Accounting for bill of exchange starts when drawer draws a bill and drawee accepts it. Drawee returns the bill to the drawer after accepting. Now drawer is the holder of the bill and he can use this bill in the following different ways.
A. By holding the bill till due date
B. By discounting the bill
C. By endorsing the bill
D. By sending bill to bank for collection
The drawee is liable to meet his acceptance but sometimes he fails to do so and dishonors the bill.
Accounting for bill of exchange is consisted of journal entries and some ledger accounts in the books of drawer and drawee. It is better to learn about journal entries under each of the above cases, detailed accounting treatment will be discussed after that.
Journal Entries for Bill of Exchange
1. When goods are sold and purchased
2. When bill is drawn and accepted
A. When drawer holds the bill with him till date (1st option)
3. If bill is honored on due date
4. If bill is dishonored on due date
B. When bill is got discounted by drawer (2nd Option)
5. When bill is discounted
6. If discounted bill is met on due date
7. If discounted bill is dishonored
C. When bill is endorsed to third party endorsee (3rd Option)
8. When bill is endorsee (Endorsee is the person to whom bill is endorsed)
9. If endorsed bill is met on due date
10. If endorsed bill is dishonored
D. When bill is sent to bank for collection (4th Option)
11. When the bill is sent for collection
12. When the bill sent for collection is met
13. If the bill sent for collection is dishonored
Sometimes drawee pays the bill before the due date and gets the rebate, it is known as “retirement” of the bill and sometimes he asks the drawer to cancel the bill and to draw another bill for an extended period. It is known as “renewal” of the bill. Drawee pays an additional amount as interest for the extended period. Journal entries under these cases are as follow:
14. If bill retired by drawee (drawee pays the bill before due date) Bill is with drawer
15. If bill canceled (for renewal purpose)
16. If partial amount is received from drawee
17. If interest is charged to drawee
18. If interest is received in cash
Options available to Drawer to use Bill of Exchange
As we know that the drawer has different options to use a bill of exchange. So for we have learned journal entries under different options, now we will discuss detailed accounting treatment of bill of exchange under each of the above options.
Option 1: When Bill is Retained by the Drawer with himself till the due date:
Sometimes drawer is not in immediate need of cash. He retains the bill with himself till due date and presents for payment. On due date, if bill is paid by the drawee, it is said that bill is honored. If bill is not paid by the drawee it is said that bill is dishonored.
Demonstration Problem No. 1 [Bill retained by drawer, Bill Met]
On January 2019 Mr. A sells goods to Mr. B for $20,000 on credit. On the same day, Mr. A draws three months bills on Mr. B who accepts it and returns the same to Mr. A. The bill is for $20,000. On due date, the bill is honored by Mr. B.
Required: Pass journal entries in the books of Mr. A and Mr. B.
Demonstration Problem No. 2 [Bill retained by drawer, Bill Dishonored]
Y purchased goods on credit from X for $15,000 on April 2019. X drew a bill of exchange on Y on same day for the same amount which was duly accepted by Y and returned to X On due date X presented the bill to Y who returned the bill dishonored.
Required: Pass journal entries in the books of both the parties.
Option 2: Discounting of Bill of Exchange
The act of selling bill of exchange to banker in consideration of small charges (discount) is called “Discounting of Bill of Exchange”.
As the term bill of exchange is drawn for a specific time period, therefore can be paid on due date only. What should the holder of the bill do? If he needs money before the due date, he can get the bill discounted from the bank.
If the holder of the bill is in need of money before the due date of the bill, he may sell it to his banker in consideration of small charges (discount). This act of holder is called “Discounting of Bill of Exchange”.
When bank discounts the bill, it deducts interest from the amount of the bill and the balance amount is credited to the account of the person who gets the bill discounted. Interest is the rent of money which is lent by the bank, as bank has to wait for the amount of the bill. Here interest is known as discount. Discount is an expense for the person who gets the bill discounted and an income for the bank. Amount of discount is based on current rate of interest and time period, i.e. from the date of discounting to the date of maturity.
Study Note: Bank does not discount the bill, if holder has overdraft balance.
Demonstration Problem No. 3 [Discounted Bill Met]
On 1st January 2019, John sold goods to David for $25,000 and drew a four months bill on the later. David accepted the bill and returned it to John. On February 3, John got the bill discounted @ 6% p.a. The bill is duly met on the due date.
Required: Pass journal entries in the books of John, David and Bank.
Study Note: As the drawer has already received the amount of the bill by way of discounting, therefore drawee will pay the amount of the bill to bank. So no entry will be made in drawer’s books when bill is met by drawee.
Study Not: Students may note that no entry is made in the books of drawee on February 3, when the bill is got discounted by the drawer because the drawee is liable to pay the bill on the due date. He has no concern with whatever the drawer does to the bill before the due date.
Discounted Bill Dishonored
When bill is got discounted by the drawer from his bank, it is the responsibility of the drawee to pay the amount of the bill to the bank on the due date, if drawee does not do so it is said that discounted bill is dishonored.
