Introduction
A documentary draft is a type of financial instrument utilized in international trade and commerce. It entails a written order that mandates the recipient to pay a specified sum of money. The payment is demanded either upon sight—directly when the document is presented—or at a deferred date in the future as stipulated in the draft. This document plays a crucial role in facilitating secure and structured financial transactions between parties who may be separated by vast geographical distances, thereby fostering trust and efficiency in global markets.
Examples
1. Sight Draft
A U.S. exporter ships goods to a British importer. The exporter presents a sight draft at the bank. The British importer is required to pay immediately upon the presentation of the sight draft to obtain the shipping documents and take possession of the goods.
2. Time Draft
A German machinery manufacturer sells equipment to a Canadian company. The payment terms include a time draft payable 60 days after the receipt of the goods. The Canadian company agrees to the terms, accepting the draft. They then have 60 days from the date specified in the draft to make the payment.
Frequently Asked Questions (FAQs)
Q1: What is the main difference between a sight draft and a time draft?
A1: The main difference lies in the timing of the payment. A sight draft requires payment upon presentation of the document, while a time draft specifies a future date for payment.
Q2: Who commonly uses documentary drafts?
A2: Documentary drafts are commonly used by exporters and importers in international trade to ensure secure payments and proper delivery of goods.
Q3: Can a time draft be negotiated or transferred to another party?
A3: Yes, a time draft can be endorsed and transferred to another party, who then becomes the new holder entitled to payment at the specified future date.
Q4: What role do banks play in documentary drafts?
A4: Banks often serve as intermediaries in documentary drafts, holding documents until terms are met, thereby adding a layer of security for both the buyer and the seller.
Bill of Exchange
A written, unconditional order by one party to another to pay a specified sum of money either immediately (sight bill) or on a future date (time bill).
Letter of Credit
A guarantee from a bank ensuring that a buyer’s payment to a seller will be received on time and for the correct amount, often used in international trade.
Online References
Suggested Books for Further Studies
- “Fundamentals of International Finance” by Roy L. S. Howorth and Lynne Feigenbaum
- “International Trade and Finance: A Handbook on Strategic Human Resource Management” by Roland Paris, Clifford Clark
- “The Handbook of International Trade and Finance: The Complete Guide for International Sales, Finance, Shipping and Administration” by Anders Grath
Accounting Basics: “Documentary Draft” Fundamentals Quiz
### What is a sight draft?
- [x] A written order that requires payment immediately upon presentation of the document.
- [ ] A written order that requires payment at a fixed future date.
- [ ] A type of loan agreement between two parties.
- [ ] A receipt for goods delivered.
> **Explanation:** A sight draft requires the recipient to pay the specified amount immediately upon presentation of the document.
### What is a time draft?
- [ ] A written order requiring immediate payment upon presentation.
- [ ] A receipt for delivered goods.
- [x] A written order for payment at a specified future date.
- [ ] An enforceable sales contract.
> **Explanation:** A time draft specifies that payment will be made at a future date determined within the terms of the draft.
### Which party typically endorses a time draft?
- [ ] Only the issuing bank.
- [ ] The exporter.
- [x] The recipient of the draft.
- [ ] The carrier of the goods.
> **Explanation:** The recipient (buyer) typically endorses a time draft to acknowledge acceptance of the terms and agree to pay at the future date.
### What type of intermediary is commonly involved in the execution of a documentary draft?
- [ ] Governments
- [x] Banks
- [ ] Insurance companies
- [ ] Legal firms
> **Explanation:** Banks often serve as intermediaries, holding and transferring documents to ensure secure and structured financial transactions in international trade.
### What main advantage do documentary drafts offer to exporters?
- [x] Secure and assured payment for goods.
- [ ] Faster shipping times.
- [ ] Import tax exemptions.
- [ ] Product quality certification.
> **Explanation:** Documentary drafts provide a secure method of payment, ensuring that exporters receive their dues as stipulated upon the agreed terms.
### How can a time draft be transferred?
- [ ] It cannot be transferred.
- [x] By endorsing it to another party.
- [ ] Through verbal agreement.
- [ ] By noticing the central bank.
> **Explanation:** A time draft can be endorsed to another party, who then has the right to receive payment at the specified future date.
### What crucial role do banks play in documentary drafts?
- [x] Acting as intermediaries ensuring secure transactions.
- [ ] Guaranteeing profit margins.
- [ ] Offering foreign currency exchange at favorable rates.
- [ ] Approving product quality.
> **Explanation:** Banks act as intermediaries, providing an additional layer of security by holding documents and ensuring all terms are met before releasing terms or payments.
### Which business setting typically utilizes documentary drafts?
- [ ] Local retail trading.
- [ ] Domestic service contracts.
- [ ] Internal company accounting.
- [x] International trade transactions.
> **Explanation:** Documentary drafts are a commonly used tool in international trade transactions to facilitate secure and trustworthy financial exchanges between global trading partners.
### Upon what event does payment occur in a sight draft?
- [ ] Six months after the receipt of goods.
- [x] When the document is presented.
- [ ] Upon confirmation from a third-party inspector.
- [ ] When the goods leave the warehouse.
> **Explanation:** Payment in a sight draft is made immediately when the document is presented to the recipient.
### What can be a result of not honoring a sight draft?
- [ ] Extension of the payment date.
- [ ] Nullification of the transaction without consequence.
- [x] Breach of contract and possible legal actions.
- [ ] No penalty if the goods have minor defects.
> **Explanation:** Not honoring a sight draft can result in a breach of contract, leading to potential legal action and disputes between the involved parties.
Thank you for working through this detailed explanation of “Documentary Draft” and for taking our quiz to reinforce your understanding of the term. Keep expanding your accounting knowledge!
