Bills of Exchange

Bills of Exchange is a very important chapter with respect to the SSC CGL exam and for UPSC exam. In SSC CGL exam, a separate paper is taken based on Economics and Accounting for the post of Assistant Audit Officer and Assistant Account Officer. This chapter is also important for the Specialist post (SO) in the banking exam, and it also comes in the UPSC exam like EPFO (EO/AO/APFC) etc. We have covered all the important aspects related to Bills of Exchange. After reading this chapter you will get to know about the basics of Bills of Exchange like Endorsement, Discounting, Maturity, and the retirement of Bill of exchange, etc

What is a Bill of Exchange:

A Bill of exchange is an unconditional order by the maker to the acceptor to pay a certain sum of money to the maker after a predetermined time. Let us understand it with an example-

Suppose, Aayush sells goods worth Rs. 10,000 on credit to Aayushi, which is to be paid by Aayushi after 3 months. Aayush Draws a bill of exchange in written format for 10,000 to be payable after 3 months and Aayushi accepts the Bill of Exchange. Here, it became a binding agreement on Aayushi to return the money after 3 months. 

In this example- Aayush is called Maker/Drawer/Holder or (Seller/Creditor)  and Aayushi is called Drawee or (purchaser/Debtor)

Endorsement of Bill of Exchange:

The situation in which the bill’s drawer transfers the bill to his creditor in order to pay off his debts. When a bill of exchange is signed, the drawer has the option of adding terms qualifying the act. The drawer becomes the endorser after using the bill as a financial instrument, and the party receiving the bill becomes the endorsee or new holder of the bill of exchange. In due course, he will be referred to as the holder. Let us understand it with an example:

Aayush Owes 10,000 to Lavi. So, the bill was transferred to Lavi. Here, Aayush is the Endorser.  Aayush may transfer the bill to Lavi. This process is called Endorsement, and the person endorsing another party is called Endorser.

Discounting of Bill of Exchange:

Short-term funding is supplied by banks through the discounting of a bill of exchange. Before the maturity date, the bank purchases a trade bill from the payee and pays the bill amount after subtracting service charges. The bank collects the money from the drawee at the bill’s maturity. Let us understand with an example-

Example-

If the person who withdrawal the bill needs money and does not want to wait until the bill’s due date, he can sell the bill to the bank at a fixed discount rate. On a signed dated order to pay to the bank, the invoice is approved by the withdrawal. Here, the bank will be the bill’s owner.
The bank pays cash to the withdrawal after receiving the bill at the agreed rate for the number of days it needs to be completed, equivalent to the face value less interest or discount, for the number of days it needs to be executed. This process is known as Bill of Exchange discounts.

Who is Payee:

Condition to being a payee-
1. Payee is the same as Drawer. 
2. Payee is the one who has discounted the bill. 
3. Payee is the one in whose name the bill has been endorsed.

Features of Bills of Exchange:

1. Acceptance by another person is a must, otherwise it would not be a valid bill of Exchange.
2. A bill of exchange must be in writing.
3. The order to make payment is unconditional.
4. The bill of exchange must be signed by the person who created it.
5. The amount of money to be paid must be certain.
6. The date on which payment is made must be precise as well.
7. The bill of exchange must be made out to a specific individual.
8. It must be stamped in accordance with legal requirements.

Maturity of the Bill of Exchange:

A bill of exchange that is receivable on demand, upon sight, or on presentment is due to mature three days after the date of payment is called maturity of the Bill of exchange. Three days of grace are permitted (Section. 22). Let us understand it with some examples:
Example:

Suppose, a bill is drawn on 5th March, is payable after 30 days then its maturity date is 4th April and the grace period by default is equal to 3 days and its final date of maturity is 7th April.
Now suppose a bill is drawn on 5th March and payable after 1 month then its maturity date is 5th April and its grace period by default is equal to 3 days and its final date of maturity is 8th April.
Let Bill be drawn on 1st April and payable after 30 days. Its final date of maturity is 4th May.
Let Bill be drawn on 1st April and payable after 60 days. Its final date of maturity is 3rd June.

Accounting Treatment of Bills of Exchange:

Bills of Exchange

Aayush	Aayushi
Drawer	Drawee
Creditor	Debtor
Bills Receivable	Bills Payable

There are two books in Bills of Exchange-
1. Books of Creditor
2. Books of Debtor

Accounting treatment of bills of Exchange in the books of Creditor- 

3 scenarios are there:

1. Creditor Retains the bill till maturity – 

There are 2 scenarios to collect it.
a. Collects on the date of maturity directly

For example- On receiving the bill            Bills receivable A/c                            Dr.             To Debtor A/c On maturity of the bill          Cash/Bank A/c                                    Dr.            To bills receivable A/c

b. Collects through Bank

On receiving the bill 

Bills receivable A/c                            Dr.             To Debtor A/c

(Few days before maturity, a bill is sent for collection to the bank)
On sending the bills for collection

Bills sent for collection A/c                  Dr.            To Bills receivable A/c

On receiving the advice from the bank that the bill has been collected 

Bank A/c                                               Dr.            To bills sent for collection

2. Creditor can get the bill discounted from the bank

For example:
On receiving the bill

Bills receivable A/c       Dr.      To Debtors A/c

On discounting the bill

Bank A/c                   Dr.   Discount A/c            Dr.           To Bills receivable A/c

Note:

On maturity, accounts of creditors will not be impacted as the creditor has already kind of sold it to the bank.

