Bills of Exchange in Accounting

During the course of trade a seller supplies goods or services to a buyer. If the transaction is carried out on credit terms, in which the seller gives the buyer a term of credit in which to settle their outstanding account, bills of exchange can be used to signify that the buyer has agreed to make a payment to the seller on a predetermined date.

Bills of exchange are simply documents which signify the agreement between the seller and the buyer. The seller draws up the bill of exchange requiring the buyer to pay the amount outstanding to the seller, or to a person nominated by the seller, on a particular date. The bill of exchange is sent to the buyer, and the buyer signs and accepts the bill, and returns it to the seller. The seller now has a transferable document which is legal proof that the buyer has agreed to pay the amount on a particular date.

Bills of Exchange Terminology

In the description above the terms seller and buyer were used to signify the parties to the agreement. In general the following terms are used when discussing bills of exchange. By way of explanation the terms seller and buyer are indicated in brackets.

The drawer is the person who draws up the bills of exchange. (Seller)

The drawee is the person on who the bills of exchange are drawn. (Buyer)

The acceptor is the person who accepts the bill of exchange. (Buyer)

The payee is the person to who the bill of exchange is to be paid at the maturity date. (Seller)

Maturity Date
The maturity date is the date on which the bill of exchange matures. (Payment date or due date)

Bills Receivable
Bills receivable represent amounts receivable under bills of exchange. The bills receivable are an asset shown in the accounting records of the person entitled to payment under the bills of exchange. In the above case the seller has bills receivable for the amount due from the buyer.

Bills Payable
Bills payable represent amounts payable under bills of exchange. The bills payable are a liability shown in the accounting records of the person responsible for making payment under the bills of exchange. In the above case the buyer has bills payable for the amount due to the seller.

It should be noted that in this particular case, the seller is both the drawer and the payee, and the buyer is the drawee, and the acceptor of the bill of exchange.

Using Bills of Exchange

Bills of exchange can be transferred between different parties. In the above discussion there was a simply arrangement between a drawer (seller) and a drawee (buyer). The drawer however is under no obligation to retain the bills of exchange, they have a number of options.

1. Hold Until Maturity

The drawer (seller) can hold the bill of exchange until its maturity date, and simply present the bill to the acceptor (buyer) for payment to be made. This process is shown in the diagram below.

bills of exchange
Bills of Exchange
(click to zoom)

2. Discounting Bills of Exchange

Alternatively, the drawer (seller) can discount the bill of exchange with a bank (discounter). The drawer transfers the right to collect payment on the bill to the bank in return for a cash payment less a discount representing the banks fee. The discount charged by the bank is the interest on the amount of the bill for the period from the date of discounting until the date of maturity.

The bank who is now the payee, holds the bill of exchange until the maturity date at which point it presents the bill to the acceptor (buyer) for payment. This process is shown in the diagram below.

discounted bills of exchange
Discounted Bills of Exchange
(click to zoom)

3. Negotiation of Bills of Exchange

Finally, the drawer (seller) can negotiate the bill of exchange with a third party in return for a payment. The drawer endorses the bill to the third party (endorsee and payee) who then holds the bill until maturity and presents it to the acceptor (buyer) for payment. Alternatively, the third party could further negotiate the bill with another third party and so on until the person who holds the bill at its maturity date presents it to the acceptor (buyer) for payment. This process is shown in the diagram below.

negotiated bills of exchange
Negotiated Bills of Exchange
(click to zoom)

Dishonored Bills of Exchange

If the acceptor (buyer) fails to make the payment required under the bill of exchange on the maturity date, the bill is said to have been dishonored.

When a discounted or negotiated bill is dishonored, the drawer of the bill (seller) becomes liable to compensate the bank, or in the case of a negotiated bill the endorsee, for the amount due. The drawer has legal recourse to the acceptor of the bill.

Bills of Exchange in Accounting April 3rd, 2017Team

You May Also Like

Related pages

how to calculate stock splitreceivable control account formatlifo reserve accountpetty cash transactions exampleshow to calculate discount on excelnormal balance of inventorywhat is present value annuityaccounting accrual vs cashlump sum discountfreight out income statementdepreciation in excelfv calculator onlinehow to calculate total fixed cost formuladefinition payback periodexample of perpetuityfv function excelaccounts receivable flowchart examplesingle entry system of accounting formathow to bookkeeping basicsnotes payable calculatorwhat type of account is a suspense accounthow to calculate payback period in yearsgaap journal entriesfixed assets sold formulaassets liability and equitycost of merchandise sold equals beginning inventoryformula for manufacturing overheadaccounts payable excelgeneral ledger example pdfwhat is a accounting equationdeclaring dividends journal entryaccounting double entry cheat sheetcalculation of accrued interest on fixed depositacceptable gearing ratioaccrued expense adjusting entryexcel calculate irraccrual accounting and adjusting entriesdiminishing value depreciation formula accountingaccounts payable receivable interview questions answersbond accounting journal entriespre operative expenses meaningformula to calculate variable cost per unitaccounts payable tutorialreducing balance method calculatorgeometric annuity200 declining balance depreciationnpv perpetuity calculatorusing npv in exceltreatment of deferred tax liability in cash flow statementmeaning of journal voucherrent paid in advance balance sheetjournal entry for rent expenseactivity ratios formulashow to calculate days receivablear turnover calculationincome tax provision templatedefine cashbookbasic accounting equation exercisesgross profit margin ratio exampledisposal of intangible assetsaccounting adjusting entries for dummieshow to calculate gross margin per unithow to calculate discount percentage in excelinterest bearing loan definitiongrowing annuitiesshort term notes receivableformula to find profit percentagelabour cost per unit formulasales journal accountingdirect material cost variancewhich journal would adjusting entries be foundexcel balance sheet formulaaccounting for joint ventures equity methodexplain petty cash transactionsliquidity ratios formula