Bills of Exchange | ISC Class 11 Accounts Notes

This note covers negotiable instruments and their meaning, the bill of exchange and its parties, the promissory note (including its specimen and its distinction from a bill of exchange), the cheque, the advantages and disadvantages of bills of exchange, key terms such as drawer, drawee, payee, endorser, endorsee, tenure, days of grace, due date, endorsement, discounting, bill sent for collection, dishonour, noting charges, notary public, renewal, retirement and insolvency of the acceptor, and journal entries for these transactions in the books of the drawer, the drawee and the endorsee.

What is a negotiable instrument?

A negotiable instrument is a document that entitles its lawful holder to a certain sum of money and that can be transferred from one person to another by delivery or by endorsement and delivery.

Once it is transferred to a person who takes it in good faith and for value, that person gets a good title to it even if the title of the previous holder was defective.

The three common negotiable instruments studied together are the bill of exchange, the promissory note and the cheque.

Each is a written, signed document that fixes a sum of money payable to a named person, to the order of that person, or to the bearer.

These instruments are used to settle business debts without the actual exchange of cash at the time of sale.

A seller who allows credit can still realise cash before the due date of payment by transferring the instrument to a bank or to another person, which is one reason such instruments are widely used in trade.

Definition: Negotiable instrument. A document in writing, signed by the maker or drawer, that is freely transferable by delivery or endorsement and gives the holder a right to receive a fixed sum of money.

What is a bill of exchange, and who are its parties?

A bill of exchange is a written instrument containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument. A bill of exchange involves three parties.

• The drawer is the person who makes and signs the bill. The drawer is usually the creditor or the seller of goods, who is owed money.
• The drawee is the person on whom the bill is drawn and who is directed to pay the amount. The drawee is usually the debtor or the buyer of goods. The drawee becomes the acceptor once they write "accepted" and sign the bill, agreeing to pay it on the due date.
• The payee is the person to whom the amount is payable. Often the drawer and the payee are the same person, unless the drawer has already transferred the bill to someone else by endorsement.

For the bill to be valid, the drawer's order to the drawee must be unconditional, the sum stated must be certain, and the bill must be signed by the drawer and (for enforcement) accepted by the drawee.

Definition: Bill of exchange. An instrument in writing containing an unconditional order, signed by the drawer, directing the drawee to pay a certain sum of money, on demand or at a fixed future time, to the payee or to the bearer.

Draw a rectangular form headed with the place and date of drawing, the amount in words and figures, the words "three months after date pay to [payee] or order the sum of ₹ ... for value received", the drawee's name and address at the bottom left, and the drawer's signature at the bottom right, with the drawee's acceptance signature and date written across the face of the bill.

What is a promissory note, and how does it differ from a bill of exchange?

A promissory note is a written instrument containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument.

Unlike a bill of exchange, a promissory note involves only two parties.

• The maker is the debtor who promises to pay. The maker signs the note.
• The payee is the creditor to whom the amount is promised.

Because the debtor himself promises to pay, there is no separate drawee and no need for acceptance; the maker's signature alone makes the note binding on them.

A bill of exchange, by contrast, is an order given by the creditor to the debtor and requires the debtor's acceptance before it becomes fully enforceable.

Distinction between a bill of exchange and a promissory note

Draw a form headed with the place and date, the words "I promise to pay [payee] or order the sum of ₹ ... for value received", the maker's signature at the bottom, and a revenue stamp affixed near the signature, with no acceptance line since a promissory note needs no acceptance.

What is a cheque, and how is it different from a bill of exchange?

A cheque is a bill of exchange drawn on a specified banker, payable always on demand.

Like a bill of exchange, a cheque has a drawer, a drawee and a payee, but its drawee is always a bank where the drawer holds an account.

A cheque does not need the drawee bank's acceptance before it is used, and it is always payable on demand, so no days of grace are added to a cheque.

A bill of exchange, in contrast, may be drawn on any person (not necessarily a bank), may be payable on demand or after a fixed period, and, when it is payable after a period, carries days of grace before its due date.

What are the advantages and disadvantages of bills of exchange?

