Chapter 7 Bills of Exchange
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Project on Bills of Exchange
Bills of exchange are financial instruments used in commercial transactions as a form of credit and a means of payment. They serve as a written order from one party (the drawer) to another (the drawee) to pay a specified sum of money to a third party (the payee) either immediately or at a future date. Bills of exchange are commonly used in international trade and domestic commerce to facilitate transactions and provide security to parties involved. Here's how they work in accounting:
Parties Involved:
- Drawer: The party that issues the bill of exchange and is owed the specified sum of money. They are usually the seller or creditor in the transaction.
- Drawee: The party directed to pay the specified sum of money. Typically, this is the buyer or debtor.
- Payee: The party to whom the payment is directed. This is often the drawer themselves or a third party designated by them.
Types of Bills of Exchange:
- Sight Bill: Payable on presentation to the drawee for immediate payment.
- Term Bill: Payable on a specified future date (e.g., 30 days after sight or date).
- Usance Bill: Similar to a term bill but with a specified grace period for payment after the due date.
Accounting Treatment:
- Issuance: When a bill of exchange is issued, the drawer records it as a receivable and the drawee records it as a payable.
- Acceptance: If the drawee agrees to pay the bill, they "accept" it, acknowledging their obligation. The drawer then records the bill as a receivable and the drawee records it as a liability.
- Payment: When the drawee pays the bill, they reduce their liability, and the drawer increases their cash or bank balance.
Discounting Bills:
- Sometimes, the drawer may need immediate funds before the bill's maturity date. They can discount the bill with a bank or financial institution, receiving the present value of the bill minus a discount (interest).
- In this case, the drawer records the discounted amount received as cash or bank balance, and the difference between the face value of the bill and the discounted amount represents interest expense or finance charges.
Endorsement and Negotiability:
- Bills of exchange can be endorsed, allowing the payee to transfer their rights to another party. Endorsement can be either blank (to bearer) or special (to a specific party).
- Endorsement ensures negotiability, allowing bills to be traded or used as a form of payment in subsequent transactions.
Recording Transactions:
- Entries in the books of accounts include recording the issuance, acceptance, payment, and discounting of bills, along with any associated interest expenses or income.
Overall, bills of exchange play a significant role in commercial transactions, providing a flexible and secure means of payment and credit. Understanding their accounting treatment is crucial for businesses involved in trade and commerce.