In business, a large number of transactions are made on credit basis. In case of credit sale of goods, buyer promises to make payment after a certain period. Under the circumstances, the seller likes to get a written undertaking from the purchaser to get the payment after a certain period. For this, the seller prepares a written agreement mentioning all the conditions relating to sale of the goods such as amount to be paid, date of payment, place of payment, etc. The buyer accepts these conditions by putting his signatures. This agreement or instrument is known as ‘bill of exchange’.
Definition : According to Indian Negotiable Instrument Act 1881, “A bill of exchange is an instrument in writing, an unconditional order signed by the maker directing to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument.”
Characteristics of bill of exchange
Following are the features of a bill of exchange :
(i) It must be in writing.
(ii) It must contain an unconditional promise to pay.
(iii) It must be signed by the maker.
(iv) The maker must be a certain person.
(v) The person to whom the payment is to be made must also be certain.
(vi) The sum payable also must be certain.
(vii) It should be properly stamped.
(viii) It must contain an order (and not a request) to make payment.
(ix) The amount is payable either to the bearer of the bill or to a specified person or to his order.
Parties to the bill of exchange
Maker or Drawer is the person who makes the bill of exchange. A seller/creditor who is entitled to receive money from the debtor can draw a bill of exchange upon the buyer/debtor. The drawer after making the bill of exchange has to sign it as a maker.
Drawee or Acceptor is the purchaser or the debtor on whom the bill is drawn and who is liable to pay the amount mentioned in the bill. He accepts to pay the amount by writing the word ‘Accepted’ on the bill and signs it.
Payee is the person who actually receives the money of the bill of exchange. When the bill of exchange is discounted through the bank, the bank becomes the payee. Sometimes, the drawee and the payee are the same.
Elements of a bill of exchange
(i) Place and Date
(ii) Stamp
(iii) Terms of Payment
(iv) Days of Grace
(v) Amount
(vi) Name of the Drawer and the Drawee
(vii) Value received means the drawee has already received the value written in the document.
Advantages of bill of exchange
Helpful in the Purchase and Sale of Goods on Credit : Goods can be purchased and sold easily on credit with the use of bill of exchange.
Legal Document : Bill of exchange is a legal document. If the drawee fails to make its payment, it would be easier to recover the amount legally in comparison to verbal promise.
Discounting Facility : The holder of the bill can discount the bill of exchange with the bank if the money is urgently needed.
Endorsement Possible : A bill of exchange can be endorsed to any third party for the settlement of debt.
Helpful in Planning Cash Operations : The seller knows the date and time when the payment would be received. As such, he can plan his cash operations accordingly.
Relief from Sending Reminders: Bill is payable on due date and needs no reminder for payment.
Saving of Money in Circulation: A bill of exchange performs the functions of money. By making payment through bills, the money in circulation will not be used and hence results in saving the wear and tear of the currency in circulation.
Convenient Means of Making Foreign Payment : In foreign trade, bills are generally used and facilitate payment.
Evidence of Debit : When the bill is accepted by the drawee, it is a proof of debit.
Promissory note
According to the Negotiable Instrument Act 1881, a promissory note is defined as an instrument in writing, not being a bank note or currency note, containing an unconditional under-taking signed by the maker, to pay a certain sum of money only to or the order of a certain person, or to the bearer.”
Features of promissory note
(i) It must be in writing.
(ii) It must contain an unconditional promise to pay.
(iii) It must be signed by the maker.
(iv) The person to whom the payment is to be made must also be certain.
(v) The sum payable also must be certain.
(vi) It should be properly stamped.
It should be noted that a promissory note does not require any acceptance because the maker of the promissory note himself promises to make the payment.
Parties to a Promissory note
Maker or Drawer : Maker or drawer is the person who makes or draws the promissory note to pay a certain amount as specified in the promissory note. He is also called the promisor.
Payee or Drawee : Payee or drawee is the person in whose favour the promissory note is drawn. He is known as promisee. Generally, the drawee is also the payee, unless, it is otherwise mentioned.
The difference
Parties : There may be three parties to a bill of exchange, viz. the drawer, the acceptor and the drawee. But there are only two parties to a promissory note—the maker or drawer who makes the bill and signs it and the payee to whom the amount is to be paid.
Drawer : A bill of exchange is drawn by the creditor. But a promissory note is drawn by the debtor.
Acceptance : A bill of exchange needs acceptance by the drawee. In case of a promissory note, no acceptance is required.
Order or Promise : A bill of exchange is an order by a creditor to a debtor to make payment. A promissory note is a promise made by a debtor to a creditor.
Liability : The liability of drawer in case of a bill is secondary. He will be responsible in case the acceptor does not pay. But the liability of the drawer of a promissory note is primary.