Advantages of bills of exchange

• A bill of exchange is a legal, written acknowledgement of a debt, so it is better evidence in a court of law than an ordinary book entry.
• The drawer can get cash before the due date by discounting the bill with a bank, which improves liquidity.
• A bill is freely transferable by endorsement, so the holder can use it to pay off their own creditors instead of waiting for cash.
• Because the due date is fixed in advance, both parties know exactly when payment falls due, which helps in planning cash flows.
• Non-payment of an accepted bill can be noted and protested through a notary public, which strengthens the drawer's legal position if the matter goes to court.

Disadvantages of bills of exchange

• Discounting a bill with a bank costs the drawer a discount charge, which reduces the amount actually received before the due date.
• If the drawee dishonours the bill, the drawer has to bear noting charges and may still have to recover the amount through legal action.
• Preparing, stamping and routing bills for acceptance and collection involves paperwork and time that a simple credit sale does not require.
• If the drawee becomes insolvent, the drawer may be unable to recover the full amount of the bill and has to treat the unrecovered part as a bad debt.

What is the tenure of a bill, and how are days of grace and the due date worked out?

The tenure of the bill is the period between the date of the bill and the date on which it is to be paid. Bills are of several kinds depending on how the tenure is counted.

• A bill on demand (also called a bill at sight or a bill on sight) is payable whenever it is presented to the drawee; no days of grace are added to such a bill.
• A bill after date is payable at a fixed period after the date on which the bill is drawn.
• A bill after sight is payable at a fixed period after the drawee accepts (sees) the bill, so its tenure is counted from the date of acceptance rather than from the date of drawing.

For a bill payable after a period, three extra days of grace are added to the period stated on the bill before it becomes legally due.

The due date of the bill is the date obtained after counting the stated period from the date of the bill (or of acceptance, for a bill after sight) and then adding these three days of grace.

If the due date calculated in this way falls on a public holiday, the bill becomes due on the preceding business day; if an unforeseen (emergency) holiday falls on the due date, the bill becomes due on the next business day.

Definition: Days of grace. Three additional days allowed by law, beyond the period of credit stated on a bill, before the bill becomes legally due for payment.

Worked example 1. A bill of exchange dated 1st January 2025 is drawn for a period of 3 months "after date". Calculate the due date of the bill.

Answer: Three months from 1st January 2025 falls on 1st April 2025. Adding 3 days of grace gives a due date of 4th April 2025.

What is endorsement, and who are the endorser and the endorsee?

An endorsement is the act of signing one's name on the back of a bill (or on a slip attached to it) in order to transfer the right to receive the amount of the bill to another person.

The person who signs and transfers the bill is the endorser, and the person in whose favour the bill is transferred is the endorsee.

A bill may be endorsed to pay off a creditor, so that the payment obligation under the bill passes from the endorser to the endorsee, who then becomes the holder entitled to receive the amount on the due date.

The person who at any point in time is legally entitled to the possession of the bill and to receive its payment is called the holder of the bill.

Definition: Endorsement. Signing a bill of exchange on its back, usually with the words "pay to [name] or order", to transfer the holder's right to receive payment to another person.

What is discounting of a bill, and how does it differ from a bill sent for collection?

Discounting of a bill means the holder of the bill gets it encashed with a bank before its due date, at a value slightly less than its face value.

The difference between the face value and the amount actually received is the discount, which is really interest charged by the bank for the remaining period of the bill.

After discounting, the bank becomes the holder of the bill and collects the full amount directly from the drawee on the due date.

A bill sent for collection is different: here the holder simply hands the bill over to the bank with instructions to collect the amount from the drawee on the due date and credit it to the holder's account.

The bank acts only as an agent for collection, charges no discount, and the amount is credited to the holder only after the drawee actually pays on the due date, not immediately as happens with discounting.

Definition: Discounting of a bill. Getting a bill of exchange encashed with a bank before its due date in exchange for a deduction (discount), which is interest for the unexpired period of the bill.

Worked example 2. Ramesh sold goods to Suresh for ₹50,000 on 1st March 2025. Suresh accepted a bill drawn by Ramesh for 3 months for the amount.

Pass the journal entries in Ramesh's books (a) on drawing the bill, and (b) if Suresh honours the bill on the due date by paying through his bank.

