Dishonour and Discharge of Bills

Dishonour and Discharge of Bills in Detail

Goods are sold in return of cash or on credit. A seller gets the payment for the goods sold immediately but when goods are sold on credit, the buyer promises to make payment after the agreed credit period. The promise to pay in future by the buyer can be a written promise; in that case it may be either Bill of Exchange or a promissory note.


Definition of Bills of Exchange

According to the Negotiable Instrument Act, 1881, a bill of exchange is a written instrument holding an unconditional order signed by the drawer directing a certain person to pay a certain amount of money only to, or to the order of, a definite person or the bearer of the instrument.


Parties to Bills of Exchange

Three parties are involved in the bill of exchange.

  1. The drawer or the person who makes or creates the bill. He is the person who has granted the credit to the buyer.

  2. The drawee or the person who is directed to pay the bill. He is the person to whom the credit has been granted by the drawer of the bill of exchange.

  3. The payee or the person to whom or to whose order the amount of the instrument is payable. The payee may be the drawer himself.

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Conditions When the Drawer is the Payee

The drawer becomes the payee himself if he keeps the bill with him till the date of its payment.


Conditions When the Drawer is not the Payee

The drawer is not the payee if he gets the bill discounted or if the bill is endorsed in favour of a creditor if the drawer. 


Features of the Bills of Exchange

  1. A bill of Exchange cannot be verbal, it must be in writing.

  2. It is made or created and signed by the drawer.

  3. It is an unconditional order to a person to whom the credit has been granted.

  4. The person or the drawee is payable to the person whose name is mentioned in the bill.

  5. The bill mentions the date by which the amount must be paid by the drawee.

  6. The bill must be accepted by the drawee to make it legal. 

Types of Bills of Exchange

There are two types of bill of exchange:

  1. Trade Bill

  2. Accommodation Bill

Dishonour of a Bill

Dishonouring a bill means that the bill is not paid by the drawee on the date that was agreed upon or due date. It occurs when the acceptor refuses or is not in a position to pay the certain sum of the bill, i.e., Bill of Exchange, promissory note or cheque. In such a situation, the holder of the bill can recover the amount from the drawer or any of the previous endorsers. The holder of the bill can get the dishonour of the bill noted by presenting the bill through a Notary public. 


Noting is the recording of the bill that was dishonoured by the Notary public on it being presented for payment. Noting is made of the following:

  1. That the bill is dishonoured.

  2. The date of the dishonour.

  3. The reason for the dishonour if any.

  4. The fee charged by the Notary public.

The benefit of noting the dishonoured bill is to record evidence.


Ways to Dishonour the Bill of Exchange

The bill of exchange can be dishonoured in two ways:

  1. Dishonour by non-acceptance.

  2. Dishonour by non-payment.

Dishonour by Non-Acceptance

Under section 91, a bill of exchange is dishonoured by non-acceptance when the drawee refuses to accept the bill within 48 hours of presentment for acceptance and when the presentation of acceptance is excused and remains unaccepted. It can also be dishonoured by non-acceptance when the drawee is incompetent to contract or drawee cannot be found after a reasonable search. When one or more of the drawees refuses to accept or when a drawee is a fictitious person, then the bill is dishonoured by non-acceptance. 


Dishonour by Non-Payment

Under section 92, when the drawee refuses to make the payment then the bill of exchange or the promissory note is dishonoured. A bill is dishonoured by non-payment.

  1. When the bill is duly presented for payment and there is no sufficient fund in the account resulting in the refusal of payment.

  2. When the bill is overdue and not paid at the time of maturity.

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Notice of Dishonour

When the bill of exchange or promissory note is dishonoured either by non-acceptance or by non-payment, the holder of the bill or the instrument or the third party who is liable thereon must give notice of dishonour to all the prior parties whom he wants to make liable on the bill. 


Discounting of Bills of Exchange

Discounting of the bills of exchange means taking the amount from a bank against the bill before its due date. Bank debits a certain amount from the face value of the bill and pays the remaining balance to the person discounting the bill.


Consequences of Dishonour

In the case of dishonour of the bill of exchange, the holder takes the following steps:

  1. He becomes entitled to file a legal case for the recovery.

  2. Subject to certain exceptions, he must give notice of dishonour to parties against whom he intends to precede the suit.

  3. He may also have the instrument note and protested before a notary public. 

Discharge of Bills

Discharge means free from all obligations. When the drawee makes the payment, then the bill is discharged. 

