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Welcome! It’s been a long time since my last lesson. Anyway let’s get back to work, in my last post I taught you about retiring the bill of exchange under the rebate. Today I’m gonna teach you what happened when the drawee become INSOLVENT?
What do we mean by Insolvent?
Well, an insolvent is the one who is in financial difficulties and is not in a position to pay the amount due by him.
How to record transactions when the acceptor of the bill becomes insolvent?
If the acceptor of a bill becomes insolvent or bankrupted, the bill of exchange or promissory note should be treated as dishonoured because he is unable to make the payment of the bill and entry relating to dishonor should be recorded.
Can we recover any amount from the insolvent or bankrupted party?
Yes, it is possible that a partial payment may be made from the estate of the insolvent; and the balance of the amount due from the insolvent which is not recovered should be written off as bad debts in the drawer’s books.
How to make transactions for that amount which the insolvent cannot pay?
The amount which the insolvent cannot pay to the drawer should be credited to unpaid or deficiency or profit and loss account and debited to Drawer’s Account in the insolvent books.
1. A owes B Rs 21,000. On 1-1-2018 he accepts a bill for 3 months for Rs 20,000 in full settlement. On the same date B discounts the bill from his banker at 6% p.a. before the due date. A becomes bankrupt and B receives first and final dividend of 20 paise in the rupee.
Write up the necessary accounts to record the above transactions in the books of A and B.
EXPLANATION:
Let me first explain the above problem. Here in this problem you can see B is the Drawer and A is the Drawee, A owes 21,000 but he accepts a bill for 20,000 in full settlement means discount is received by him then the Drawer B discounted at 6% on 20,000(i.e., 1,200) but A becomes bankrupted and B received only 4,200 from his estate as first and final payment.
How to calculate bad debt?
Bad debt = Actual Amount due to Drawer – Amount recovered from the Insolvent Party
Where as,
Amount recovered is 20 paise in the rupee i.e., 21,000 x 20/100 = 4,200
Hence bad debt will be 21,000 – 4,200 = 16,800.
So let us analyze transactions for both the parties.
In the books of Drawer B:
1st entry A accepts the bill drawn by B (A owes 21,000 but bill is drawn for 20,000 so B allowed discount of 1,000 to A)
2nd entry B discounted the bill with bank @6%
3rd entry dishonor the bill as A become insolvent
4th entry first and final dividend received from A.
SOLUTION: here’s how you pass the journal entries in the books of Drawer B
Next in the books of Drawee A:
1st entry A accepts the bill drawn by B (A owes 21,000 but bill is drawn for 20,000 so B allowed discount of 1,000 to A)
2nd entry dishonoured the bill as being bankrupted also disallowed the discount.
3rd entry for final claim paid and the unpaid amount credited as Deficiency account.
Note: Deficiency account should be credited with 16,800 correct the amount!
I hope you have understood this lesson. Now let me give you one (DIY) for your practice let’s see how you will do! Well practice makes us perfect, right! Well I have shared my knowledge with you let’s see did you gained that knowledge?
DO IT YOURSELF (DIY):
1. A draws a bills for Rs 3,000 on B, which was duly accepted by B. A discounts the bill for Rs 2,800. Before the maturity of the bill; B becomes insolvent. 50 paise in the rupee was received from the private estate of B in final settlement of the amount due. Show the necessary journal entries in the books of both parties.
Inshallah next time, I will teach you about Accommodation of bill. Till then take care.
If you find this Article useful, please mark your reaction below and don’t forget to share with others who is in need, because sharing knowledge means gaining knowledge, also subscribe to my newsletters with your email id to get latest updates in your inbox. If you have any queries regarding this article please feel free to use comment section or just send me an e-mail, I would love to hear from you.
What do we mean by Insolvent?
Well, an insolvent is the one who is in financial difficulties and is not in a position to pay the amount due by him.
How to record transactions when the acceptor of the bill becomes insolvent?
If the acceptor of a bill becomes insolvent or bankrupted, the bill of exchange or promissory note should be treated as dishonoured because he is unable to make the payment of the bill and entry relating to dishonor should be recorded.
Can we recover any amount from the insolvent or bankrupted party?
Yes, it is possible that a partial payment may be made from the estate of the insolvent; and the balance of the amount due from the insolvent which is not recovered should be written off as bad debts in the drawer’s books.
How to make transactions for that amount which the insolvent cannot pay?
The amount which the insolvent cannot pay to the drawer should be credited to unpaid or deficiency or profit and loss account and debited to Drawer’s Account in the insolvent books.
Now let’s take a look at the chart of important journal entries. In the below table you can find insolvency entries in yellow colour. As well as you can find dishonor entries in red color.
Well let’s see an Example Problem
EXAMPLE PROBLEM:1. A owes B Rs 21,000. On 1-1-2018 he accepts a bill for 3 months for Rs 20,000 in full settlement. On the same date B discounts the bill from his banker at 6% p.a. before the due date. A becomes bankrupt and B receives first and final dividend of 20 paise in the rupee.
Write up the necessary accounts to record the above transactions in the books of A and B.
EXPLANATION:
Let me first explain the above problem. Here in this problem you can see B is the Drawer and A is the Drawee, A owes 21,000 but he accepts a bill for 20,000 in full settlement means discount is received by him then the Drawer B discounted at 6% on 20,000(i.e., 1,200) but A becomes bankrupted and B received only 4,200 from his estate as first and final payment.
How to calculate bad debt?
Bad debt = Actual Amount due to Drawer – Amount recovered from the Insolvent Party
Where as,
Amount recovered is 20 paise in the rupee i.e., 21,000 x 20/100 = 4,200
Hence bad debt will be 21,000 – 4,200 = 16,800.
So let us analyze transactions for both the parties.
In the books of Drawer B:
1st entry A accepts the bill drawn by B (A owes 21,000 but bill is drawn for 20,000 so B allowed discount of 1,000 to A)
2nd entry B discounted the bill with bank @6%
3rd entry dishonor the bill as A become insolvent
4th entry first and final dividend received from A.
SOLUTION: here’s how you pass the journal entries in the books of Drawer B
Next in the books of Drawee A:
1st entry A accepts the bill drawn by B (A owes 21,000 but bill is drawn for 20,000 so B allowed discount of 1,000 to A)
2nd entry dishonoured the bill as being bankrupted also disallowed the discount.
3rd entry for final claim paid and the unpaid amount credited as Deficiency account.
Note: Deficiency account should be credited with 16,800 correct the amount!
I hope you have understood this lesson. Now let me give you one (DIY) for your practice let’s see how you will do! Well practice makes us perfect, right! Well I have shared my knowledge with you let’s see did you gained that knowledge?
DO IT YOURSELF (DIY):
1. A draws a bills for Rs 3,000 on B, which was duly accepted by B. A discounts the bill for Rs 2,800. Before the maturity of the bill; B becomes insolvent. 50 paise in the rupee was received from the private estate of B in final settlement of the amount due. Show the necessary journal entries in the books of both parties.
Inshallah next time, I will teach you about Accommodation of bill. Till then take care.
If you find this Article useful, please mark your reaction below and don’t forget to share with others who is in need, because sharing knowledge means gaining knowledge, also subscribe to my newsletters with your email id to get latest updates in your inbox. If you have any queries regarding this article please feel free to use comment section or just send me an e-mail, I would love to hear from you.
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