Accounting for Bills of Exchange

Definition

A Bill of Exchange is a written, unconditional order signed by the maker (drawer) directing a certain person (drawee) to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument.

Explanation

Think of it as a formal "I owe you" note. It turns a verbal promise into a legally binding instrument.

The Three Key Parties:

• Drawer: The person who makes/writes the bill (The Seller/Creditor).
• Drawee: The person on whom the bill is drawn (The Buyer/Debtor). Once they sign, they are called the Acceptor.
• Payee: The person entitled to receive the money (can be the Drawer or a Bank).

Example

Imagine Rahul (Seller) sells a laptop to Aryan (Buyer). Rahul writes a note saying "Aryan, pay me $1,000 in 30 days." Once Aryan signs it, it becomes a Bill of Exchange.

Real-Life Use Case

Samsung supplying components to a smaller plant. The plant signs a bill to get 90 days of credit to sell finished goods before paying Samsung. It acts as a "credit bridge."

Classification

• Based on Usage:
  • Trade Bills: To facilitate sale/purchase of goods.
  • Accommodation Bills: To help parties raise urgent cash (not linked to trade).
• Based on Timing:
  • Demand Bills: Payable immediately on presentation.
  • Time/Usance Bills: Payable after a specific period (includes 3 Days of Grace).
• Based on Location:
  • Inland Bills: Drawn and payable within the same country.
  • Foreign Bills: Drawn in one country and payable in another.

Comparison Table: Trade Bill vs. Accommodation Bill

Renewal of Bills

When a Drawee cannot pay, they request a new bill. The old bill is cancelled, and a new one is drawn, usually involving interest for the delay.

Dishonour of Bills

When payment is not made on the due date. The holder takes the bill to a Notary Public, who records the non-payment and charges Noting Charges (borne by the Drawee).

Insolvency of Parties

The extreme case where the Drawee is legally declared unable to pay. The Drawer recovers only a percentage and treats the rest as a Bad Debt.

Scenario: A sells goods to B for $1,000. A draws a 2-month bill, which B accepts.

Problem Statement

On Jan 1, X sells goods to Y for $5,000. X draws a 3-month bill which Y accepts. On March 1, X discounts the bill with the bank at 10% p.a. On the due date, the bill is dishonoured and noting charges of $50 are paid by the bank.

Step-by-Step Calculation

Step 1: Calculate the Due Date

Date of Bill: Jan 1
Period: 3 months (Jan 1 -> April 1)
Add 3 Days of Grace: April 4 (Due Date)
        

Step 2: Calculate Discounting Charges

Amount: $5,000
Rate: 10% p.a.
Time: 3/12 years
Formula: 5,000 * (10/100) * (3/12) = $125
Cash Received: 5,000 - 125 = $4,875
        

Step 3: Journal Entry for Dishonour (In X's Books)

Y's A/c ...Dr $5,050
  To Bank A/c $5,050
(Being bill dishonoured and noting charges paid)
        

• Digital Bills/E-Invoicing: Managed via SAP/Oracle workflows.
• Supply Chain Finance (SCF): The modern "Accommodation Bill." Large buyers (like Walmart) allow suppliers to discount invoices instantly via digital platforms for immediate cash.

GreenTech Solutions used Bills of Exchange to manage working capital while supplying solar panels to BuildCorp. When BuildCorp faced a liquidity crunch, the bill was dishonoured.

To avoid legal action, GreenTech entered a renewal agreement, charging 8% interest. This illustrates the "counterparty risk" inherent in credit-based business models.

1. The person who draws the bill is called:
   a) Drawee b) Payee c) Drawer d) Acceptor
   Answer: c
2. How many days of grace are added to a time bill?
   a) 1 b) 3 c) 7 d) 10
   Answer: b
3. An accommodation bill is drawn for:
   a) Sale of goods b) Mutual financial help c) Payment of interest d) None
   Answer: b
4. If a bill is dishonoured, the noting charges are ultimately borne by:
   a) Drawer b) Bank c) Drawee d) Notary
   Answer: c
5. A bill payable on demand is also known as:
   a) Usance bill b) Sight bill c) Time bill d) Inland bill
   Answer: b
6. When a bill is renewed, the old bill is:
   a) Endorsed b) Cancelled c) Discounted d) Honoured
   Answer: b
7. The person who accepts the bill becomes the:
   a) Drawer b) Payee c) Acceptor d) Endorsee
   Answer: c
8. Insolvency means:
   a) Not wanting to pay b) Delay in payment c) Inability to pay d) Paying in installments
   Answer: c
9. A bill drawn in India and payable in India is:
   a) Foreign bill b) Inland bill c) Trade bill d) Sight bill
   Answer: b
10. Discounting of a bill is done with:
    a) The Drawee b) The Notary c) The Bank d) The Court
    Answer: c

1. Define Bill of Exchange. List its essential characteristics.
   Ans: An unconditional written order. Characteristics: In writing, signed, unconditional, certain amount, and certain parties.
2. Distinguish between Trade Bills and Accommodation Bills.
   Ans: Trade bills settle genuine trade debts; Accommodation bills are for mutual financial help/cash raising.
3. What are Noting Charges? Why are they paid?
   Ans: Fees paid to a Notary Public to certify the dishonour of a bill; they serve as legal evidence.
4. Explain the accounting treatment for the dishonour of a bill in the books of the Drawer.
   Ans: Debit the Drawee's A/c and Credit the Bills Receivable A/c (and Bank if noting charges were paid).
5. What happens when a Drawee requests a renewal of a bill?
   Ans: The old bill is cancelled, interest is charged to the Drawee, and a new bill is drawn.
6. Explain the concept of "Days of Grace."
   Ans: Three extra days added to the period of the bill to determine the final due date.
7. How is insolvency different from dishonour?
   Ans: Dishonour is a failure to pay on time; Insolvency is a legal status where the person is declared unable to pay any debt.
8. Write the journal entry for discounting a bill in the Drawer's books.
   Ans: Bank A/c Dr, Discount A/c Dr $\rightarrow$ To Bills Receivable A/c.
9. What is an "Inland Bill"?
   Ans: A bill drawn in one country and payable within that same country.
10. Why does the Drawee become the 'Acceptor'?
    Ans: Because the drawee signs the bill, signifying their formal agreement to the obligation to pay.

• Bill = Legal Promise.
• Drawer = Writes it.
• Drawee = Signs it (Accepts it).
• Dishonour = No money.
• Noting Charges = Legal proof cost (Drawee pays).
• Renewal = New bill + Interest.
• Insolvency = Bankruptcy (Bad debt).

Mnemonic to remember the three parties: "D-D-P"

• Drawer (The Creator/Seller)
• Drawee (The Debtor/Buyer)
• Payee (The Receiver)