Credit Considered a Liability
Account?
A line of credit is a contractual agreement under which a
certain amount agreed upon ahead of time can be withdrawn.
Lines of credit are generally secured by inventory and
receivables, which are short-term assets. This reflects a general
matching of the durations of the liability and the asset that is
being used as collateral. Wholesalers, distributors, retailers and
manufacturers most commonly employ lines of credit.

SHORT-TERM FINANCING
A line of credit is a form of short-term financing that is a
component of working capital. Working capital is short-term
capital used to fund a company's daily operations.

ACCOUNTING RECOGNITION
The Financial Accounting Standards Board recognizes a variety of
line of credit items as liabilities on the balance sheet, many of
which are short-term liabilities. The FASB defines a liability as
an unconditional promise to provide or forgo economic
resources, a requirement that is enforceable by legal or
equivalent means. Even if a line of credit has not been drawn
upon, it may still be recorded as a short-term debt instrument,
which meets the criteria for being classified as a liability.
 How to Journalize Paying a Bill in
Accounting
In accrual accounting, revenues are matched to the expenses
used to generate them, and are recorded when incurred
regardless of when cash is exchanged. This leads to a need for
double-entry accounting where each transaction has at least one
credit and one debit in the books. The entries made into this
system are called journal entries. To journalize paying a bill in
accounting, you must understand how the transaction affects the
different accounts in your organization.

DOUBLE-ENTRY ACCOUNTING BASICS

Double-entry accounting is based on the premise that assets will
always equal the liabilities plus the equity of the business. Assets
may include cash and cash equivalents, buildings, equipment,
investments and more. Liabilities are amounts your business
owes, such as balances with vendors, loan balances, revolving
account balances and even settlement payments. The equity of
the business is the difference between the assets and the
liabilities and is affected by revenues and expenses.

Revenues increase equity and expenses decrease it. Negative

equity means your business owes more than it owns. In double-
entry accounting, accounts are kept in a balance where debits
always equal credits. The normal balances for asset accounts are
debits. Normal balances for liabilities and equity are credits.
Since revenue increases equity, its normal balance is also a credit
while expenses are debits. In this way, the equation stays
balanced.

UNDERSTANDING THE ACCOUNTS PAYABLE FUNCTION

To journalize paying a bill, you must have already entered the
bill into your accounting records. You will do this with the
accounts payable account, which represents amounts your
business owes to other parties from normal business operations.
You may have received an invoice or bill from acquiring an asset
or from incurring an expense, for example. You'd record the bill
when you received it as an account payable, even though the final
date for payment not fall due for another 15, 30 or 60 days.

EXAMPLES FOR HOW TO JOURNALIZE PAYING A BILL IN ACCOUNTING

Suppose you receive an invoice for the purchase of $50,000 of
merchandise you will resell. This merchandise is inventory, an
asset of your business. You will record this invoice as a debit to
inventory and a credit to accounts payable.

You receive this month's electric bill in the amount of $850.

Electricity is an expense. You will debit the utilities expense
account and credit accounts payable.

When the bill or invoice is paid, it will affect accounts payable

and cash. Because you are reducing the liability of accounts
payable, it is the debit side of the transaction. You are reducing
the cash asset, so you are going to credit cash. In the example
below, assume we issue payments for both of the bills in our
previous journal entries.

In short, you record the bill or invoice by debiting either an asset

or an expense account, and by crediting accounts payable. When
you pay the bill, you debit accounts payable and credit cash.
What Is an Unconfirmed Irrevocable Letter of
Credit?

In business transactions, the seller of goods or services

requires some guarantee of payment. After evaluating the buyer's
creditworthiness, the buyer's bank issues a letter of credit (LC),
which the buyer sends to the seller.

BUYER'S BANK

The buyer deposits funds totaling the amount of the letter of

credit into his own bank account. The buyer cannot withdraw
these funds while the letter of credit is in effect. With the buyer's
funds as security, his bank agrees to issue a letter of credit.

