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Dishonor of Bill of Exchange:

Definition and Explanation of Dishonor of Bill:

What happens when a bill is not honored by the acceptor on the due date (cash is not paid to the holder of the bill)? A bill of exchange is said to be dishonored when its acceptor refuses to pay the amount of the bill to the holder of the bill on its maturity. The bill then becomes useless and the party from whom it has been received will be liable to pay for the amount. It is very important to know that, when a bill is dishonored, in whose possession it was? Because when a bill is dishonored, all the parties involved are effected and books of accounts of all the parties have to be adjusted. For example, A draws a bill of $5,000 on B and B accepts it and returns it to A. A retains the bill in his possession till the due date. On the due date the bill is not honored by the acceptor. We can see, there are two parties involved whose books are to be adjusted. If suppose, A has discounted or endorsed the bill, then there are three parties involved and books of accounts of all the parties are effected.

Noting Charges:

When a bill is dishonored, the holder of the bill, (drawer, banker, endorsee or any other party) in order to make a strong ground for drawing legal proceeding against the acceptor may get the official recognition that the bill has been dishonored. He goes to an official called notary public, and gives the bill to him. The notary public will present the bill for payment again to the acceptor and if the money is received he will hand over the money to the original party. But if the bill is again dishonored, the notary public will note the fact of dishonor and the reasons of the dishonor on the bill and will give the bill back to the holder of the bill. It is now a strong evidence against the acceptor, in case, if the case is filed in the court.

For this service, the notary public will charge a small fee obviously from the holder of the bill. This fee is known as "noting charges" and is always recoverable from the party responsible for dishonor (the acceptor).

It must be remembered that noting charges are not the expenses of any party involved. They are always expenses of the acceptor in whose books they will be debited.

Who Pays Noting Charges:

  1. If the bill is retained by the drawer, the drawer will pay the noting charges.

  2. If the bill has been discounted the bank will pay.

  3. If the bill has been endorsed to the endorsee, the endorsee will pay.

  4. If the endorsee has endorsed the bill to his creditor (a new endorsee), the new endorsee will pay.

But the new endorsee will recover the noting charges from first endorsee, the first endorsee from the drawer and ultimately the drawer from the acceptor (being an expense of acceptor).

Example:

On 1st Jan. 2005. the X sold goods to Y. for $10,000 on credit basis. On the same date X drew a bill for $10,000 on Y. at two months. Y accepted the bill and returned it to X. On the due date Y could not honor acceptance.

Required: Give journal entries in the books of X and Y.

Solution:

X's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
1.1.2005 Y A/C................................................Dr.
     Sales A/C
(Goods sold on credit basis)
  10,000
10,000
1.1.2005 Bill receivable A/C...............................Dr.
     Y A/C
(Acceptance received at two months)
  10,000
10,000
4.3.2005 Y A/C...............................................Dr.
     Bill receivable account A/C
(Bill is dishonored on the due date)
  10,000
10,000

When the goods were sold to Y, he became a debtor for $10,000. Then he paid his debts by giving acceptance (B/R) to X. But when he did not honor his acceptance on the due date, he again became a debtor of X. (Amount is still due from him).

Y's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
1.1.2005 Purchases A/C.....................................Dr.
     X A/C
(Goods purchased on credit)
  10,000
10,000
1.1.2005 X A/C.................................................Dr.
     Bill payable A/C
(Acceptance given at two months)
  10,000
10,000
4.3.2005 Bill payable A/C...................................Dr.
     X A/C
(Acceptance not honored on maturity)
  10,000
10,000

In the above example, the drawer (X) has not got the bill noted by the notary public and so no noting charges were paid by him.

Suppose if he also paid $40 as noting charges, then a further entry will have to be made both in the books of X as well as in the books of Y.

In X's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
4.3.2005 Y A/C...............................................Dr.
     Cash A/C
(Cash paid as noting charges on behalf of Y)
  40
40

In Y's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
4.3.2005 Noting charges A/C...............................Dr.
     X A/C
(Noting charges paid by the X)
  40
40

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More study material from this topic:

Definition and explanation of bill of exchange
Types and classification of bill of exchange
Accounting treatment of bill of exchange
Discounting of a bill of exchange
Endorsement of bill of exchange
Bill of exchange sent to bank for collection
Dishonor of bill of exchange
Renewal of bill of exchange
Insolvency of one party
Retiring a bill of exchange under rebate
Accommodation bills of exchange
Bills receivable and bills payable books
Promissory note
Questions and answers

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
----------------------------------------------------------------------------
  Special Journals
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  Cash Book
----------------------------------------------------------------------------
Bank Reconciliation Statement
----------------------------------------------------------------------------
  Final Accounts
----------------------------------------------------------------------------
  Work Sheet
----------------------------------------------------------------------------
  Capital and Revenue Items
----------------------------------------------------------------------------
  Valuation of Inventories
----------------------------------------------------------------------------
  Accounts of Non-profit Making Organizations
----------------------------------------------------------------------------
  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
----------------------------------------------------------------------------
  Depreciation, Provisions and Reserves
----------------------------------------------------------------------------
  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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