There are times when a drawee may find himself to be unable to make the payment of a bill of exchange on its date of maturity. During such cases, he can request his drawer to draw a fresh or new bill on him instead of his actual bill. If this drawee agrees to pay additional interest on anextended period, then a drawer can agree to his proposal. As a business practice, it is assumed that this interest will only be the extended period.
A renewal pre-assumes that a bill could have been dishonoured. Thus, it is important that while drawing this new or fresh bill, the original bill is dishonoured no matter whether it is stated or not. Only after this original one is dishonoured, should an interest be taken. Both a drawer and his drawee should agree on the amount of interest. In case, if no amountis agreed upon, this amount needs to be calculated at a particular rate as per the amount due or the actual amount of a bill.
For instance, A had sold his goods to B for $ 4000 on credit on 1st January 2015. B accepted this draft of A after three months from the date of credit. Now as the date of maturity appears, B realizes that he will not be able to make the necessary payment. B requests A to renew this existing bill. A agrees to draw a new bill which is payable after two months as per the original amount of their bill of exchange in addition to an interest of 12%.
In such a case, the interest will be calculated only for the period extended- 2 months. Here, the drawer will not charge any interest for the entire period of their original bill. This is because that bill was on credit sale where the payment was agreed to be payable after a definite time span. Since B is extending the period only by 2 months, it is justified that interest should be charged only for this extended period. Here, the interest will be calculated like-
Interest = (12 × 4000 × 2) / (100) 12
Since A will receive this interest, he will credit his interest account as a drawer. B, being a drawee will debit his interest account since it proves to be an expense for him. This amount of interest will be paid in cash. In case it is received in cash, it will not be considered in the amount of their new bill. However, if it has not been received, it will get added to the amount of their original bill of exchange.
Renewal of the bill: Accounting Treatment
In this process of bill renewal, the first journal entry that a drawer needs to pass is regarding the dishonoured bill. While passing this entry regarding dishonoured bill, it should be assessed if that bill has been reserved by the drawer himself or endorsed or discounted. Based on this, the entry will be passed.
It is quite natural that a drawer will charge some interest for making a new bill for an extended period. Since this interest is a profit for the drawer as a creditor, it will be credited in his books with a debit on his cash account (if the interest has been received in cash). If the interest remains due, it will be debited in the drawee’s account. This process of preparing a fresh bill will mark the end of this renewal process.
It needs to be remembered that the value of a fresh bill will include that of the original bill of exchange along with an amount of interest, if it remains due. However, if the interest has already been received, it will not be included.
Just like his drawer, a drawee too will pass certain journal entries. Since the interest for the extended period is an interest for him, he will debit his interest account and credit the drawer’s account. In case if the payment is made in cash, his interest account will be debited with a corresponding credit in his cash account.
While passing an entry based on the acceptance of this fresh bill, the interest amount will get added to that amount of their bill, if the interest is still due. However, this interest will not be added in case the interest is paid in cash.
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