When a business buys goods from a supplier, the supplier might also draw up a bill of exchange on the business. By accepting the bill of exchange the business effectively agrees to pay the amount due on a specified date. The purpose of the bill of exchange is to provide proof of debt in the form of a transferable document which the supplier can either hold, discount, or negotiate. This process is more fully explained in our bills of exchange tutorial.
The amounts owed by the business (acceptor of the bill) are liabilities referred to as bills payable or more fully bills of exchange payable.
Bills Payable on the Balance Sheet
Short term bills payable are due within one year from the balance sheet date and classified under current liabilities in the balance sheet, long term bills payable have terms exceeding one year and are classified as long term liabilities in the balance sheet.
Bill Payable Accounting Entries
There are three stages in the bills payable accounting process.
- The business purchases goods from a supplier and records the liability as an accounts payable in the normal manner.
- The business accepts the bill of exchange and transfers the liability to a bills payable account.
- The business makes the payment to the payee when the bill is presented on the maturity date.
Suppose for example a business purchases goods and accepts a bill of exchange for 9,000 due in 3 months.
Record the Supplier Liability
The first journal is to record the liability to the supplier as an accounts payable in the usual manner.
The debit is to purchases representing the goods bought by the business. The credit records the liability to the supplier as an accounts payable.
Record the Acceptance of the Bill of Exchange
The second journal is to record the acceptance of the bill of exchange by the business and record the liability as a bills payable.
The debit is to clear the supplier accounts payable account. By accepting the bill of exchange the business creates a liability which is reflected by the credit to the bills payable account.
Make Payment of the Bills Payable
Finally, at the end of the 3 month term the bill payable has to be paid, and the following journal completes the transaction.
The credit reflects the payment of cash, and the debit reflects the bills payable entry to clear the liability account on settlement.
It should be noted that the bill of exchange may have been discounted to a bank or negotiated to a third party by the supplier, in which case the person to who the cash payment is made (the payee) might not be the original suppler of the goods. As far as the business is concerned under the bills payable process, it simple has to pay the amount due to the person (supplier, bank or third party) who presents the bill of exchange on maturity.
Bills Payable Dishonored
When a bill of exchange is not settled on the due date it is said to be dishonored. At this point the process is reversed and the liability is transferred back to the accounts payable account of the supplier.
As the business caused the non-payment of the bill of exchange it is responsible from any noting charges and fees due which might have been paid by the supplier.
The journal entry to post the transfer of the liability back to accounts payable and to reflect the noting charges is as follows.
|Noting charges expense||100|
The liability for the bill of exchange is transferred to the supplier’s accounts payable account, and the noting charges and fees are included as an expense in the income statement of the business.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.