40

Bills of exchange
Objectives
After you have studied this chapter, you should:

understand what is meant by the term bill of exchange, how they are used, and by
whom
know how to make the entries in the accounts for a bill of exchange

40.1 Nature of bills of exchange

When goods are supplied to someone on credit, or services performed for him, then that
person becomes a debtor. The creditor firm would normally wait for payment by the
debtor. Until payment is made the money owing is of no use to the creditor firm as it is
not being used in any way. This can be remedied by factoring the debtors, which
involves passing the debts over to a finance firm. They will pay an agreed amount for the
legal rights to the debts.
Another possibility is that of obtaining a bank overdraft, with the debtors accepted as
part of the security on which the overdraft has been granted.
Yet another way that can give the creditor effective use of the money owing to him is
for him to draw a bill of exchange on the debtor. This means that a document is drawn
up requiring the debtor to pay the amount owing to the creditor, or to anyone
nominated by him at any time, on or by a particular date. He sends this document to the
debtor who, if he agrees to it, is said to accept it by writing on the document that he
will comply with it and appends his signature. The debtor then returns the bill of
exchange to the creditor. This document is then legal proof of the debt. The debtor is not
then able to contest the validity of the debt except for any irregularity in the bill of
exchange itself.

40.2 How bills of exchange are used

The creditor can now act in one of three ways:
1
2

He can negotiate the bill to another person in payment of a debt. That person may
also renegotiate it to someone else. The person who possesses the bill at maturity, i.e.
the date for payment of the bill, will present it to the debtor for payment.
He may discount it with a bank. Discount here means that the bank will take the
bill of exchange and treat it in the same manner as money deposited in the bank
account. The bank will then hold the bill until maturity when it will present it to the
debtor for payment. The bank will make a charge to the creditor for this service,
known as a discounting charge.
The third way open to the creditor is for him to hold the bill until maturity when he

Bills of exchange

413

will present it to the debtor for payment. In this case, apart from having a document
which is legal proof of the debt and could therefore save legal costs if a dispute
arose, no benefit has been gained from having a bill of exchange. However, action 1
or 2 could have been taken if the need had arisen.

40.3 The parties to a bill of exchange

The creditor who draws up the bill of exchange is known as the drawer. The debtor on
whom it is drawn is the drawee, when accepted he becomes the acceptor, while the
person to whom the bill is to be paid is the payee. In fact, it may be recognised that a
cheque is a special type of bill of exchange where the drawee is always a bank and, in
addition, is payable on demand. This chapter, however, refers to bills of exchange other
than cheques.
To the person who is to receive the money on maturity of the bill of exchange the
document is known as a bill receivable, while to the person who is to pay the sum due
on maturity it is known as a bill payable.

40.4 Dishonoured bills

When the debtor fails to make payment on maturity the bill is said to be dishonoured. If
the holder is someone other than the drawer then he will have recourse against the
person who has negotiated the bill to him, that person will then have recourse against
the one who negotiated it to him, and so on until final recourse is had against the drawer
of the bill for the amount of money due on the bill. The drawers right of action is then
against the acceptor.
On dishonour, a bill is often noted. This means that the bill is handed to a lawyer acting
in his capacity as a notary public, who then re-presents the bill to the acceptor. The
notary public then records the reasons for it not being discharged. The notary publics
fee is known as a noting charge. With a foreign bill, in addition to the bill being noted, it
is necessary to protest the bill in order to preserve the holders rights against the drawer
and previous endorsers. Protest is the term which covers the legal formalities needed.
The action to be taken by the drawer depends entirely upon circumstances. Often the
lack of funds on the acceptors part is purely temporary. In this case the drawer will
negotiate with the acceptor and agree to draw another bill, or substitute several bills of
smaller amounts with different maturity dates, for the amount owing, frequently with an
addition for interest to compensate for the extended period of credit. Negotiation is the
keynote; it must not be thought that acceptors are always sued when they fail to make
payment. They are customers, and where future dealings with them are expected to be
profitable harsh measures are certainly to be avoided. Legal action should be the last
action to be considered. Any interest charged to the acceptor would be debited to his
account and credited to an Interest Receivable Account.

40.5 Discounting charges and noting charges

From the acceptors point of view the discounting of a bill is a matter wholly for the
drawer or holder to decide. He, the acceptor, has been allowed a term of credit and will
pay the agreed price on the maturity of the bill. Therefore the discounting charge is not
one that he should suffer; this should be borne wholly by the person discounting the bill.

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Business Accounting 1

On the other hand, the noting charge has been brought about by the acceptors default.
It is equitable that his account should be charged with the amount of the expense of
noting and protesting.

