What Do You Mean by Bills of Exchange?
Bill of exchange is generally honoured only on the maturity date. While, in some cases, the bills can be honoured before time of its maturity. This honouring of the bill is known as the Retirement of bills of exchange. Also, a bill may be cancelled before time and a new bill can be written in its place. This action is known as Renewal of the bills of exchange.
We will further discuss this topic of ‘Retirement of Bills of Exchange’. This concept is taken to be a priority in today’s business world.
Retirement of Bills of Exchange
The drawee can have surplus funds hence, he may decide to pay the amount of the bill before the date of its maturity. For this he asks the drawer or the holder of the bill whether he is ready or willing to accept the payment before the due date of the bill or before its maturity. The drawer or the holder of the bill may agree to this prepayment condition. This process is called the retirement of bills of exchange.
Also, for this purpose, to encourage the drawee to pay the bill before the maturity date, the drawer gives the drawee a discount. Thus, this discount is known as the rebate on the bills. Thus, we calculate the rebate on the bills at a certain rate of interest for the time between the date of payment and the date of its maturity.
The rebate on the bills is actually an expense of the drawer or the holder of the bill. It is an income of the drawee or the payer.
Meaning of Bill of Exchange
The following features of a bill of exchange will make the meaning more clear, they are as follows:
A bill of exchange is required to be in writing.
It is an order to make the required payment.
The order to make the same payment is unconditional.
The maker of the bill of exchange are required to sign it
The payment should be of a definite amount.
The date on which payment is to be made must also be definite.
The bill of exchange is to be payable to a certain person.
The amount which is mentioned in the bill of exchange is payable either on demand or after the expiry of a fixed period of time.
The bill must be stamped as per the requirement of the law.
Parties to a Bill of Exchange
In a bill of exchange, there are three parties:
Drawer is the one who makes the bill of exchange. A seller or the creditor who should receive the money from the debtor can draw a bill of exchange upon the buyer or the debtor. The drawer then after writing the bill of exchange is required to sign it as maker of the bill of exchange.
Drawee is the one on whom the bill of exchange is drawn. Drawee is the purchaser or the debtor of the goods on whom the bill of exchange is drawn
Payee is the person to whom the payment is contracted to be made.
In a case, the drawer of the bill will himself be the payee if he keeps the bill with him till the date of its payment or maturity.
FAQs on Retirement of Bills of Exchange Explained
1. What is meant by the retirement of a bill of exchange in accounting?
The retirement of a bill of exchange is the process where the drawee (the person who owes the money) pays the bill to the drawer (the person who is owed the money) before its official due date. This early payment is usually initiated by the drawee. To encourage this, the holder of the bill typically offers a discount, known as a rebate, for the remaining period of the bill.
2. Who are the main parties involved in a bill of exchange?
A bill of exchange primarily involves three parties:
- The Drawer: The person who creates or writes the bill. This is the seller or creditor who is entitled to receive the money.
- The Drawee: The person on whom the bill is drawn. This is the purchaser or debtor who is ordered to pay the amount. Once the drawee accepts the bill, they become the 'acceptor'.
- The Payee: The person to whom the payment is to be made. The drawer can also be the payee if they keep the bill until maturity.
3. How is the rebate on a retired bill calculated? Give an example.
The rebate is a discount calculated on the bill amount for the period from the date of early payment to the original maturity date. For example, if a bill of ₹20,000 with a 3-month term is retired one month before the due date at a rebate of 12% per annum, the calculation would be:
Rebate = Bill Amount × Rate of Rebate × Unexpired Period
Rebate = ₹20,000 × (12/100) × (1/12) = ₹200.
The drawee would pay ₹19,800 to settle the bill.
4. What are the journal entries passed for the retirement of a bill of exchange?
The accounting treatment for retiring a bill involves the following journal entries:
- In the books of the Drawer (who receives the payment):
Bank/Cash A/c Dr. (Amount received)
Rebate on Bill A/c Dr. (Discount allowed)
To Bills Receivable A/c (Full amount of the bill) - In the books of the Drawee (who makes the payment):
Bills Payable A/c Dr. (Full amount of the bill)
To Bank/Cash A/c (Amount paid)
To Rebate on Bill A/c (Discount received)
5. Why would a drawee choose to retire a bill early, and why would a drawer agree?
There are benefits for both parties, which is why this occurs.
- For the Drawee (Payer): If the drawee has surplus funds, they can retire the bill early to earn a rebate (discount), which is a financial gain for them. It also settles their liability ahead of schedule.
- For the Drawer (Receiver): The drawer agrees to this because it improves their cash flow by providing funds earlier than expected. It also completely eliminates the risk of the bill being dishonoured on its due date.
6. How is the 'rebate on a bill' treated in the final accounts of the drawer and the drawee?
The treatment of the rebate reflects its nature as a financial expense or income:
- For the drawer (the one who allows the rebate), it is a financial expense. It is shown on the debit side of the Profit and Loss Account.
- For the drawee (the one who receives the rebate), it is a financial income or gain. It is shown on the credit side of the Profit and Loss Account.
7. What is the main difference between the retirement of a bill and the renewal of a bill?
The key difference lies in the reason and outcome:
- Retirement of a Bill: This is an early settlement of a bill, initiated by a drawee who is financially capable of paying. It results in a discount (rebate) for the drawee.
- Renewal of a Bill: This happens when the drawee is unable to pay the bill on the due date. The old bill is cancelled, and a new bill is drawn for an extended period, usually with interest charges added as a penalty for the delay.
8. What happens if the holder of the bill refuses the drawee's request for early payment?
The retirement of a bill is a mutual agreement, not an obligation. If the holder (drawer or payee) refuses the drawee's offer of early payment, the original terms of the bill remain in effect. The drawee is then legally required to honour the bill by paying the full amount on the original date of maturity. No rebate will be granted, and the transaction proceeds as initially planned.
