Accommodation Bills of Exchange


Accommodation Bills of Exchange:

Learning Objectives:

  1. Define and explain an accommodation bill of exchange.

  2. What is the difference between trade bill and an accommodation bill?

  3. Make journal entries in the books of drawer and acceptor when accommodation bills are used.

Definition and Explanation of an accommodation bill:

An accommodation bill of exchange is a bill of exchange which has been drawn for the mutual financial accommodation of the parties involved. Generally it is drawn not for value received. In order to oblige friends, many times bills are drawn, accepted and endorsed by businessmen without any consideration. By accepting such a bill the acceptor is able to lend his name, and the other party (drawer) taking advantages of the reputation of the acceptor gets it discounted with his bank. After meeting his aim with this temporary finance, he (drawer) sends back money to the acceptor thus making it possible for him to meet the bill on the due date. Since such bills are accepted without consideration, therefore, there is no liability of the acceptor to the drawer but since the third party takes such a bill for value, therefore, the acceptor is liable to the third party.

Difference Between Trade Bill and Accommodation Bill:

Following is the distinction between a trade bill of exchange and an accommodation bill of exchange.

Trade Bill Accommodation Bill
1 Trade bills are drawn for trade purposes. 1 Accommodation bills are drawn and accepted for financial assistance
2 These are drawn against proper consideration. 2 These are drawn in absence of any consideration
3 These bills are proof of debt 3 These are not a proof of debt
4 If discounted full sum retains with holder of the bill 4 If discounted the amount may be divided between drawer and acceptor in pre-determined ratio.
5 For obtaining the debt from drawee, drawer can resort to legal action. 5 Legal action cannot be resorted for recovery of amount against these bills by the immediate parties.

The bookkeeping entries in connection with accommodation bills are made in the same way as for genuine bills. Generally there are three methods of raising money on accommodation bills. They are as under:

  1. When accommodation bill is written for the accommodation of the drawer.

  2. When accommodation bill is written for the mutual accommodation of the drawer and the drawee.

  3. When the drawer and the drawee write accommodation bills on each other.

All these bills have been discussed below:

Accommodation of the drawer:

When a bill is written for the accommodation of the drawer then the drawee of the bill accepts the bill without any consideration and returns the bill to the drawer. The drawer gets the bill discounted with his bank and uses the amount in his business. On the due date he remits the amount to the acceptor or the bill to enable him to honour the bill on the due date.

Example (Accommodation of the Drawer):

A accepts a bill drawn by B for his accommodation on 1st January, 1991 for $500 at 3 months. The bill is discounted $ 490 on 4th January. On due date B sends a cheque to A to meet the bill. A duly honours his acceptance.

Pass journal entries in the books of both the parties.

Solution:

Journal Entries in the books of B

1991 500
Jan. 1 Bills receivable account 500
     To A
(Bills drawn on A)

Jan. 4 Bank account 490
Discount account 10
     To Bill receivable account 500
(Bill discounted)

April 4 A 500
     To Bank account 500
(Cheque sent to A)

Journal Entries in the books of A

1991
Jan. 1 B 500
     To Bill payable account 500
(Acceptance given)

April 4 Cash account 500
     To B 500
(Cheque received)

April 4 Bills payable account 500
     To Cash account 500
(Acceptance met)

Accommodation of the Drawer and the Drawee:

When a bill is drawn by one party for the mutual accommodation then the drawee after accepting the bill returns to the drawer. The drawer gets the bill discounted with his banker and after retaining the agreed portion of the proceeds of the bill remits rest of the proceeds to the acceptor of the bill. On the date of maturity the drawer of the bill remits rest to the acceptor the amount retained by him earlier to enable the acceptor to honour the bill. The expenses of discount are shared by the parties.

Example (Accommodation of the Drawer and the Drawee):

For mutual convenience of  X and Y, X draws a bill for $1,000 on Y at three months on 1at January, 1991. The bill is discounted on 4th January by X at 6 per cent per annum with his bank: half the proceeds being handed over to Y. On the bill falling due date, X remits $500 by cheque to Y who then pays the bill.

Pass journal entries in the books of X and Y.

Solution:

Journal Entries in the Books of X

1991
Jan. 1 Bills receivable account 1,000
     To Y 1,000
(Bill drawn on Y)

Jan. 4 Bank account 985
Discount account 15
     To Bills receivable account 1,000
(Bill discounted)

April 4 Y 500
     To Cash account 492.5
     To Discount account 7.5
(Half the proceeds remitted)

April 4 Y 500
     To Cash account 500
(Cheque sent to him)

Journal Entries in the Books of X

1991
Jan. 1 X 1,000
     To Bills payable account 1,000
(Acceptance given)

Jan. 4 Cash account 492.5
Discount account 7.5
     To X 500
(Half the proceeds received)

April 4 Cash account 500
     To X 500
(Cheque received from him)

April 4 Bills payable account 1,000
     To Cash account 1,000
(Acceptance given)

Accommodation Bills Written on Each Other:

In this case both the parties draw bills on each other and get them discounted from their bankers. On the due date each meets his own bill. The expenses of discount is to be paid by each on other’s bill.

Example (Accommodation bills written on Each Other):

On 1st January 1991 P draws a bill on Q at four months for $500 and Q draws on P for similar amount and term. Both the bills are accepted and discounted respectively at 6 per cent. At maturity both the parties meet their respectively acceptances. Show the journal entries in the books of both the parties.

Solution:

Journal Entries in the Books of P

Jan. 1 Bills receivable account 500
     To Q 500
(Bill drawn on Q)

Q 500
     To Bill payable account 500
(Acceptance given)

Bank account 490
Discount account 10
     To Bill receivable account 500
(Bill discounted)

May 4 Bill payable account 500
     To Cash account 500
(Acceptance met)

Journal Entries in the Books of Q

Jan 1 P 500
     To Bill payable account 500
(Acceptance given)

Bill receivable account 500
     To P 500
(Acceptance received)

Bank account 490
Discount account 10
     To bill receivable account 500
(Bill discounted)

May 4 Bill payable account 500
     To Cash account 500
(Acceptance met)

You may also be interested in other articles from “accounting for bills of exchange page” chapter:

  1. Definition and Explanation of Bill of Exchange
  2. Advantages of a Bills of Exchange
  3. How a Bill of Exchange Functions
  4. Promissory Note
  5. Difference between Bill of Exchange and Promissory Note
  6. Difference Between Bill of Exchange and Cheque/Check
  7. Recording Transactions of Bill of Exchange
  8. Drawing, Acceptance, and Payment of Bill of Exchange
  9. Discounting of Bill of Exchange
  10. Bills of Exchange for Collection
  11. Endorsement of a Bill of Exchange
  12. Dishonour of a Bill of Exchange
  13. Renewal of a Bill of Exchange
  14. Retiring of a Bill of Exchange
  15. Accommodation Bill of Exchange
  16. Insolvency of the Acceptor in a Bill of Exchange

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