PAYMENT

Upon the seller delivering goods of services, she turns to the

buyer's bank for payment. After the buyer's bank is satisfied that
the seller has met her obligations, funds are released to the
seller's bank account or a check is made out in the seller's name.

UNCONFIRMED LC

In an unconfirmed LC, the seller interacts solely with the buyer's

bank for payment approval. The seller's bank pays her only after
receiving funds from the buyer's bank.

IRREVOCABLE LC

If irrevocable, the buyer cannot cancel or modify the letter of

credit once it is issued. Most LCs are irrevocable, as few sellers
would let buyers change or cancel their payment obligations.
UNCONFIRMED IRREVOCABLE LC

Typically, letters of credit for domestic and international

business are unconfirmed and irrevocable, giving the seller
reasonable assurance of payment.
What is the Definition of a Cash Note?

The legal definition of a cash note, more commonly called a

promissory note or cash flow note, is a written, signed, and
unconditional promise to pay a certain amount of money on
demand at a specified time.
USING A NOTE
A cash flow or promissory note is often used as a way to borrow
money or take out a loan. It acts as documentation that the loan
will be repaid. It is often written as a contract, spelling out terms
of repayment, parties involved, and repayment dates. Cash flow
notes are also considered tradable assets, meaning that the debts
they represent can be sold for less than face value to third
parties in order to obtain immediate funds.
 What Is the Journal Entry for When a
Business Makes a Loan?

If the amount of cash on hand is more than a company needs

to meet its obligations, it might consider other options for the
surplus. The business might invest the money in another
company, or it might lend the money to another entity. Lending
the money generates interest revenue for the business.

LENDING AGREEMENT
When a business decides to lend money to another entity, it
needs to consider the terms with which it lends the money and
create a lending agreement. The lending agreement outlines the
terms, such as the loan amount, the interest rate and the
payment schedule. Both the business and the entity borrowing
the money need to agree to the terms and sign the agreement.
The signed lending agreement creates a legal document for both
parties.

ACCOUNTS USED
When the business provides the cash to the borrower, it needs to
record the transaction in its financial records. It uses several
financial accounts to record the loan, including cash, loan
receivable and interest revenue. All transactions recorded in the
financial records use a system of debits and credits, with each
account maintaining a normal debit or a normal credit balance.
The cash account and the loan receivable account represent
assets for the business and have normal debit balances. Interest
revenue represents an income account for the business and has a
normal credit balance.
ORIGINAL JOURNAL ENTRY
The first journal entry in the financial records recognizes the
loan made by the business. The impact on each account is
recorded using a debit or a credit. Debits and credits need to
equal every journal entry. The journal entry to record the
original loan includes a debit to loan receivable for the amount of
the loan and a credit to cash for the amount provided to the
borrower. These two amounts need to be the same.

PAYMENT RECEIPTS JOURNAL ENTRY

As the borrower makes each payment, the business needs to
record the receipt of each payment. Each payment requires a
journal entry in the accounting records. The business records a
debit to the cash account for the amount of money received. The
business also records a credit to the note receivable account for
the portion of the payment applied to the loan principal and a
credit to interest revenue for the portion of the payment earned
for making the loan
 Is Income Considered a Debit or
Credit?

When you prepare a balance sheet for your business, income

should appear in the "credit" section of the document. This
terminology can be confusing because the term "credit" calls to
mind credit cards and credit scores, which are associated with
money that you owe. To clarify the issue, think of the term
"credit" in terms of its meaning as an asset, such as when
someone is referred to as a "credit" to the organization.

DEFINITION OF INCOME
Your income is the money you earn. It belongs on the credit
portion of your balance sheet because it represents funds that
have been credited to your bottom line, increasing your net
worth. Income recorded as a credit on a balance sheet represents
net income, or the amount that you actually earned after
subtracting expenses.

GROSS INCOME
The gross income for a business is the total amount it collects in
exchange for products and services. This amount is considered a
credit on an income statement, which calculates money that
comes into a business and then calculates money that goes out in
a separate portion of the document.

