Mastering Journal Entries: Bills of Exchange
Your Comprehensive Guide to Recording Transactions in the Drawer's Books
Welcome, aspiring accountants! Bills of Exchange are a cornerstone of credit transactions in business. As a seller (the Drawer), understanding how to correctly record these transactions in your journal is crucial. This guide will walk you through the essential journal entries from the Drawer's perspective.
What is a Bill of Exchange & Who is the Drawer?
A Bill of Exchange is a written, unconditional order signed by the maker (Drawer), directing a certain person (the Drawee) to pay a certain sum of money only to, or to the order of, a certain person (the Payee) or to the bearer of the instrument, on demand or at a fixed or determinable future time.
- Drawer: The person who makes or draws the bill. This is usually the seller of goods or a creditor to whom money is owed. We are focusing on the Drawer's books.
- Drawee: The person on whom the bill is drawn. This is usually the buyer of goods or a debtor who owes money. They must "accept" the bill to become liable.
- Payee: The person to whom the payment is to be made. Often, the Drawer is also the Payee.
When a Drawer draws a bill on a Drawee and the Drawee accepts it, it becomes a "Bills Receivable" for the Drawer (an asset) and "Bills Payable" for the Drawee (a liability).
The Basic Transaction: Sale of Goods and Drawing a Bill
Let's assume 'A' (Drawer) sells goods to 'B' (Drawee) for ₹10,000 and draws a bill for the same amount for 3 months, which 'B' accepts.
1. On Sale of Goods (Credit Sale)
B's A/c (Debtor) 10,000
Sales A/c 10,000
(Being goods sold to B on credit)
2. On Drawing and Acceptance of the Bill
Bills Receivable A/c 10,000
B's A/c (Debtor) 10,000
(Being bill drawn on B for 3 months and accepted by him)
Reasoning: Bills Receivable is an asset (comes in, so debit). B, who was a debtor, is now settling that personal account by giving an instrument (his account is credited as the giver of the bill acceptance).
What the Drawer Can Do With the Bill:
The Drawer has several options for the Bills Receivable before its maturity date:
Option 1: Retaining the Bill Till Maturity
The Drawer keeps the bill and presents it to the Drawee on the due date.
3. (a) On Maturity: If the Bill is Honoured
The Drawee pays the amount on the due date.
Cash/Bank A/c 10,000
Bills Receivable A/c 10,000
(Being amount of bill received on maturity)
Option 2: Discounting the Bill with a Bank
The Drawer can get immediate cash from their bank by discounting the bill before its due date. The bank deducts a small charge called "discount". Assume the bank charges ₹200 as discount.
3. (b) On Discounting the Bill with Bank
Bank A/c 9,800
Discount A/c (Expense) 200
Bills Receivable A/c 10,000
(Being bill discounted with the bank for ₹10,000 at a discount of ₹200)
If this discounted bill is honoured on maturity, the Drawer makes no further entry as the bank receives the money directly from the Drawee.
Option 3: Endorsing the Bill to a Creditor
The Drawer can transfer the bill to one of their own creditors ('C') to settle a debt. Assume A owes C ₹10,000.
3. (c) On Endorsing the Bill to a Creditor (C)
C's A/c (Creditor) 10,000
Bills Receivable A/c 10,000
(Being bill endorsed to C in settlement of his account)
If this endorsed bill is honoured on maturity, the Drawer makes no further entry as C receives the money directly from the Drawee.
Option 4: Sending the Bill to Bank for Collection
The Drawer can send the bill to their bank with instructions to collect the amount from the Drawee on the due date and credit it to the Drawer's account. The bank may charge a small fee for this service.
3. (d) (i) On Sending the Bill for Collection
Bill Sent for Collection A/c 10,000
Bills Receivable A/c 10,000
(Being bill sent to bank for collection)
3. (d) (ii) On Receiving Information from Bank that Bill is Honoured
Assume bank charges ₹50 for collection.
Bank A/c 9,950
Bank Charges A/c (Expense) 50
Bill Sent for Collection A/c 10,000
(Being amount of bill collected by bank after deducting charges)
When Things Go Wrong: Dishonour of a Bill
If the Drawee fails to make payment on the due date, the bill is said to be dishonoured. The Drawer then has the right to recover the amount from the Drawee. Often, the holder of the bill (Drawer, bank, or endorsee) may get the fact of dishonour noted by a Notary Public, and the fees paid are called "Noting Charges". These charges are initially paid by the holder but are ultimately recoverable from the Drawee.