Payee : In case of a bill, a drawer can be payee but maker of a promissory not cannot be its payee.
Stamps : Whereas stamps have to be affixed on a promisory note, there is no need of fixing stamps on the bills payable on demand.
Noting : Noting in not required in case of promissory note. But in the case of a bill of exchange, it is better to get it noted with the notary in case of dishonour.
Copies : Only one copy is prepared whether the promissory note is local or foreign. But in case of foreign bills of exchange three copies are prepared. However in case of a local bill only one copy is prepared.
Important terms
Endorsement : Endorsement is handing over the bill by the holder to a third party. The term endorsement means transfer of the bill of exchange or promissory note to another person. Any holder may transfer a bill unless its transfer is restricted, i.e. the bill has been negotiated containing the words prohibiting its transfer.
The bill can be initially endorsed by the drawer by putting his signature at the back of the bill along with the name of the party to whom it is being transferred. The act of signing and transferring the bill is called ‘endorsement.’
Days of Grace : The date on which the payment of the bill becomes due is called ‘due date’ or ‘date of maturity’. At the time of calculating the due date of the bill, it is compulsory to add three days to the period of the bill. These three days are known as ‘days of grace’.
Bill at Sight : It means that the amount of bill is to be paid at sight when it becomes due for payment. The sight bills do not have the days of grace.
Bill after Date : When the amount of the bill is payable after a fixed date ‘after date’, the period starts from the date of drawing the bill, three days of grace are allowed by law.
Negotiation : Bills of exchange can be passed on safely from one person to another person. This transfer is called negotiation and the holder gets good title. The instrument payable to the bearer can he transferred or negotiated by delivery while instrument payable to order can be negotiated by endorsement and delivery. Negotiation enables the bill to be discounted by the bank. The bank discounts the bill because in addition to the liability of acceptor, the drawer and the payee are also liable.
Dishnour of the Bill of Exchange : Dishnour is that situation when the acceptor of the bill refuses to pay the amount or unable to pay it because of insolvency. In such a case, the holder of the bill is generally got noted.
Noting of the Bill : When the bill is not honoured by the drawee on the due date, the bill should be presented to the notary public who are appointed by the courts of law. It is again presented for payment to the drawee through the notary public. The notary public charges a fixed amount as fee which is called noting charges. Noting is an official proof of presentation of the bill to the drawee and dishonour of a negotiable instrument obtained through the notary public.
Insolvency : Drawee may be declared as insolvent. In case of insolvency of the drawee, the full amount is not received. Hence, the bill stands dishonoured. A fraction of the amount is received from the official and the balance is debited to bad debts account.
Retirement of a Bill : Normally, acceptor of the bill makes payment on presentation of the bill on due date. If the acceptor makes the payment before due date of the bill, he is given some concession by the holder of the bill. Concession or incentive given by the drawer for payment before due date of maturity is called retiring the bill under rebate.
Renewal of a Bill : When the acceptor requests the drawer to cancel the old bill and draw a new bill, it is known as the renewal of bill. It provides to acceptor for making payment of the amount due. For renewal of bill, interest is charged by the drawer for the period of new bill. Interest is a gain for drawer and an expense for the drawee. Interest can be paid in cash by the drawee or may be added to the amount of the new bill.
Journal of Drawer
Journal entries regarding bills of exchange in the books of drawer
1. On credit sale
Drawee’s Personal Ac/ Dr
To Sales A/c
(For goods sold to him on credit)
2. On receiving acceptance
Bills Receivable A/c Dr
To Drawee’s Personal A/c
(Being acceptance received for…months)
3. On receiving payment
Cash A/c Dr.
To Bills Receivable A/c
(Being payment of the bill received
on due date)
4. On discounting of bill
Cash A/c Dr.
Discount A/c Dr.
To Bills Receivable A/c
(Being the acceptance of bill discounted with bank at Rs….)
5. On endorsement of bill
Creditors’ Personal A/c Dr.
To Bills Receivable A/c
(Being acceptance of bill endorsed to the creditor)
6. On sending bill to bank for collection
Bills for Collection A/c Dr.
To Bills Receivable A/c
(Being the acceptance sent to bank for collection )
7. When bank receives payment
Bank A/c Dr.
To Bills Sent for Collection A/c
(Being the payment of bill received by bank on
due date)
8. Dishonour of Bill
(a) When the drawer keeps it with him till due
date
Drawee’s Personal A/c Dr.
To Bills Receivable A/c
(Being the bill dishonoured on due date)
(b) After Discounting
Drawee’s Personal A/c Dr.