He is the person, who is appointed by the central government to administer oaths, certifies the documents, and attests the authenticity of signatures and to perform other official acts like this.
The act of the notary public such as noting of re-presentment of bill, fact and reason for dishonor of
on the bill itself or on a slip of paper attached to the bill is called “Noting”.
Noting is mere a record of dishonor on the face of the bill or on a slip of paper attached to the bill. Protest is a formal certificate of dishonor of bill, issued by the notary public to the holder of the bill. The set of issuing certificate is called “protesting”.
A small fee received by the notary public from the holder of the bill for noting and protesting is known as “Noting charges”. Noting charges are paid by the holder of the bill which are ultimately recovered from the drawee. Now, if holder of the bill sues for the recovery of his amount, noting and protest would be strong legal evidence.
Study Tip: Discounted and Endorsed Bill – A Contingent Liability:
It means that after getting the bill discounted or endorsing the drawer has no more responsibility. But his accounting record may be affected in one way. That is if drawee dishonors the bill on the due date. So till the date of the discounted or endorsed bill, it remains the contingent liability of the drawer.
Demonstration Problem No. 4 [Discounted Bill Dishonored]
P bought goods from “Q” for $5,000 on 1st March 2019. “Q” drew a three months bill on “P”
who accepted it and returned it to “Q”. “Q” immediately got the bill discounted With Metropolitan Bank
Ltd. @ 10% p.a. But on due date “P” dishonored the bill and bank pays $100 for noting charges.
Required: Journal entries in the books of Q, P and Bank
Study Note: Students should note that noting charges is an expense of drawee, who dishonored the bill, not of the holder who paid the amount.
Study Note: Students may note that noting charges are paid by bank deducted from “Q’s Account” and ultimately will be recovered from “P”. It is an expense of “P” that’s why only in “P’s” books “Trade Expenses A/c” is debited.
Option 3: Endorsement of Bill of Exchange
This is another use of bill of exchange by the drawer. A bill of exchange is easily transferable from one person to another. This is because bill of exchange is a negotiable instrument. Its negotiability makes it transferable by mere physical delivery, which increases its usefulness. The act of transferring bill of exchange from one person to another for the settlement of debts is called “Endorsement” of bill. The person who transfers or endorses the bill is called endorser and the person to whom bill is transferred or endorsed is called endorsee.
Demonstration Problems No. 5 [Endorsed Bill Met]
On 1st January 2019, John sold goods worth of $12,000 to David on credit basis. John drew a three months bill on David on the same date for the amount. John having bought goods from Harry for $15,000. On 4th February, John endorsed the bill of David to Harry to settle his debt paying the balance in cash. On the due date, the bill was met by David.
Required: Record the transaction in the books of all the parties.
Study Note: John having bought goods from Harry means John is already a debtor of Harry. Entry to record sale & purchased b/w John and Harry are not required.
Demonstration Problem No. 6 [ Endorsed Bill Dishonored]
On 1st June 2019, A owed B for $10,000 and accepted a bill for three months drawn on him by B. B settled his debt by endorsing A’s bill to C. C endorsed it to his creditor D, D got the bill discounted by his bank @ 12% p.a. On the due date, the bill is dishonored by A and bank paid $50 for noting charges.
Required: Pass Journal entries in the books of B, A, C, D and Bank.
Study Note: Students may note that noting charges are paid by bank deducted from D’s Account and ultimately will be recovered from A. It is an expense of A that’s why only in A’s Books “Trade Expenses A/c” is debited.
Option 4: Sending the bill to bank for collection
Sometimes a drawer has many bills receivable at a time. It becomes difficult for the drawer to keep the bills safely and to present them to their respective drawee. To overcome this difficulty the drawer has the option to send the bills to bank for safety & collection purpose.
The act of drawer sending the bill to bank for safety and collection purpose is called “Bill sent for collection”. Bill sent for collection should not be mixed up with discounting of bill. In discounting, bill is sold to the bank while in case of bill sent for collection; bill is given in the custody of the bank for safety and collection purpose.
Demonstration Problem No. 7 [Bill sent for Collection Met]
John sold goods to Harry for Rs.20,000. Later on John drew a three months bill on Harry for the amount. Harry accepted the bill and returned it to John, who sent the bill to his banker for collection. on the due date, the bill is met by the drawee, bank deducted collection charges of $100.
Required: Pass journal entries in the books of Arif, Abid and Bank.
Study Note: It should be noted that bank does not make journal entry in its books of accounts in respect of bill received by bank for collection. However, bank records all particulars of the bill in a Memorandum Book.
Bank for Collection Account
“Bank for Collection Account” does not show bank balance like “Bank Account” rather it is a temporary account which shows that bills of exchange have been kept in bank. This account is closed on the due date of the bill, when bill is either met or dishonored.
Demonstration Problem No. 8 [Bill sent for collection, Dishonored]
On 1st September 2019, John draws a three months bill on Harry for $5,000. Harry accepts the bill and returns to John. On 15th September, John sends the bill to NIB Bank for Collection. On the due date, the bank presents the bill to Harry, Who returns the bill dishonored.
Required: Journal entries in the books of John and Harry.