ASSIGNMENT

ON
BILLS DISCOUNTING

Submitted By: Submitted To:

Ritika Garg Ms. Vinita Mishra

MBA 3rd Sem (Visiting Faculty)

(Finance) (IBMR B School, Gurgaon)

 BILLS DISCOUNTING

Definition and Explanation of Bill of Exchange:

A bill of exchange has been defined as an unconditional order in writing addressed
by one person to another; signed by the person giving it, requiring, the person to
whom it is addressed to pay on demand or at a fixed or determinable future time, a
certain sum in money to or to the order of a specified person or to bearer.

Advantages of Bills of Exchange:

The following are the advantages of a bill of exchanges:

1. It is a legal evidence of debt.

 

2. It is a convenient method for the transfer of debt

 

3. A creditor can sue on the bill itself

 

4. It is a negotiable instrument and can be transferred for settlement of one's

debt without difficulty.
 

5. It can be cashed before due date by discounting.

 

6. A debtor enjoys the benefit of full period of credit.

 

7. It affords an ease means of transmitting money from one place to another.

It is for the aforesaid advantage, a buyer can easily be included to purchase goods
and accept bills drawn on him by the seller when he is not prepared to pay cash at
the time of purchase.

How a Bill of Exchange Functions:

In order to fully grasp the transactions relating to bill of exchange we thoroughly
learn the procedure. The following example will make it clear.

Suppose A sells goods to the value of $500 to B. The most ready means of closing
the transaction will be cash payment by B to A. But payment of this nature are not
many in actual practice. The greatest volume of business is done on credit. That
being the case A will have to wait for some time to receive payment from B. A,
merchant can hardly afford to be out of funds for long. Moreover, to sell goods on
credit is rather a risky job. Therefore as soon as A sells goods to B, he will draw a
bill for $500 on B and forward the same to him together with the goods with
instructions to B to accept the bill and return the same to A. Upon receipt of the
bill, B would write on the face of the bill "accepted" and put his signature below. It
means that B approves the bill and also binds himself to pay the amount thereof
when due. The bill is thus complete and comes back to A to remain in his
possession till maturity or can be endorsed or discounted by him. On the due date
the holder of the bill presents it before the acceptor and receives payment of the
bill from the acceptor.

Thus the bill of exchange is the instrument, rather the mechanism which finances
the major portion of all commercial transactions these days and it helps both the
debtor and the creditor alike.

Tenor and Usance:

Tenor is the period of time after which a bill becomes payable. Thus, where a bill
is payable after 90 days from the date of drawing or acceptance, the tenor of the
bill is 90 days. Bill may be made payable:

On Demand. The bill so drawn is payable as soon as its payment is demanded by

the holder of the bill.

A Sight. A bill of exchange so drawn becomes payable immediately it is brought

to the notice of the drawee.

After Date. When a bill is drawn 'after date' its due date is calculated from the
date of the bill.
After Sight. When a bill is drawn 'after sight' its due date is calculated from the
date on which it is sighted or seen by the drawee i.e., from the date of acceptance
by the drawee.

Usance. It is the usual time of payment of a bill of exchange as fixed by custom.

Days of grace:

In calculating the due date of payment it is customary in business circle to allow

three additional days to the drawee or acceptor to meet the bill. The extra days are
called "days of grace" or "grace days". Thus a bill dated 15th March, for three
months becomes payable on the 18th June and this is the due date.

Holder:

Holder of a bill is a person who is entitled in his own right to the possession
thereof and to claim the amount due thereon.

Holder in Due Course:

When a person takes a bill, complete and regular on the face of it and before its
due date, in good faith and for valuable consideration he is called the holder in due
course.

Acceptance:

When a drawee signs his name across the face of along with the word "accepted"
the bill is said to be accepted and this act of the drawee is called acceptance of a
bill. Before this is done, the drawee cannot be made liable for the bill.

Different Kinds of Acceptance:

General Acceptance:

When a bill is accepted without any condition to the order of the drawer, it is called
general acceptance.
Qualified Acceptance:

When a bill is accepted with some qualifications to the order of the drawer it is
called qualified acceptance.

A qualified acceptance again may be of five different types. These are following
types:

Time. When the acceptor agrees to pay the bill on some day other than the date
required by the drawer, it is called qualified acceptance as to time.

Place. When a bill is payable at a particular place and there only, it is called local
qualified acceptance.

Partial. When a bill is accepted for a part of the amount of a bill, it is called
partial qualified acceptance.

Parties. When a bill is accepted by one or two of the drawees, but not all, it is
called qualified acceptance as to parties.

Condition. When a bill is accepted subject to a certain condition being fulfilled it

is called conditional qualified acceptance.