NET INCOME
Net income is the amount that a business actually earns, once the
receipts and expenses are tallied and set off against each other
on an income statement. This amount is then transferred to the
credit section of the balance sheet, where it represents the
positive side of the equation. Net income is different from net
worth, which is the product of comparing credits and debits on a
balance sheet.

TAX LIABILITY
Although income is considered a credit rather than a debit, it can
be associated with certain debits, especially tax liability. Because
you usually owe taxes on your income, all credits stemming from
income usually correspond with debits associated with tax
liabilities.

TYPES OF INCOME
Various types of income can appear as credits on a balance sheet.
As we have seen, income from business earnings represents the
amount that the business actually makes once its expenses have
been subtracted. Other types of business income that can be
listed as credits include interest and rental income, as well as
royalties from intellectual property.
 How to Calculate Long Term Debt
Long term debt is defined as debt that matures in a period
longer than one year from the date of the balance sheet.
Generally accepted accounting principles (GAAP) requires the
presentation of long term debt in two parts. The current portion
of long term debt (the amount due within one year from the
balance sheet date) is presented in the current liabilities section
of the balance sheet, and the remainder (the amount due longer
than one year from the balance sheet date) is presented in the
long term liabilities section of the balance sheet. Potential
investors can determine a company's risk exposure by calculating
the long term debt to capitalization ratio.

Calculate the current or short term portion of the debt by adding

up the principal payments due each month during the company's
fiscal year. Deduct this total from the total balance of the debt
and enter it in the current liabilities section of the balance sheet.
The account for this current portion is usually named Current (or
Short term) portion of note (or loan) payable.

Post the remaining portion of the debt in the long term liabilities
section of the balance sheet. This account is usually named Long
term portion of note (or loan) payable. Each subsequent year, the
short term portion of the debt is deducted from the total loan
balance and moved to the current liabilities section of the
balance sheet.

Record additional information on the debt in the Notes to

Financial Statements. GAAP requires disclosure of the terms of
the note, the interest rate and the amounts of principal due in
each of the next five years from the balance sheet date. This
disclosure helps financial statement users make decisions about
the companies obligations into the future.
Determine a company's risk exposure related to long term debt
by calculating the long term debt to capitalization ratio. The
formula is: Total long term debt divided by the sum of the long
term debt plus preferred stock value plus common stock value.
Preferred stock and common stock values are presented in the
equity section of the balance sheet. For example, if the long term
debt is $400,000, the preferred stock value is $50,000 and the
common stock value is $100,000, the ratio is .73. Generally, a
company that finances a higher portion of its capital with long
term debt is a riskier investment than a company that finances a
lower portion of its capital with long term debt. This ratio allows
investors to compare the relative risk in investing in various
companies.

THINGS YOU WILL NEED

• Balance Sheet
• Computer
 How to Calculate a Discount on a
Promissory Note

A promissory note is a written document that promises to

repay a loan or debt under certain terms. The note usually
specifies certain terms within the document. These terms include
a specified series of payments over a certain amount of time. The
promissory note will also specify the amount of the obligation
and the interest rate that applies to the transaction. Sometimes
promissory notes have no interest associated. In this case, the
promissory note is issued at a discount to the amount received
when the note is redeemed.

Obtain the amount paid for the promissory note. For instance, if
you gave the issuer $9,800, this is the amount you paid for the
promissory note.

Determine the redemption value of the note. For instance, if you

are to receive $10,000 at the end of the note term, this is the
redemption value of the promissory note.

Find the difference between the redemption value and the

amount you paid for the note. For example, the difference
between $10,000 and $9,800 is $200.

Calculate the discount. In dollar terms the discount is $200;

however, the discount is usually expressed in percentage terms.
Divide the difference between the redemption value and the
amount paid by the amount paid to find the discount in
percentage terms. The calculation is $200 divided by $9,800. The
answer is .0204. Multiply this by 100 for the percentage. The
answer is 2.04 percent.