Answer: (a) On 1st March 2025: Bills Receivable A/c Dr. ₹50,000; To Suresh's A/c ₹50,000 (being a bill drawn on Suresh and accepted by him). (b) On the due date: Bank A/c Dr. ₹50,000; To Bills Receivable A/c ₹50,000 (being the bill met on maturity).

Worked example 3. A trader holds a bill of ₹60,000 due in 2 months. He discounts it with his bank immediately at 12% per annum. Calculate the discount and pass the journal entry in his books on discounting.

Answer: Discount = ₹60,000 × 12% × 2/12 = ₹1,200. Amount received from the bank = ₹60,000 − ₹1,200 = ₹58,800. Journal entry: Bank A/c Dr. ₹58,800; Discount A/c Dr. ₹1,200; To Bills Receivable A/c ₹60,000 (being the bill discounted with the bank at 12% p.a. for the unexpired period of 2 months).

Worked example: a bill sent for collection. On 10th April 2025, Ramesh sent a bill of ₹30,000 to his bank for collection. On the due date the bank collected the amount and credited his account after deducting collection charges of ₹50. Pass the journal entries in Ramesh's books.

Answer: On sending the bill: Bills Sent for Collection A/c Dr. ₹30,000; To Bills Receivable A/c ₹30,000 (the bill leaves the holder's hands but is still owed to him). On collection: Bank A/c Dr. ₹29,950 and Bank Charges A/c Dr. ₹50; To Bills Sent for Collection A/c ₹30,000. No discount entry arises, because the bank acted only as an agent and paid nothing before the due date.

What happens when a bill is dishonoured?

Dishonour of a bill occurs when the drawee fails to accept the bill when it is presented for acceptance, or fails to pay the amount of the bill on its due date when it is presented for payment.

When a bill is dishonoured, the holder's right to receive the money from the bill itself is lost, and the holder must instead recover the amount directly from the drawer or from the parties through whom the bill passed, along with any expenses incurred because of the dishonour.

In the drawer's books, dishonour is recorded by cancelling the Bills Receivable account and debiting the drawee (with the bill amount plus any noting charges paid on the drawer's behalf).

In the drawee's (acceptor's) books, dishonour is recorded by cancelling the Bills Payable account and crediting the drawer, again including noting charges.

If the bill had been discounted with a bank or endorsed to a third party before dishonour, the party who had to bear the noting charges debits the drawer (or the party from whom the bill was received) with the full amount, including those charges, since the original holder (such as the bank) looks to that party for reimbursement.

Worked example 4. Mohan had accepted a bill of ₹20,000 drawn on him by his supplier. On the due date the bill was dishonoured, and the supplier paid noting charges of ₹200. Pass the journal entry for dishonour in Mohan's (the drawee's) books.

Answer: Bills Payable A/c Dr. ₹20,000; Noting Charges A/c Dr. ₹200; To Supplier's (Drawer's) A/c ₹20,200 (being the bill dishonoured and noting charges debited to Mohan, since he caused the expense).

What are noting charges, and who is a notary public?

When a bill is dishonoured, the holder can get the fact of dishonour officially certified by a notary public, a legally authorised official who verifies that the bill was presented and dishonoured, and records the date and the reason for dishonour.

The fee paid to the notary public for this service is called noting charges. This formal record, called "noting" (and sometimes followed by a "protest"), is valuable evidence if the holder later has to sue the drawer or the drawee to recover the amount.

Noting charges are ultimately recoverable from the party responsible for the dishonour, usually the drawee or acceptor, and are added to the amount debited to that party's account.

Definition: Noting charges. The fee paid to a notary public for officially certifying and recording that a bill of exchange has been dishonoured, together with the date and reason for dishonour.

What are renewal and retirement of a bill?

Sometimes the drawee is unable to pay a bill on its due date and asks the drawer for more time.

If the drawer agrees, the original bill is cancelled and a new bill is drawn for an extended period; this process is called renewal of a bill.

The new bill is usually drawn for the original amount plus interest for the extra period of credit allowed, since the drawer has agreed to wait longer for payment.

Occasionally the drawee wants to pay the bill before its due date rather than waiting until maturity.

If the holder agrees to accept payment earlier and allows a small reduction (a rebate) for the early payment, this is called retirement of a bill.