Discounting a Bill of Exchange:

Business activities across borders are done through letter of credit. Letter of credit
is an instrument issued in the favor of the seller by the buyer bank assuring that
payment will be made after certain timer frame depending upon the terms and
conditions agreed, it could be either sight, 30 days from the Bill of Lading or 120
days from the date of bill of lading. Now when the seller receives the letter of
credit through bank, seller prepares documents and presents the same to the bank.

The most important element in the same is the bill of exchange which is used to
negotiate a letter of credit. Seller discounts that bill of exchange with the bank and
gets money. Discounting bill terminology is used for this purpose. Now it is
seller’s bank responsibility to send documents and bill of exchange to buyer’s bank
for onward forwarding to the buyer for the acceptance and the buyer finally,
accepts bill of exchange drawn by the seller on buyer’s bank because he has
opened that LC. Buyers bank than get that signed bill of exchange from the buyer
as guarantee and release payment to the sellers bank and waits for the time span
will buyer will pay the bank against that bill of exchange.

Bill Discounting:
When a firm holds other drawer’s bills of exchange with distant terms of payment
and is money short, the amount of the bill shall be subject to a discount.
Discounting is a special form of lending, when a bank buys a bill prior to maturity
at a price lower then the nominal amount of the bill of exchange (with a discount).
Discounting bills indicates the operation by means of which a bank, having
previously deducted the interest, advances to its client - the creditor - the amount
corresponding to the value of one or more bills bearing a future date which the
client cedes to the bank by endorsement.
The discounting of bills are a widely used source of short-term finance.
Commercial bill discount refers to the service that the holder commercial
acceptance draft transfers his draft to bank for obtaining funds before the day of
draft maturity. The cash received is posted to the bank account and the bill of
exchange charges are posted to the appropriate expense account. If the drawee
does not pay the bill of exchange on the date of maturity, it isprotested.

If the holder of a bill is need of money before the due date of the bill he may sell it
to the bank. The bank (buyer) will give cash fir it in consideration of a small
charge. This is called discounting the bill. The amount deducted by bank of the bill
from the face value of the bill is called "discount". The discount is usually
calculated at a certain rate per annum on the amount of the bill.

The grounds for discounting the bill:

Bills of exchange are discounted before their maturity date. The grounds for
discounting the bill before its maturity date is Bank’s consent for discounting,
written request addressed to the chairman of board by the drawer, and the bill of
exchange itself.
Before the bills can be discounted they are checked for juridical authenticity and
legitimacy of the drawer (the number of valid endorsements is considered,
though the last endorsement may be the blank endorsement).
Discounting of bills means purchase of bill by the Bank from the drawer before
the due date.
All discount transactions are performed by the Bank basing on agreement
concluded between the Bank and the drawer. Pricing for bills discounting is
determined basing on the bill discount rate and is specially agreed with the
drawer for every separate bill. The Bill Discounting operations include
presentation of bills, application of conditions, dispatch of Bills to the concerned
banks for collection and dispatch of unpaid bills to the notary for protest

Charges:
A fee is charged as payment is made before the due date is reached. In other
words face value minus the fee will be paid. the fees charged by the bank for
accepting the bill of exchange. The minimum charge for bill discounting tends to
vary according to the credit-worthiness of the companies. The pricing for bill
discounting is determined individually.

The accounting entries will be:

Creditor's Books
(a) When a bill of exchange is discounted.
Bank account (discounted value) [Dr.]
Discount account (amount of discount) [Dr.]
     To Bills receivable account                    [Cr.]

Debtor's Books:

The acceptor has no concern with the discounting of the bill. He has to pay it on
the due date to the holder. Whoever he may be. There will be no journal entry for
discounting of the bill of exchange.
Example:

X draws a three month bill for $2,000 on Y on the 1st January, 1991 for the value
received. Y accepts it and returns it to X, who discounts it on 4th January, 1991
with his bank at 6 per cent per annum. Y pays acceptance on the due date.

Record the transactions in the books of X and Y.

Journal Entries in the Books of X

   
1991 $ $
Jan. 1 Bills receivable account   2,000  
       To Y     2,000
  (Acceptance received)      
       
Jan. 4 Bank account 1,970
Discount account 30*
     To Bills receivable account 2,000
(Bill discounted at bank)

*Calculation of discount: 2000 × 6/10 × 3/12

Journal Entries in the Books of Y

   
1991 $ $
Jan. 1 X   2,000  
       To Bills payable account     2,000
  (Acceptance given)      
       
Apr. 2 Bills payable account 2,000
     To Cash account 2,000
(Acceptance paid)