40.6 Retired bills

Instead of waiting until maturity, bills may be retired, i.e. not allowed to run until
maturity. They may be paid off before maturity, in which case a rebate is often allowed
because the full term of credit has not been taken; or else renewed by fresh bills being
drawn and the old ones cancelled. The new bills often include interest because the term
of credit has been extended.

40.7 Examples of bookkeeping entries

Exhibit 40.1
1 Drawers Books
Goods had been sold by D Jarvis to J Burgon on 1 January 19X6 for 400. A bill of
exchange is drawn by Jarvis and accepted by Burgon on 1 January 19X6, the date of
maturity being 31 March 19X6. The following accounts show the entries necessary:
(a) If the bill is held by the drawer until maturity when the drawee makes payment.
J Burgon
19X6
Jan
1 Sales

400

19X6
Jan
1 Bill receivable

400

Bills Receivable
19X6
Jan
1 J Burgon

400

19X6
Mar 31 Bank

400

Bank
19X6
Mar 31 Bills receivable

400

(b) Where the bill is negotiated to another party by the drawer, in this case to IDT Ltd
on 3 January 19X6.
J Burgon
19X6
Jan
1 Sales

400

19X6
Jan
1 Bill receivable

400

Bills Receivable
19X6
Jan
1 J Burgon

400

19X6
Jan
3 IDT Ltd

400

Bills of exchange

415

(c) If the bill is discounted with the bank, in this case on 2 January 19X6, the
discounting charges being 6.
J Burgon
19X6
Jan
1 Sales

400

19X6
Jan
1 Bill receivable

400

Bills Receivable
19X6
Jan
1 J Burgon

400

19X6
Jan
2 Bank

400

Bank
19X6
Jan
2 Bills receivable

400

19X6
Jan
2 Discounting charges

Discounting Charges
19X6
Jan
2 Bank

2 Acceptors Books
The instances (a), (b) and (c) in the drawers books will result in similar entries in the
acceptors books. From the acceptors point of view two things have happened, first the
acceptance of the bill, and second its discharge by payment. The fact that (a), (b) and (c)
would result in different payees is irrelevant so far as the acceptor is concerned.
D Jarvis
19X6
Jan
1 Bills payable

400

19X6
Jan
1 Purchases

400

Bills Payable
19X6
Mar 31 Bank

400

19X6
Jan
1 D Jarvis

400

19X6
Mar 31 Bill payable

400

Bank

40.8 Dishonoured bills and accounting entries

These can be illustrated by reference to Exhibit 40.2.
Exhibit 40.2
On 1 April 19X7 A Grant sells goods for 600 to K Lee, a bill with a maturity date of
30 June 19X7 being drawn by Grant and accepted by Lee on 2 April 19X7. On 30 June

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Business Accounting 1

19X7 the bill is presented to Lee, but he fails to pay it and it is therefore dishonoured.
The bill is noted, the cost of 2 being paid by Grant on 7 July 19X7.
The entries needed will depend on whether or not the bill had been discounted by
Grant.
1 Drawers Books
Where the bill had not been discounted or renegotiated:
K Lee
19X7
Apr 1 Sales

600

Jun
Jul

600
2

30 Bill receivable dishonoured

7 Bank: Noting charge (a)

19X7
Apr 2 Bills receivable

600

Bills Receivable
19X7
Apr 2

K Lee

600

19X7
Jun 30 K Lee bill dishonoured

600

Bank
19X7
Jul
7 Noting charges K Lee (a)

Note:
(a) As the noting charges are directly incurred as the result of Lees default, then Lee
must suffer the cost by his account being debited with that amount.
Where the bill has been discounted with a bank:
The entries can now be seen as they would have appeared if the bill had been discounted
on 5 April 19X7, discounting charges being 9.
K Lee
19X7
Apr 1 Sales

600

Jun
Jul

600
2

30 Bank bill dishonoured (c)

7 Bank: Noting charge

19X7
Apr 2 Bill receivable

600

Bills Receivable
19X7
Apr 2 K Lee

600

19X7
Apr 5 Bank

600

19X7
Apr 5 Discounting charges (b)
Jun 30 K Lee bill dishonoured (c)
Jul
7 Noting charges K Lee

9
600
2

Bank
19X7
Apr 5 Bills receivable

600

Bills of exchange

417

Discounting Charges
19X7
Apr 5 Bank (b)

Notes:
(b) The discounting charges are wholly an expense of A Grant. They are therefore
charged to an expense account. Contrast this with the treatment of the noting
charges.
(c) On maturity the bank will present the bill to Lee. On its dishonour the bank will
hand the bill back to Grant, and will cancel out the original amount shown as being
deposited in the bank account. This amount is then charged to Lees personal
account to show that he is still in debt.
2 Acceptors Books
The entries in the acceptors books will not be affected by whether or not the drawer has
discounted the bill.
A Grant
19X7
Apr 1 Bill payable

600

19X7
Apr 1 Purchases

600

Jun
Jul

600
2

30 Bill payable dishonoured

7 Noting charge (d)

Bills Payable
19X7
Jun 30 A Grant bill dishonoured

600

19X7
Apr 1 A Grant

600

Noting Charges
19X7
Jul
7 A Grant (d)

Note:
(d) The noting charges will have to be reimbursed to A Grant. To show this fact A
Grants account is credited while the Noting Charges Account is debited to record
the expense.