The rebate is, in effect, interest that the holder gives up in exchange for getting the money sooner than the due date.

1. The drawee, finding they cannot pay on the due date, requests the drawer to cancel the existing bill and draw a fresh bill.
2. The drawer agrees and works out the interest for the additional period of credit being allowed.
3. The original Bills Receivable or Bills Payable, as applicable, is cancelled in both sets of books.
4. A new bill is drawn and accepted for the original amount plus interest, and the interest is recorded as income to the drawer and as an expense to the drawee.

Worked example: renewal of a bill. Kiran drew a bill of ₹10,000 on Lata, which fell due on 4th April 2025. Lata could not pay and asked for 2 months more. Kiran agreed, charging interest at 12% per annum; Lata paid the interest in cash and accepted a new bill for ₹10,000 for 2 months. Pass the journal entries on 4th April 2025 in both sets of books.

Interest = 10,000 × 12/100 × 2/12 = ₹200.

In Kiran's books: (1) Lata's A/c Dr. ₹10,000; To Bills Receivable A/c ₹10,000 (old bill cancelled). (2) Lata's A/c Dr. ₹200; To Interest A/c ₹200 (interest due on renewal). (3) Cash A/c Dr. ₹200; To Lata's A/c ₹200 (interest received). (4) Bills Receivable A/c Dr. ₹10,000; To Lata's A/c ₹10,000 (new bill received).

In Lata's books: (1) Bills Payable A/c Dr. ₹10,000; To Kiran's A/c ₹10,000. (2) Interest A/c Dr. ₹200; To Kiran's A/c ₹200. (3) Kiran's A/c Dr. ₹200; To Cash A/c ₹200. (4) Kiran's A/c Dr. ₹10,000; To Bills Payable A/c ₹10,000. If the interest is not paid in cash, it is added to the new bill instead, which is then drawn for ₹10,200 and entries (3) are left out.

Worked example: retirement of a bill. Neha held Om's acceptance for ₹24,000. One month before the due date, Om retired the bill under a rebate at 10% per annum, paying by cheque. Pass the journal entries in the books of Neha and Om.

Rebate = 24,000 × 10/100 × 1/12 = ₹200, so Om pays 24,000 − 200 = ₹23,800.

In Neha's books: Bank A/c Dr. ₹23,800 and Rebate on Bills A/c Dr. ₹200; To Bills Receivable A/c ₹24,000. In Om's books: Bills Payable A/c Dr. ₹24,000; To Bank A/c ₹23,800 and To Rebate on Bills A/c ₹200. The rebate is an expense for the holder and an income for the acceptor.

What happens on insolvency of the drawee or acceptor?

If the drawee (acceptor) becomes insolvent before the due date, they are unable to pay the full amount of the bill.

In such a case, only a part of the amount, expressed as so many paise in the rupee, is recoverable from the insolvent drawee's estate, and the remaining amount becomes a bad debt for the holder of the bill.

In the drawer's books, the amount actually recovered is debited to Cash or Bank, and the irrecoverable balance is written off as a bad debt by debiting a Bad Debts account and crediting the drawee's (or Bills Receivable) account.

Worked example: insolvency of the acceptor. Raj held Vikram's acceptance for ₹15,000. Before the due date Vikram became insolvent, and a first and final dividend of 40 paise in the rupee was received in cash from his estate. Pass the journal entries in the books of Raj and Vikram.

Amount recovered = 15,000 × 0.40 = ₹6,000; amount lost = 15,000 − 6,000 = ₹9,000.

In Raj's books: (1) Vikram's A/c Dr. ₹15,000; To Bills Receivable A/c ₹15,000 (the bill is treated as dishonoured on insolvency). (2) Cash A/c Dr. ₹6,000 and Bad Debts A/c Dr. ₹9,000; To Vikram's A/c ₹15,000.

In Vikram's books: (1) Bills Payable A/c Dr. ₹15,000; To Raj's A/c ₹15,000. (2) Raj's A/c Dr. ₹15,000; To Cash A/c ₹6,000 and To Deficiency A/c ₹9,000. The insolvent acceptor shows the unpaid part in a Deficiency Account, because the debt is settled by law rather than paid.

