Financial Accounting - Bills of Exchange

 

Financial Accounting

Bills of Exchange

Part A: Discussion of (i) basic theories explaining different aspects and features of bills of exchange, (ii) journal entries to be made both in the books of drawer and drawee of a bill under different situations, and (iii) what is accommodation bill and how it can be used by the business community for arranging finance for their businesses in times of need.

 

Part B: Seven Illustrations with Solutions.

 

 

 Part A

 

Introduction and basic theories

 

A bill of exchange can be defined as a legal evidence of debt (an acknowledgement of debt) which fixes the date of payment. Section 5 of the Negotiable Instruments Act, 1881 defines a bill of exchange as under:

“A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument”.

 

Therefore, the distinguishing features of a bill of exchange are:

i.                      It must be in writing;

ii.                   It must be signed by the maker;

iii.               It must be an unconditional order to pay;

iv.             The maker must direct a certain person to pay a certain sum of money.

 

Format of a bill of exchange

Parties to a bill of exchange

There are three parties to a bill of exchange – the drawer, the drawee and the payee. The maker of the bill of exchange is known as the drawer. The signature of the drawer is necessary to complete the instrument; there is, however, no bar in accepting the bill before the drawer signs it. The drawee is the person on whom the bill is drawn and is thereby directed to pay. When the drawee signs his acceptance on the bill and sends the bill back to the drawer, he becomes the acceptor of the bill. The acceptance of a bill by the drawee signifies his assent to the order of the drawer. The drawee of a bill does not render him liable on the bill until he accepts the bill. But once he accepts the bill he becomes primarily liable on the bill. The payee is the person to whom the payment is to be made by the drawee on the due date of the bill. Usually, the holder of a bill on the due date of the bill is known as the payee of the bill.

 

From practical point of view, a drawer is a person who sells goods to drawee on credit and draws the bill of exchange on the drawee for the unpaid amount of the goods sold. On the other hand, a drawee is a person who purchases goods from drawer on credit and accepts the bill of exchange drawn by the drawer for the unpaid amount of the goods purchased.

 

Courses of action the drawer can take with the bills receivable:

 

After the drawee accepts the bill by signing it and sends the bill back to the drawer, the drawer can take four courses of action with the bill as follows:

1.           The drawer can retain the bill till the due date of the bill;

 

Important notes:

(i)              Due date

= Date of maturity + 3 days of grace

(ii)           Date of maturity (when the bill is payable “X-months after date”)

= Date of drawing of the bill + “X-months”

(iii)        Date of maturity (when the bill is payable “X-months after sight”)

= Date of acceptance of the bill     + “X-months”

 

(iv)            When the period of the bill is stated in days, the calculation of the due date will be in days (which include the date of payment but exclude the date of transaction).

(v)               When the period of the bill is stated in months, the calculation of the due date will be made in terms of calendar months, ignoring the number of days in a month.

(vi)            If the due date falls on a day which is a public holiday, the due date shall be the preceding business day, and if the preceding business day is also a public holiday, the due date shall be the preceding business day to that earlier preceding business day. Example of public holiday: 26^th January, 15^th August, etc.

(vii)        If the due date falls on a day which is an emergency holiday declared by the Government as per the Negotiable Instrument Act, 1881, the due date shall be the next working day.

 

2.     The drawer can discount the bill with the banker before the due date of the bill. If the bill is discounted, the proceeds to be received by the drawer from the banker can be calculated as follows:

Proceeds     =

Face value of the bill − Discount

Where,

Discount =

Face value of the bill x ROI x (Unexpired days of the bill ÷ 365)

ROI =

Rate of Interest

 

3.     The drawer can endorse the bill in favour of his creditor.

 

4. The drawer can send the bill to the banker for collection.

 

Journal entries

In the books of drawer

(Say Mr. X)