40.9 Bills receivable as contingent liabilities

The fact that bills had been discounted, but had not reached maturity by the balance
sheet date, could give an entirely false impression of the financial position of the business
unless a note to this effect is made on the balance sheet. That such a note is necessary
can be illustrated by reference to the following balance sheets.

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Business Accounting 1
Balance Sheet as at 31 December 19X7

Fixed assets
Current assets:
Stock
Debtors
Bills receivable
Bank
Less Current liabilities
Working capital

(a)

3,500

1,000
1,200
1,800
500

1,000
1,200

2,300

4,500
3,000

4,500
3,000

1,500
5,000

Financed by:
Capital

5,000

(b)

3,500

1,500
5,000

5,000

Balance sheet (a) shows the position if 1,800 of bills receivable were still in hand.
Balance sheet (b) shows the position if the bills had been discounted, ignoring
discounting charges. To an outsider, balance sheet (b) seems to show a much stronger
liquid position with 2,300 in the bank. However, should the bills be dishonoured on
maturity the bank balance would slump to 500. The appearance of balance sheet (b) is
therefore deceptive unless a note is added, e.g. Note: There is a contingent liability of
1,800 on bills discounted at the balance sheet date. This note enables the outsider to
view the bank balance in its proper perspective of depending on the non-dishonour of the
bills discounted.

New terms
Bill of exchange (p. 412): A document drawn up by the drawer which requires his debtor, the
drawee, to accept the bill, agreeing to pay a specified sum to the person called the payee on the
due date specified.
Acceptor (p. 413): The drawee, when he accepts the bill, becomes the acceptor, thereby accepting

liability to pay the debt.

Dishonoured bill (p. 413): Where the acceptor fails to pay his debt on the due date.
Contingent liability (p. 417): Until the acceptor pays his debt owing on the bill, the drawer will
have a liability for the contingency that the bill will be dishonoured.
Factoring (p. 412): Passing the legal right to debts to a finance firm for an agreed amount.

Main points to remember

1

Bills of exchange enable businesses to obtain money owing to them in advance of the
date when the debtor is expected to clear his debt.

They are also a form of evidence should the amount due be disputed later.

Bills of exchange are not a guarantee that a debt will be honoured.

Bills of exchange

419

Review questions
40.1 N Gudgeon sells goods to two companies on July 1 19X7.
To R Johnson Ltd
To B Scarlet & Co Ltd

2,460
1,500

He draws bills of exchange on each of them and they are both accepted.
He discounts both of the bills with the bank on July 4 19X7, and suffers discounting charges of
80 on Johnsons bill and 65 on Scarlets bill. On September 1 19X7 the bills mature and
Johnson Ltd meets its liability. Scarlets bill is dishonoured and is duly noted on September 4, the
noting charge being 6.
Show the above in the necessary accounts:
(a) In the books of Gudgeon.
(b) In the books of Scarlet Ltd and of Johnson Ltd.

40.2A P Cummings buys goods from T Victor Ltd on January 21 19X7 for 2,900 and from C
Bellamy & Co for 4,160. Bills are drawn on him and he accepts them.
T Victor Ltd discount their bill with their bank on January 29, the discounting charge being 110.
C Bellamy & Co simply keep their bill waiting for maturity.
On maturity of the bills on April 21 19X7, Cummings duly meets (pays) Bellamys bill. He is
unable to pay Victors bill and it is accordingly dishonoured. Victor duly has it noted on April 28
19X7, the noting charge being 10.
Show the entries necessary in:
(a) The books of P Cummings.
(b) The books of T Victor Ltd.
(c) The books of C Bellamy & Co.

40.3 KC owed TM 960. KC accepted a bill of exchange at three months date for this amount.
TM discounted it for 948.
Before the due date of the bill TM was informed that KC was unable to meet the bill and was
offering a composition of 37.5 per cent of each to his creditors. This offer was accepted and cash
equivalent to the composition was received.
Show the ledger entries to record the above in TMs ledger.