How are these transactions recorded in the books of the drawer, drawee and endorsee?

The same bill transaction is recorded differently in the books of each party connected with it, because each party's position (holder of a receivable, payer of a payable, or holder by endorsement) is different.

When a bill is endorsed to a third party, the endorsee who receives it in settlement of a debt owed to them records it as a receivable in their own books, debiting Bills Receivable and crediting the endorser's account.

On the due date, if the drawee pays, the endorsee debits Bank and credits Bills Receivable.

If the drawee dishonours the bill instead, the endorsee debits the endorser's account (with the bill amount plus any noting charges paid) and credits Bills Receivable and Cash, since the endorsee now looks to the endorser (and ultimately to the drawer) for payment rather than to the defaulting drawee.

Worked example: one bill in the books of all three parties

On 1st January 2025, Asha sold goods to Bina for ₹20,000 and drew a bill on her for 2 months, which Bina accepted the same day. On 4th January 2025, Asha endorsed the bill to her creditor Chetan, to whom she owed ₹20,000. On the due date the bill was dishonoured, and Chetan paid noting charges of ₹100.

The due date is 1st March 2025 (2 months from 1st January) plus 3 days of grace, that is, 4th March 2025. The accounts are balanced on 31st March 2025.

What entries does Asha, the drawer and endorser, pass?

What entries does Bina, the drawee, pass?

Bina makes no entry on 4th January: the endorsement transfers the right to receive payment between Asha and Chetan and does not change what Bina owes.

What entries does Chetan, the endorsee, pass?

Ledger accounts for the worked example

In Asha's ledger, the Bills Receivable Account closes when the bill passes to Chetan, while the personal accounts of Bina and Chetan carry the dishonour forward.

Asha's ledger: Bills Receivable Account

Asha's ledger: Bina's Account

Asha's ledger: Chetan's Account

Bina's ledger: Bills Payable Account

Bina's ledger: Asha's Account

Chetan's ledger: Bills Receivable Account

Chetan's ledger: Asha's Account

The closing balances tell the story of the dishonour: Bina owes Asha ₹20,100, Asha owes Chetan ₹20,100, and the noting charges travel back along the chain until they rest with Bina, the party who failed to pay.

Ledger accounts for discounting, renewal, retirement and insolvency

The same posting rule applies to every practical problem: each journal entry is posted to the debit side of one account and the credit side of another, and each account is then balanced. The ledgers below follow the worked examples earlier in this note.

Discounting (Worked example 3), the trader's ledger: Bills Receivable Account

Renewal (Kiran and Lata), Kiran's ledger: Lata's Account, taking the original bill as drawn on 1st January 2025 for 3 months against goods sold to Lata

Renewal, Kiran's ledger: Bills Receivable Account, with the new bill met on its due date, 7th June 2025 (2 months from 4th April plus 3 days of grace)

Retirement (Neha and Om), Neha's ledger: Bills Receivable Account

Insolvency (Raj and Vikram), Raj's ledger: Vikram's Account

Insolvency, Vikram's ledger: Raj's Account

In each case the account closes with no balance, because the bill has been fully settled: by the bank, by a new bill, by early payment, or partly by the insolvent's estate and partly by a written-off loss.

Glossary

• Negotiable instrument: a document, signed by its maker, transferable by delivery or endorsement, giving its holder a right to a fixed sum of money.
• Bill of exchange: a written, unconditional order by the drawer directing the drawee to pay a certain sum to the payee or bearer.
• Promissory note: a written, unconditional promise by the maker to pay a certain sum to the payee or bearer.
• Drawer: the person who draws and signs a bill of exchange, usually the creditor.
• Drawee: the person directed to pay the amount of a bill, usually the debtor, who becomes the acceptor on signing the bill.
• Payee: the person named in a bill or note to whom the amount is to be paid.
• Endorsement: signing the back of a bill to transfer the right to receive its payment to another person.
• Endorsee: the person in whose favour a bill is endorsed and transferred.
• Holder of a bill: the person currently entitled to possession of the bill and to receive its payment.
• Tenure of the bill: the period between the date of the bill and the date fixed for its payment.
• Days of grace: three extra days added to a bill's stated period before it becomes legally due.
• Discounting of a bill: encashing a bill with a bank before its due date in return for a deduction of interest.
• Dishonour of a bill: failure of the drawee to accept or pay the bill when it is presented.
• Noting charges: the fee paid to a notary public for certifying the dishonour of a bill.
• Renewal of a bill: cancelling a bill that cannot be paid on time and drawing a fresh bill for an extended period, usually with interest.