	Particulars		Debit (Rs)	Credit (Rs)
1	Y A/c	Dr
	To Sales A/c
	(Goods sold to Y on credit)
2	Bills Receivable A/c	Dr
	To Y A/c
	(Bill accepted by Y)
3	Bank A/c	Dr
	Discount on Bills A/c	Dr
	To Bills Receivable A/c
	(Bill discounted with the banker)
4	Z A/c	Dr
	To Bills Receivable A/c
	(Bill endorsed to Z)
5	Bills for collection A/c	Dr
	To Bills Receivable A/c
	(Bill sent to the banker for collection)
6	Bank A/c	Dr
	To Bills Receivable A/c
	(Retained bill honoured at maturity)
7	Bank A/c	Dr
	To Bills sent for collection A/c
	(Bill sent for collection honoured at maturity)
	Note: No journal entry is required in the books of the drawer for honour of discounted or endorsed bill by drawee at maturity.
8	Y A/c	Dr
	To Bills Receivable A/c
	(Retained bill dishonoured at maturity)
9	Y A/c	Dr
	To Bank A/c
	(Discounted bill dishonoured at maturity)
10	Y A/c	Dr
	To Z A/c
	(Endorsed bill dishonoured at maturity)
11	Y A/c	Dr
	To Bills sent for collection A/c
	(Bill sent to bank for collection dishonoured at maturity)
12	Y A/c	Dr
	To Bank A/c
	(Noting charges on dishonour of retained bill)
13	Y A/c	Dr
	To Bank A/c
	(Noting charges for dishonour of discounted bill)
14	Y A/c	Dr
	To Z A/c
	(Noting charges for dishonour of endorsed bill)
15	Y A/c	Dr
	To Bank A/c
	(Noting charges for dishonour of bill sent to bank for collection)
16	Y A/c	Dr
	To Interest A/c
	(Interest for the new period on renewal of bill)
	Note: Before renewal of a bill entry for dishonour of the bill and entry for noting charges for such dishonour have to be made.
17	Bank A/c	Dr
	Rebate on bill retired A/c	Dr
	To Bills Receivable A/c
	(Bill retired i.e. settled before maturity)

 

 

In the books of drawee

(Say Mr. Y)

	Particulars		Debit (Rs)	Credit (Rs)
1	Purchases A/c	Dr
	To X A/c
	(Goods purchased from X on credit)
2	X A/c	Dr
	To Bills Payable A/c
	(Bill drawn by X accepted)
	Note: No journal entry is required in the books of the drawee for discounting, endorsing and sending the bill to bank for collection by the drawer.
3	Bills Payable A/c	Dr
	To Bank A/c
	(The bill is honoured at maturity)
4	Bills Payable A/c	Dr
	To X A/c
	(The bill is dishonoured at maturity)
5	Noting charge A/c	Dr
	To X A/c
	(Noting charges on dishonour of the bill)
6	Interest A/c	Dr
	To X A/c
	(Interest for the new period on renewal of bill)
	Note: Before renewal of a bill entry for dishonour of the bill and entry for noting charges for such dishonour have to be made.
7	Bills Payable A/c	Dr
	To Bank A/c
	To Rebate on bill   retired A/c
	(Bill retired i.e. settled before maturity)

 

 

Accommodation bill

 

An accommodation bill is a bill of exchange which is drawn and accepted without any consideration to assist one or both the parties (drawer and drawee) financially. An accommodation bill is also known as kite bill. In the case of an accommodation bill one party (drawer) draws the bill and the other party (drawee) accepts it. Then, the drawer gets it discounted from the bank and receives ready cash which he is in need of. The money received may, however, be utilized either wholly by the drawer, or by both the drawer and the drawee. Before the due date approaches, the required sum of money is sent by the drawer to the drawee in order to make the drawee able to honour the bill and the bill is honoured by the drawee on the due date. The journal entries in the case of accommodation bills are the same as those discussed above.

 

Important Note:

If, after the accommodation bill is discounted by the drawer with his banker, the proceeds (i.e. the realized cash) are shared by the drawer and the drawee in an agreed ratio, the loss by way of discounting charges is also to be shared by the drawer and the drawee in the same ratio in which they shared the proceeds.

