Q.What is meant by dishonour of a bill of exchange?

Start with something you have already seen. A friend borrows ₹5,000 from you and promises to return it next month. You note it down mentally — or better, you ask him to sign a small slip: "I owe Rohan ₹5,000, payable on 30 June." That slip is not money. It is a promise to pay money. Now 30 June arrives, you present the slip, and he says, "Sorry, I can't pay right now." The promise has collapsed. That collapse is exactly what dishonour means in accounting.

A bill of exchange works the same way. The drawer (creditor/seller) draws a bill on the drawee (debtor/buyer), the drawee accepts it — signs across it — and by that acceptance he becomes the acceptor, legally bound to pay the amount on the due date. When the bill matures, the holder presents it to the acceptor for payment. If the acceptor pays, the bill is honoured. If he refuses, or cannot pay, the bill is dishonoured.

The precise meaning: dishonour of a bill is the failure of the acceptor to make payment on the due date when the bill is presented to him. The moment this happens, the bill ceases to be an asset — it is no longer a claim you can convert into cash. The debt that the bill had temporarily "converted" into a negotiable instrument springs back to life as an ordinary debt owed by the acceptor.

Why does this matter so much in the books? Because until maturity, the drawer's books show the bill as an asset (Bills Receivable), not as the debtor's personal account. The debtor's account was closed when he accepted the bill. So when the bill bounces, you must reopen the debtor's account and remove the bill from Bills Receivable. If you don't, your books will show an asset that does not exist — a false picture of what you are owed.

There is one more layer. A bill is often discounted with a bank before maturity, or endorsed to a creditor. If the bill is later dishonoured, the bank (or the endorsee) will recover the money from you, the drawer, because you had guaranteed it. So dishonour can hit you twice: the original debt revives, and you may also have to pay a noting charge and the discounted amount back to the bank.

Now the accounting treatment. The entries depend on what the drawer did with the bill before maturity.

Case 1 — Bill was retained till maturity (with the drawer)

The drawer simply reverses the original entry. The acceptor's personal account is debited (he owes you again), and Bills Receivable is credited (the asset disappears).

If the drawer had also incurred noting charges (a small fee paid to a notary to formally record the dishonour — it is legal evidence), the acceptor must bear it. So the entry becomes:

Case 2 — Bill was discounted with the bank

The drawer had already received cash (less discount) from the bank. On dishonour, the bank debits the drawer's account for the full bill amount plus noting charges. The drawer then recovers this from the acceptor.

Case 3 — Bill was endorsed to a creditor

The drawer had used the bill to settle a debt. On dishonour, the creditor returns the bill and the drawer must pay him. The acceptor is again debited.

Now look at it from the acceptor's (drawee's) side. His books had shown Bills Payable as a liability. When he dishonours, that liability does not vanish — it merely changes form back to a debt owed to the drawer. So he debits Bills Payable and credits the drawer's account. …