Common errors and misconceptions

• Misconception: a promissory note also needs the payee's acceptance, like a bill of exchange. Correct: a promissory note is signed only by the maker and needs no acceptance; only a bill of exchange requires the drawee's acceptance.
• Misconception: a cheque is given three days of grace before it becomes due, like an ordinary bill. Correct: a cheque is always payable on demand, so no days of grace are added to it.
• Misconception: discounting a bill with a bank and sending a bill for collection are the same thing. Correct: discounting gives immediate cash minus a discount and makes the bank the holder, while a bill sent for collection is only collected by the bank as an agent, with proceeds credited after the drawee actually pays.
• Misconception: noting charges are always borne by the party who pays them to the notary public. Correct: whoever pays the noting charges first recovers them from the party responsible for the dishonour, usually the drawee.
• Misconception: renewal and retirement of a bill mean the same thing. Correct: renewal replaces an unpaid bill with a fresh one for a longer period with added interest, while retirement is paying an existing bill before its due date, usually with a rebate.
• Misconception: on the drawee's insolvency, the drawer always loses the entire amount of the bill. Correct: only the part that is not recovered from the insolvent estate is a bad debt; whatever amount is actually received reduces the loss.
• Misconception: the due date of a bill is simply the period stated on it, counted from the date of drawing. Correct: days of grace must be added, and for a bill after sight the period is counted from acceptance, not from the date of drawing.

Exam-style questions with model answers

Q1. State what is meant by the "tenure" of a bill of exchange. [2 marks]

1. The tenure of a bill is the period between the date of the bill (or the date of acceptance, for a bill after sight) and the date fixed for its payment.
2. It determines, along with the three days of grace, the due date on which the drawee must pay the bill.

Q2. Distinguish between a bill on demand and a bill after date. [2 marks]

1. A bill on demand is payable whenever it is presented to the drawee, and no days of grace are added to it.
2. A bill after date is payable at a fixed period counted from the date on which the bill was drawn, and three days of grace are added to find its due date.

Q3. A bill of exchange dated 10th February 2025 is drawn for 2 months "after date". Calculate its due date, showing your working. [3 marks]

1. Two months from 10th February 2025 falls on 10th April 2025.
2. Three days of grace are added to this date, as the bill is payable after a fixed period.
3. Adding 3 days to 10th April 2025 gives a due date of 13th April 2025.

Q4. Explain the difference between discounting a bill of exchange and sending a bill for collection. [4 marks]

1. Discounting means the holder gets the bill encashed with a bank before its due date, in return for a deduction called discount.
2. On discounting, the bank becomes the holder of the bill and collects the full amount directly from the drawee on the due date.
3. A bill sent for collection is simply handed to the bank with instructions to collect the amount on the due date and credit it to the holder's account.
4. No discount is charged on a bill sent for collection, and the amount is credited to the holder only after the drawee actually pays, unlike the immediate cash received on discounting.

Q5. Prakash sold goods to Deepak for ₹40,000 on 1st May 2025 and drew a bill on Deepak for 3 months for the amount, which Deepak accepted. On the due date, Deepak paid the bill through his bank. Pass journal entries for these transactions in Prakash's books. [4 marks]

1. On 1st May 2025, drawing the bill: Bills Receivable A/c Dr. ₹40,000; To Deepak's A/c ₹40,000.
2. This records that Prakash now holds an accepted bill receivable from Deepak instead of a simple book debt.
3. On the due date, 4th August 2025 (3 months from 1st May plus 3 days of grace): Bank A/c Dr. ₹40,000; To Bills Receivable A/c ₹40,000.
4. This records that the bill has been honoured and the amount received through Deepak's bank, closing the Bills Receivable account.