40.4 Draw up a sales ledger control account for the month of August 19X6 from the following:
19X6
Aug 1

Aug 31

Balances (Dr)
Balances (Cr)
Totals for the month:
Sales journal
Returns inwards journal
Cheques received from customers
Bills receivable accepted
Cash received from customers
Bad debts written off
Cash discounts allowed
Bill receivable dishonoured
Balances (Cr)
Balances (Dr)

Note: This question is being asked because it contains entries for bills of exchange.

12,370
105
16,904
407
15,970
1,230
306
129
604
177
88
?

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Business Accounting 1

40.5 A purchases ledger control account should be drawn up for February 19X7 from the
following:
19X7
Feb
1

Feb 28

Balances (Dr)
Balances (Cr)
Totals for month:
Purchases journal
Returns outwards journal
Bills payable accepted by us
Cheques paid to suppliers
Cash paid to suppliers
We were unable to meet a bill payable on maturity and it was
therefore dishonoured
We agreed to suffer noting charge on dishonoured bill
Balances (Dr)
Balances (Cr)

33
8,570
11,375
568
1,860
9,464
177
800
20
47
?

Note: This question is being asked because it contains entries for bills of exchange.

40.6A Prepare journal entries to indicate how the following would appear in the ledger accounts
of (a) Noone, (b) Iddon.
19X8
Jan
1
,,

Feb 29
Apr

,,

,,
May

9
7

Iddon sells goods 420 to Noone, and Noone sends to Iddon a three months acceptance
for this amount.
Iddon discounts the acceptance with the Slough Discount Co. Ltd, receiving its cheque
for 412.
One-third of Noones stock, valued at 3,600, is destroyed by fire. Noone claims on the
underwriters at Lloyds with whom he is insured.
The underwriters admit the claim for 3,000 only as the total stock was only insured for
9,000.
In view of Noones difficulties Iddon meets the acceptance due today by giving his
cheque for 420 to the Slough Discount Co. Ltd; he draws on Noone a further bill for
one month for 430 (to include 10 interest) which Noone accepts.
Noone receives cheque from the underwriters in settlement of the admitted claim.
Noones bank honours the acceptance presented by Iddon as due today.

40.7A Enter the following in the appropriate ledger accounts of R Smith:

19X9
Jan
5
,,

Apr

,, 14
May 18

R Smith sold goods to P Thomas, 320, and Thomas accepted Smiths bill for three
months for this amount.
R Smith discounted Thomass bill at the London Discount Co. for 304, and pays this
amount into his account at the bank.
The London Discount Co. notified Smith that Thomass bill had been dishonoured.
Smith at once sent a cheque to the London Discount Co. for the full amount of the bill
plus 3 charges.
Smith agreed that Thomass bankers should accept a further bill for one month for the
total amount owing plus 10 interest, and received the new acceptance.
Smiths bank informed him the new bill had been paid.

Bills of exchange

421

40.8A

On 1 June 19X8, X purchased goods from Y for 860 and sold goods to Z for 570.
On the same date, X drew a bill (No. 1) at three months on Z for 400 and Z accepted it.
On 12 June 19X2, Z drew a bill (No. 2) at three months on Q for 150 which Q accepted.
On 14 June, Z endorsed bill No. 2 over to X and, on 16 June, X endorsed this bill over to Y.
On 20 June, X accepted a bill (No. 3) at three months for 720 drawn by Y in full settlement
of his account, including interest. On 23 June, Y discounted bill No. 3 at his bank.
On 17 September, Y informed X that Qs acceptance had been dishonoured and X sent a
cheque for 150 to Y. The other bills were paid on the due dates.
On 20 September, X received a cheque from Z for half the amount due from him.

Required:
Show the entries to record these transactions in the ledger and cash book of X.

40.9A Balances and transactions affecting a companys control accounts for the months of May
19X8 are listed below:
Balances at 1 May 19X8:
Sales ledger
Purchases ledger
Transactions during May 19X8:
Purchases on credit
Allowances from suppliers
Receipts from customers by cheque
Sales on credit
Discounts received
Payments to creditors by cheque
Contra settlements
Allowances to customers
Bills of exchange receivable
Customers cheques dishonoured
Cash receipts from credit customers
Refunds to customers for overpayment of accounts
Discounts allowed
Balances at 31 May 19X8:
Sales ledger
Purchases ledger

9,123
211
4,490
88

(debit)
(credit)
(credit)
(debit)

18,135
629
27,370
36,755
1,105
15,413
3,046
1,720
6,506
489
4,201
53
732
136
67

(credit)
(debit)

Required:
(a) Explain the purposes for which control accounts are prepared.
(b) Post the sales ledger and purchases ledger control accounts for the month of May 19X2 and
derive the respective debit and credit closing balances on 31 May 19X8.
Note: This question is being asked because it contains entries for bills of exchange.
(Association of Chartered Certified Accountants)