The bill is discharged when -

  • By payment of the bill of exchange.

  • By waiving off the bill. 

  • By cancellation of the instrument.

  • By material alteration or lapse of time.

Entries on Dishonour of a Bill

When the bill is dishonoured, entries are passed differently for the dishonour of bill under different situations.

Let us study the situations one by one.


In the Drawer’s books:

a. When the bill of exchange is retained till maturity by the drawer and dishonoured on the due date.

Drawee ….Dr [Bill Amount plus noting charges if any]

       To        Bills Receivable a/c [The amount of the bill]

       To       Cash or Bank a/c [Noting Charges, if any] 

b. When the bill is discounted with the bank and is dishonoured.

Drawee …..Dr         [The amount of the bill and noting charges, if any]

      To Cash or Bank

c. When the bill is endorsed and is dishonoured.

Drawee                 …..Dr

          To Bills sent for collection a/c [Amount of bill]

           To cash or Bank a/c [Amount of noting charges if any]

d. When the bill was sent to the bank for collection and is dishonoured.

Drawee               ……Dr

       To Bills sent for collection a/c [Amount of bill]

        To cash or Bank a/c [Amount of noting charges, if any]

When a bill is dishonoured after sending it to the bank for collection, the bank returns the bill to the drawer and the drawer pays the noting charges.


In the Drawee’s Books:

If the bill is dishonoured, the liability is transferred to the concerned creditor. If the bill is getting noted then the noting charges get added to the bill amount and will be payable to the creditor. Therefore, the creditor’s account is credited with the amount of bill plus the noting charges, if any. The format of the entry is below:

Bills payable a/c               …..Dr [Amount of the bill]

Noting charges a/c …..Dr [Noting charges, if any]

To Creditor (Drawer) [Amount of the bill plus noting charges]

It is important to note that if the Drawee is stated insolvent on or before the due date, the bill is deemed to have been dishonoured and all entries for dishonour are passed in the books of the concerned parties as given above.


Note: When the bill is dishonoured then under all circumstances, the drawee or acceptor is debited in the books of account to cancel the credit given to him at the time of his acceptance of the bill. In the books of the drawee, the drawer’s account is credited and Bills Payable Account is debited.


Illustration 1.

Ramesh sold goods for Rs. 70,000 to Chetan on 1st January 2020 and on the same day he drew a bill on Chetan at three months for the amount. The bill is duly accepted but is dishonoured on the due date. Ramesh pays Rs.2000 as noting charges. Record these transactions in the Journals of Ramesh and Chetan. 


In Ramesh’s Journal


Date

Particulars

L.F

Dr. (Rs)

Cr. (Rs)

2020 Jan 1

Chetan                                                         ….Dr

To Sales a/c     

(Being the goods sold on credit)            


70000

70000

Jan 1

Bill Receivable a/c                                   …… Dr

To Chetan

(Being the acceptance received)


70000

70000

April 4

Chetan                                                        …… Dr

To Bills Receivable a/c

(Being the bill dishonoured and noting charges paid)


72000

70000

2000


In Chetan’s Journal


Date

Particulars

L.F

Dr. (Rs)

Cr. (Rs)

2020 Jan 1

Purchases a/c                                           …… Dr

To Ramesh

(Being the purchased goods on credit)


70000

70000

Jan 1

Ramesh                                                         …… Dr

To Bills Payable a/c

(Being the acceptance given)


70000

70000

April 4

Bills Payable                                                 …… Dr

 Noting charges a/c


           To Ramesh                                          …… Dr

(Being the bill dishonoured and noting charges paid by Ramesh)


70000

2000

72000


FAQs (Frequently Asked Questions)

Q1. Name any Two Types of Commonly Used Negotiable Instruments.

Ans. Two negotiable instruments are bills of exchange and promissory note.

Q2. State the Three Parties Involved in Bills of Exchange.

Ans. Drawer, drawee and payee are the three parties involved in bills of exchange.

Q3. What does the Discounting of Bills of Exchange Mean?

Ans. Discounting of the bills of exchange means taking the amount from a bank against the bill before its due date. Bank debits a certain amount from the face value of the bill and pays the remaining balance to the person discounting the bill.

Q4. Anand Drew a Bill on Ranjit and Ranjit Accepts the Same. State with Reason, Who Among them Cannot Endorse the Bill to Manav?

Ans. Ranjit cannot endorse the bill to Manav, as he is a drawee. Only Anand can endorse the bill.