Q6. Explain, with reasons, what happens to a bill of exchange when the drawee becomes insolvent before the due date. [5 marks]

1. An insolvent drawee is unable to pay the bill in full, so the holder cannot recover the entire amount from them.
2. Only a part of the amount, expressed as so many paise in the rupee recoverable from the insolvent's estate, is actually received by the holder.
3. The part of the amount that cannot be recovered is treated as a bad debt and written off by the holder.
4. In the drawer's books, the amount recovered is debited to Cash or Bank, and the irrecoverable balance is debited to a Bad Debts account, with the drawee's account (or Bills Receivable) credited for the full original amount.
5. If the bill had already been discounted or endorsed before the insolvency, the drawer still bears this loss, because the bank or endorsee looks to the drawer for reimbursement once the drawee fails to pay.

Q7. Ajay accepted a bill of ₹30,000 drawn on him by Vijay. On the due date, the bill was dishonoured, and Vijay paid noting charges of ₹300 to get the dishonour recorded. Pass the journal entry for the dishonour in the books of (a) Vijay (the drawer) and (b) Ajay (the drawee). [6 marks]

1. In Vijay's (the drawer's) books, the dishonour means the Bills Receivable account must be cancelled and Ajay's personal account debited instead, since Vijay must now recover the money directly from Ajay.
2. Entry in Vijay's books: Ajay's A/c Dr. ₹30,300; To Bills Receivable A/c ₹30,000; To Cash A/c ₹300.
3. This records that Ajay now owes Vijay the original bill amount plus the noting charges Vijay paid on his behalf.
4. In Ajay's (the drawee's) books, the dishonour means the Bills Payable account must be cancelled and Vijay's personal account credited instead, since Ajay's liability reverts to an ordinary trade debt.
5. Entry in Ajay's books: Bills Payable A/c Dr. ₹30,000; Noting Charges A/c Dr. ₹300; To Vijay's A/c ₹30,300.
6. This records that Ajay once again owes Vijay ₹30,300, made up of the bill amount and the noting charges he must reimburse.

Key takeaways

• A negotiable instrument is freely transferable and gives its holder a right to a fixed sum of money.
• A bill of exchange is an order to pay, involving a drawer, a drawee and a payee, and needs the drawee's acceptance.
• A promissory note is a promise to pay, involving only a maker and a payee, and needs no acceptance.
• A cheque is a bill of exchange drawn on a bank, always payable on demand, with no days of grace.
• Three days of grace are added to a bill's stated period, except for bills payable on demand, to find the due date.
• Endorsement transfers the right to receive a bill's payment from the endorser to the endorsee.
• Discounting gives immediate cash minus interest, while sending a bill for collection only uses the bank as a collecting agent.
• Dishonour cancels the bill asset or liability and shifts the debt back to the drawee's (or drawer's) personal account, plus any noting charges.
• Renewal extends the period of an unpaid bill with added interest, while retirement is early payment with a rebate.
• On the drawee's insolvency, only the recoverable part is collected, and the rest is written off as a bad debt.

Test yourself

Who is the "acceptor" of a bill of exchange?

The drawee becomes the acceptor once they write "accepted" on the bill and sign it, agreeing to pay the amount on the due date.

Why does a promissory note need no acceptance, unlike a bill of exchange?

A promissory note is a direct promise by the debtor (maker) to pay, so the maker's own signature is enough; a bill is an order by the creditor to the debtor, which the debtor must separately accept.

What are "days of grace", and how many are usually added to a bill?

Days of grace are extra days added to a bill's stated period before it becomes legally due; three days of grace are usually added.

How is a "bill after sight" different from a "bill after date" in counting its tenure?

A bill after date is counted from the date the bill was drawn, while a bill after sight is counted from the date the drawee accepted (sighted) the bill.

What entry does the drawer pass when a discounted bill is dishonoured?

The drawer debits the drawee's account with the bill amount plus any noting charges paid, and credits Bills Receivable and Cash (for the noting charges), since the bank now looks to the drawer for payment.

What is the difference between "renewal" and "retirement" of a bill?

Renewal cancels an unpaid bill and replaces it with a fresh bill for a longer period, usually with added interest; retirement is paying an existing bill before its due date, usually with a rebate.

Who certifies the dishonour of a bill, and what is the fee for this called?

A notary public certifies and records the dishonour, and the fee paid for this service is called noting charges.