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Insolvency of One Party:

Contents:

Definition and Explanation of Insolvency:

When a person's liabilities are more than his assets and he is not in a position to pay all of his debts when they become due. Such a person is called insolvent.

When a person or party is declared by court as insolvent or bankrupt he is considered to be unable to pay his liabilities. It means, the bills accepted by him will be naturally dishonored. Therefore, when it is known that a person has become insolvent, entry for the dishonor of the bill of exchange should be passed both in the books of the drawer and acceptor.

When a person becomes insolvent, his private property, if he has any, is sold by a liquidator appointed by the court. Something may be received from his estate. Thus after passing entries for dishonor, we should prepare acceptor's account in the books of the creditor (drawer).

The acceptor's account in the books of the drawer will disclose the net amount dew from him. Generally the amount received from the estate of insolvent party is less than the amount due from him. The unsatisfied balance is treated as bad debts and debited to "bad debts" account in the books of the drawer and credited to "deficiency account" in the books of the drawee.

Journal Entries:

On the insolvency of drawee, the following entries are passed in books of both the parties:
 
In drawer's Books In Drawee's Books
1. Entry for dishonor:

Bills receivable A/C........XXX
     Drawee's A/C..................XXX

2. When final dividend is received:

Cash A/C.................XXX  (with actual amount received)
Bad debts A/C.........XXX  (unsatisfied amount)
     Drawee's A/C................XXX  (full amount)

1. Entry for dishonor:

Bill payable A/C........XXX
     Drawer's A/C..................XXX

2. When final claim is paid to the creditor:

Drawer's A/C..............XXX
     Cash A/C.........................XXX
     Deficiency A/C................XXX

Example:

A sold goods to S worth $20,000, taking a bill of exchange at 3 months, dated 1st July 2005. On the 4th august he discounted the bill at 15% p.a. with his bank. At maturity the bill was returned by the bank dishonored and A had to pay the bill. S paid $8,000 to A and accepted another bill at three months $12,000 and 14% interest. But, before maturity, he became insolvent and only 50% was received as first and final dividend form his estate.

Required: Give journal entries in the books of A and S.

Solution:

A's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
1.7.2005 S A/C................................................Dr.
     Sales A/C
(Goods sold on credit basis)
  20,000
20,000
1.7.2005 Bill receivable A/C...............................Dr.
     S A/C
(Acceptance received at three months)
  20,000
20,000
4.8.2005 Bank A/C...........................................Dr.
Discount A/C......................................Dr.
     Bill receivable A/C
(Bill discounted at 15% two months before its maturity)
  19,500
500

20,000
4.10.2005 S A/C................................................Dr.
     Bank A/C
(Old bill cancelled and amount paid to bank due to acceptor's inability)
  20,000
20,000
4.10.2005 Cash A/C..........................................Dr.
     S A/C
(Cash received from acceptor as a part payment)
  8,000
8,000
4.10.2005 S A/C...............................................Dr.
     Interest A/C
(Interest due from acceptor on the outstanding balance for 3 months)
  420
420
4.10.2005 Bill receivable A/C..............................Dr.
     S A/C
(A new bill received at 3 months)
  12,420
12,420
  S A/C...............................................Dr.
     Bill receivable A/C
(Bill dishonored due to acceptor's insolvency)
  12,420
12,420
  Cash A/C.........................................Dr.
Bad debts A/C..................................Dr.
     S A/C
(Cash received from estate of acceptor and the balance written off as bad debts)
  6,210
6,210


12,420

S's Journal
Date Particulars L.F Amount (Dr.) Amount (Cr.)
1.72005 Purchases A/C.....................................Dr.
     A A/C
(Goods purchased on credit)
  20,000
20,000
1.7.2005 A A/C.................................................Dr.
     Bill payable A/C
(Acceptance given at three months)
  20,000
20,000
4.10.2005 Bill payable A/C...................................Dr.
     A A/C
(Bill cancelled for renewal purpose)
  20,000
20,000
4.10.2005 A A/C.................................................Dr.
     Cash A/C
(Cash paid as part payment)
  8,000
8,000
4.10.2005 Interest A/C.......................................Dr.
     A A/C
(Interest payable to the drawer)
  420
420
4.10.2005 A A/C................................................Dr.
     Bill payable A/C
(New acceptance given at 3 months)
  12,420
12,420
  Bill payable A/C.................................Dr.
     A A/C
(Bill dishonored due to insolvency)
  12,420
12,420
  A A/C...............................................Dr.
     Cash A/C
      Deficiency A/c
(Dividend of 50 cents in a dollar paid and balance transferred to deficiency account)
  12,420
6,210
6,210

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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
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  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
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  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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