3. A creditor can endorse the bill in favour of the creditor.

For Example-
On receiving the bill

Bills receivable A/c       Dr.      To Debtors A/c

On endorsing the bill

Creditor’s A/c                   Dr.     To Bills receivable A/c

Note: 

On maturity, accounts of creditors will not be impacted, as a creditor has already transferred it to other parties.

Accounting treatment of bills of Exchange in the Books of Debtor:

It makes no difference whether the bill is retained till maturity, discounted or endorsed.

On accepting the bill

Creditor’s A/c                              Dr.  To bills payable A/c

On maturity of the bill

Bills payable A/c                   Dr.          To Bank A/c

Dishonour of Bill, Retirement of Bill, Renewal of Bill, Accommodation of Bill:

Dishonour of a bill means that a bill which was accepted by the debtor was not honoured. In other words, at maturity, the money which the debtor owed was not returned.

Accounting Treatment for Dishonor of Bill in:
1. Books of Creditor
2. Books of Debtor

Accounting treatment for the dishonour of bill in Books of Creditor – 

There are 3 scenarios for it.

1. Creditor retains the bill till maturity-

a. Collects on the date of maturity directly:

For example-
On receiving the bill 

Bills receivable A/c                            Dr.             To Debtor A/c

Cash/Bank A/c                                    Dr.            To bills receivable A/c

 On maturity of the bill

Now reverse entry – when the bill was kept with her till maturity.

Debtor’s A/c                                 Dr.   To Bill Receivable A/c

b. Collects through Bank:

On receiving the bill 

Bills receivable A/c                            Dr.             To Debtors A/c

On sending the bills for collection

Bills sent for collection A/c                  Dr.            To Bills receivable A/c

On receiving the advice from the bank that the bill has been collected 

Bank A/c                                               Dr.                     To bills sent for collection

Reverse entry:
When the bill was sent for collection-

Debtor’s A/c                                             Dr. To Bill sent for collection A/c

2. Creditor can get the bill discounted from the bank:

For example:
On receiving the bill

Bills receivable A/c       Dr.      To Debtors A/c

On discounting the bill

Bank A/c                   Dr.   Discount A/c            Dr.           To Bills receivable A/c

Reverse Entry

Debtor A/c              Dr. To bank A/c

3. Creditor can endorse the bill in favour of his creditor:

For Example-
On receiving the bill

Bills receivable A/c       Dr.      To Debtors A/c

On endorsing the bill

Creditor’s A/c                   Dr.     To Bills receivable A/c

Reverse Entry

Debtor A/c                             Dr.  To Creditors A/c

Accounting treatment for the dishonour of bill in Books of Debtor:

On accepting the bill

Creditor’s A/c                              Dr.      To bills payable A/c

On maturity of the bill

Bills payable A/c                   Dr.          To Bank A/c

Reverse Entry

Bills Payable A/c                 Dr.         To Creditor’s A/c

Retirement of Bill:

When the drawee has funds available to pay the bill of exchange and requests that the drawer or holder accept payment of the bill before its maturity date with a discount. The retirement of a bill of exchange occurs when the holder agrees to do so. Let us understand with an example-

Suppose that, Aayush Sells Goods on Credit to Aayushi. Aayush Draws a Bill of Exchange for 10,000 to be Payable after 3 months. Aayushi Accepts the Bill of Exchange. Now suppose before the completion of 3 months, Aayushi (Drawee /Debtor) offers to pay the money because he has some extra funds. If Aayush (Drawer) agrees, then the bill is said to be retired. Aayushi would take some rebate (discount) because he is paying the money early. So, transaction records in the books of the holder are-

On retiring the acceptance and rebate allowed

Cash A/c                                          Dr. Rebate on bills A/c                          Dr.    To bills receivable A/c

In the books of Drawee-

Bills payable A/c                        Dr. Cash A/c                                      Dr.    To rebate on Bills A/c

Renewal of bills:

When the bill acceptor come to the drawer with a request for a payment extension, the old bill is cancelled and a new bill with new payment terms is drawn, formally accepted, and delivered. This is referred to as a bill of exchange renewal. Let us understand with an example-

Example-

Suppose that, after 3 months Aayushi is not able to pay. Instead of dishonouring the bill, Aayushi requests Aayush to Renew the Bill. Renewing means creating a new bill and Cancelling the old bill. Since Aayush will get his money late, he asks for interest for this extra duration. So they will create a new bill with a new date, cancel the old bill and will Pay interest for this extra duration. This whole process is called Renewal of Bill

Accommodation of Bills:

A bill that is drafted and accepted without any consideration is known as an accommodation bill. These bills are drawn to help one or both parties in a bill of exchange financially. Let us understand with an example-

Example-

Suppose that, Aayush has need of money. In this case,  Aayush draws a bill upon Aayushi worth Rs. 5000 Payable after 3 months. Aayushi accepts the same. Aayush then goes to the bank and gets it discounted at 12%. So the bank gives him, Rs. 4850. Aayush uses this money. On maturity, Bank will take 5000 from Aayushi. Just before maturity, Aayush gives 5000 to Aayushi. On the maturity date, the bank gets its 5000. Here, the accommodation party is Aayush and the accommodating Party is Aayushi.