Part B

FINANCIAL ACCOUNTING

BILLS OF EXCHANGE

Selected Problems

 

Illustration: 1

Sunil owed Anil Rs 80,000. Anil draws a bill on Sunil for that amount for 3 months on 1^st April 2015. Sunil accepts it and returns it to Anil. On 15^th April 2015, Anil discounts it with Citi Bank at a discount of 12% p.a. On the date of maturity the bill was dishonoured, the bank paid noting charges of Rs 100. Anil settles the bank’s claim along with noting charges in cash. Sunil accepted another bill for 3 months for the amount due plus interest of Rs 3,000 on 1^st July 2015. Before the new bill became due, Sunil retires the bill with a rebate of Rs 500. Show journal entries in books of Anil.

 

Click here for Solution: 1 in PDF

Illustration: 2

On 1^st April 2015 Mr. Bala draws a bill of Rs 1, 20,000 on Mr. Lala for the amount due for 4 months. On getting acceptance, on 5^th April 2015, Bala endorses it to Mr. Kala in full settlement of his claim of Rs 1, 40,000 by paying the difference in cash. Lala approached Bala on 25^th July saying that he needed to renew the bill for a further period of 4 months at an interest of 12% p.a. which Bala accepted. A fresh bill including interest was accepted by Lala on 1^st August 2015. Bala settled his liability to Kala by cheque and the fresh bill was duly settled on the due date.

 

Pass journal entries in the books of Bala and Lala.

 

Click here for Solution: 2 in PDF

Illustration: 3

On 1^st January, 2015, P draws three months bill of exchange for Rs 30,000 on his debtor, Q who accepts it on the same date. P discounts the bill on 4^th January, 2015 with his bankers, the discount rate being 6% p.a. On the due date, the bill is dishonoured, the noting charges being Rs 200. Q immediately makes an offer to P to pay him Rs 10,000 cash on account and to settle the balance by agreeing to accept one bill of exchange for Rs 12,000 at one month and the other for the balance at three months, the later including interest at 12% p.a. for both the bills. P accepts the arrangement. The bill for Rs 12,000 is met on the due date, but the other bill is dishonoured. Show Q’s A/c and Bills Receivable A/c in the books of P.

 

Click here for Solution: 3 in PDF

Illustration: 4

X bought goods from Y for Rs 4,000. Y draws a bill on 1.1.2015 for 3 months which was accepted by X for this purpose. On 1.3.2015, X arranged to retire the bill at a rebate of 12% p.a. Show the entries in the books of X and Y.

 

Click here for Solution: 4 in PDF

Illustration: 5

Mohan sold goods to Gupta on 1^st September, 2015 for Rs 1,600. Gupta immediately accepted a three months bill. On the due date, Gupta requested that the bill be renewed for a fresh period of two months. Mohan agreed to that provided interest at 9% was paid immediately in cash. To this Gupta was agreeable. The second bill was met on due date.

 

Give journal entries in the books of Mohan.

 

Click here for Solution: 5 in PDF

Illustration: 6

Vijay draws a bill for Rs 60,000 and Anand accepts the same for mutual accommodation of both of them to the extent of Vijay 2/3rd and Anand 1/3rd. Vijay discounts it with bank for Rs 56,400 and remits 1/3rd share to Anand. Before the due date, Anand draws another bill for Rs 84,000 on Vijay in order to provide funds to meet the first bill on same sharing basis. The second bill is discounted at Rs 81,600. With these proceeds, the first bill is settled and Rs 14,400 were remitted to Vijay. Before the due date of the second bill, Vijay becomes insolvent and Anand receives a dividend of only 50 paise in a rupee in full satisfaction. Pass journal entries in the books of Vijay.

 

Click here for Solution: 6 in PDF

Illustration: 7

Rahim, for mutual accommodation, draws a bill for Rs 3,000 on Ratan. Rahim discounted it for Rs 2,925. He remits Rs 975 to Ratan. On the due date, Rahim is unable to remit his dues to Ratan to enable him to meet the bill. He, however, accepts a bill for Rs 3,750 which Ratan discounts for Rs 3,625. Ratan sends Rs 175 to Rahim after discounting the above bill. Rahim becomes insolvent and a dividend of 80 paise in the rupee is received from his estate.

 

Pass the necessary journal entries in the books of both the parties.

Click here for Solution: 7 in PDF