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Home Accounting for Bills of Exchange Discounting of a Bill of Exchange
 
 

Discounting of a Bill of Exchange:

When the acceptor of a bill of exchange is a reputable person the bill is as good as money, and any bank will discount it.

Definition and Explanation of Discounting a Bill:

If the drawer of the bill does not want to wait till the due date of the bill and is in need of money, he may sell his bill to a bank at a certain rate of discount. The bill will be endorsed by the drawer with a signed and dated order to pay the bank. The bank will become the holder and the owner of the bill. After getting the bill, the bank will pay cash to the drawer equal to the face value less interest or discount at an agreed rate for the number of days it has to run. This process is know as discounting of a bill of exchange.

Example:

For example, a drawer has a bill for $10,000. He discounted this bill with his bank two months before its due date at 15% p.a. rate of discount. Discount will be calculated as the follow:

1,000 15/100 2/12 = 250

Thus the drawer will receive a cash worth $9,750 and will bear a loss of $250.

The bank will keep this bill in possession till the due date. On maturity (due date) the bank will present the bill to the acceptor and will receive cash from him (if the bill is honored). In case, the acceptor does not make the payment to the bank, then the drawer on any person who has discounted the bill have to take this liability and will pay cash to the bank.

Until the bill is honored on the due date, there is always a chance that the drawer will become liable on the bill. This is called a contingent liability - a liability that will only arise if a certain event occurs - the acceptor does not honor the bill.

discounting of bill of exchange

Drawer discounted the bill for $9,750 and suffered a loss of $250. In other words drawer had to pay the price in order to receive the cash before maturity.

When a bill is discounted by the holder, the following entries are passed in the books of drawer, drawee and bank:

When the bill is drawn by the drawer (A) and accepted by drawee (B)

Drawer's Journal Drawee's Journal
B/R A/C..................XXX
          B A/C..................XXX
(Acceptance received)
A A/C..................XXX
          B/P A/C.................XXX
(Acceptance given)
When a bill is discounted at bank:

Bank A/C......................XXX
Discount A/C.................XXX
         B/R A/C....................XXX
(Bill discounted at bank)


No journal entry at the time of discounting of bill in the books of drawee.

The entry for discounting a bill in drawer's journal shows increase in drawer's bank balance at present value (face value - discount given), increase in a loss (discount given) and decrease in an asset (bill receivable).

The entry in the journal of bank will be as under:

When a bill is discounted at bank:

B/R A/C............XXX
        Drawer A/C........XXX
        Discount A/C.....XXX
(Bill discounted)

This journal entry indicates, increase in assets (B/R) in the bank, increase in a liabilities (the amount transferred to the drawer's account) and in revenue for the bank (discount).

When the bank presented the bill to the acceptor on maturity date and the acceptor met his obligation, the following entries are passed:

Drawer's Journal Drawee's Journal Bank's Journal
No entry in the books of drawer. Bill payable A/C...XXX
        Cash A/C.........XXX
(Acceptance honored and cash paid to bank on presentation of the bill)
Cash A/C.......XXX
       B/R A/C.........XXX
(Cash received from acceptor equal to full value of the bill)

Note that the drawee pays full amount of the bill to the bank at the time of maturity but bank pays face value less discount to the drawer when drawer discounts the bill with the bank. This difference (discount) is revenue of the bank and expense of the drawer.

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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
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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
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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