4. Dishonour of Bill (General Principle for Drawer)
Regardless of who held the bill, upon dishonour, the Drawee (B) again becomes a debtor to the Drawer (A) for the bill amount plus any noting charges paid by A (or paid by the bank/endorsee, for which A becomes liable to them).
Entry always involves debiting the Drawee. The credit depends on what happened to the bill. Assume noting charges are ₹100.
Case 1: Bill was Retained by Drawer (A pays noting charges)
B's A/c (Debtor) 10,100
Bills Receivable A/c 10,000
Cash/Bank A/c (Noting Charges) 100
(Being bill dishonoured and noting charges ₹100 paid)
Case 2: Bill was Discounted with Bank (Bank pays noting charges, Drawer's account debited by bank)
B's A/c (Debtor) 10,100
Bank A/c 10,100
(Being discounted bill dishonoured, bank paid noting charges ₹100, and debited our account)
Case 3: Bill was Endorsed to C (C pays noting charges, A becomes liable to C)
B's A/c (Debtor) 10,100
C's A/c (Creditor) 10,100
(Being endorsed bill dishonoured, C paid noting charges ₹100, we are now liable to C)
Case 4: Bill was Sent for Collection (A instructs bank to pay noting charges or pays them)
B's A/c (Debtor) 10,100
Bill Sent for Collection A/c 10,000
Cash/Bank A/c (Noting Charges) 100
(Being bill sent for collection dishonoured, noting charges ₹100 paid)
Other Important Scenarios for the Drawer
Renewal of a Bill
If the Drawee is unable to meet the bill on the due date, they may request the Drawer to cancel the old bill and draw a new one for an extended period. The Drawer usually charges interest for this extension.
Suppose B requests A to renew the ₹10,000 bill. A agrees, charges interest of ₹300. B pays ₹2,300 immediately (₹2000 part payment + ₹300 interest) and accepts a new bill for the balance (₹8,000) for 2 months.
5. Renewal of a Bill
(i) For Cancellation/Dishonour of Old Bill (if not already recorded):
B's A/c 10,000
Bills Receivable A/c 10,000
(Being old bill cancelled for renewal)
(ii) For Interest Charged:
B's A/c 300
Interest A/c (Income) 300
(Being interest due from B for renewal)
(iii) For Cash Received (Part Payment + Interest):
Cash/Bank A/c 2,300
B's A/c 2,300
(Being cash received for part payment and interest)
(iv) For Drawing New Bill for the Balance (₹10,000 - ₹2,000 = ₹8,000):
Bills Receivable A/c (New) 8,000
B's A/c 8,000
(Being new bill drawn and accepted by B for 2 months)
Retirement of a Bill
If the Drawee pays the bill before its due date, it's called "retirement of a bill". The Drawer usually allows a discount or rebate for early payment. Suppose B retires the ₹10,000 bill one month early, and A allows a rebate of ₹100.
6. Retirement of a Bill
Cash/Bank A/c 9,900
Rebate on Bill A/c (Expense) 100
Bills Receivable A/c 10,000
(Being bill retired by B under rebate of ₹100)
Insolvency of Drawee
If the Drawee becomes insolvent, they may only be able to pay a part of their debts. The unpaid amount is a "Bad Debt" for the Drawer. Suppose B becomes insolvent, and only 60 paise in a rupee (60%) is recovered from his estate on the ₹10,000 bill.
7. Insolvency of Drawee (B)
(i) First, ensure B's account is debited if the bill was held by someone else or for dishonour (e.g., if bill was discounted, it would be B Dr. to Bank for dishonour). If A holds the bill and it's dishonoured due to insolvency:
B's A/c 10,000
Bills Receivable A/c 10,000
(Being bill dishonoured due to B's insolvency)
(ii) For Amount Received and Bad Debt Written Off:
Cash/Bank A/c (60% of 10,000) 6,000
Bad Debts A/c (40% of 10,000) 4,000
B's A/c 10,000
(Being final dividend of 60 paise per rupee received from B's estate, balance written off as bad debt)
Key Takeaways for the Drawer:
- Drawing a bill converts a debtor (personal account) into Bills Receivable (asset account).
- The treatment of Bills Receivable depends on what the Drawer does with it (retain, discount, endorse, send for collection).
- Dishonour always means the Drawee becomes a debtor again, plus any noting charges. The corresponding credit depends on who held the bill.
- Interest for renewal is an income for the Drawer. Rebate for retirement is an expense.
- Insolvency of Drawee leads to Bad Debts for the Drawer.
Mastering these journal entries is essential for accurate financial reporting. Practice with various examples, and you'll find Bills of Exchange much easier to handle! Good luck!