To Bank A/c
(Being the bill dishonoured after discounting)
(c) After Endorsement
Drawee’s Personal A/c Dr.
To Creditor’s Personal A/c
(endorsee’s)
(Being the bill dishonoured after endorsement)
(d) After sending for collection
Drawee’s Personal A/c Dr.
To Bill Sent for Collection A/c
(Being the bill dishonoured after sent for collection)
9. Noting charges
(a) When the bill is kept by Drawer
Noting charges A/c Dr.
To Cash A/c
(For noting charges paid)
(a) Drawee’s Personal A/c Dr.
(Amt. of bill + noting charges)
To Noting charges A/c
To Bills Receivable A/c
(For noting charges charged from the drawee)
(b) If he discounted with the bank and noting charges paid by the bank on dishonour of the bill
Drawee’s Personal A/c
(Amt of bill + nothing charges) Dr.
To Bank A/c (Amt. of bill + noting charges)
(For the bill dishonoured & noting charges of Rs….paid by the bank)
(c) If the bill is endorsed & noting charges paid by the creditor
Drawee’s Personal A/c Dr.
To Endorsee’s Personal A/c
(For the bill dishonoured & noting charges paid by the endorsee)
(d) When the bill is sent for collection and noting charges are paid by bank on dishonour of bill
Drawee’s Personal A/c Dr.
(Amt of bill + noting charges paid by the
creditor)
To Bank for the Collection of Bills
A/c (Amt. of bill + noting charges)
(For bill dishonoured after it was sent to bank for collection & noting charges paid by the bank)
10. Renewal of Bill
(a) On cancellation of old bill
When the old bill was kept upto due date
Drawee’s Personal A/c Dr.
To Bills Receivable A/c
(For the original bill cancelled)
(b) When the bill is discounted
Drawee’s Personal A/c Dr.
To Bank A/c
(For the original bill cancelled)
(c) When the bill is endorsed :
Drawees Personal A/c Dr.
To Endorsee’s Personal A/c
(d) When the bill was sent to bank for collection and then cancelled to issue a new bill
Drawee’s Personal A/c Dr.
To Bill Sent to the Bank
for Collection A/c
(For the original bill cancelled to issue new one)
11. (a) Receipt of Full Interest Money in Cash
Cash A/c Dr.
To Interest A/c
(For interest received in cash)
(b) When the amount of interest is not
received in cash
Drawee A/c Dr.
To Interest A/c
(Being the interest due on account of new bill)
(c) When new bill is received duly accepted
Bills Receivable A/c Dr.
To Drawee
(Being the new acceptance received)
12. Retiring of a Bill under Rebate
Cash A/c Dr.
Rebate A/c Dr.
To Bills Receivable A/c
(For payment of the bill received under rebate allowed.)
13. Insolvency of Drawee
When part payment is received form the govt.
auctioneers :
Cash A/c Dr.
Bad Debts A/c Dr.
To Drawee
(Being part payment received & balance written off as bad debts on the insolvency of the drawee).
journal of drawee
1. Purchases on credit
Purchases A/c Dr.
To Supplier
(Being goods purchased from him on credit)
2. On giving acceptance on bill
Supplier/Drawer Dr.
To Bill Payable A/c
(Being acceptance given to him for…months)
3. On payment of bill
Bills Payable A/c Dr.
To Cash A/c
(For payment of the bill made)
4. Payment of the bill before maturity (on rebate)
Bills Payable A/c Dr.
To Cash A/c
To Rebate A/c
(Being cash paid…months before maturity at a rebate of Rs….p.m.)
5. Dishonour of bill
Bills payable A/c Dr.
To Drawer
(Being the bill dishonoured)
6. Noting charges
Bills Payable A/c Dr.
Noting Charges A/c Dr.
To Drawer
(Being the bill dishonoured and the expenses of noting charges incurred thereon)
7. Renewal of bill
(a) Cancellation of original bill
Bills Payable A/c Dr.
To Drawer
(Being the old/original bill cancelled)
(b) When interest is paid in cash
Interest A/c Dr.
To Cash A/c
(Being interest paid in cash)
(c) When interest is not paid in cash
Interest A/c Dr.
To Drawer
(Being interest due on account of renewal of old bill)
(d) On giving acceptance on new bill
Drawer (Interest) A/c
To Bills Payable A/c
(Being acceptance given on the new bill)
(In case interest is not paid in cash, its amount is added in the new bill)
8. On insolvency
Drawer Dr.
To Cash A/c
To Profit & Loss A/c or To amount not paid A/c
(The amount due to drawer settled by payment of only…%)
endorsee’s journal
1. On receiving bill from the endorser
Bills receivable A/c Dr.
To Endorser
(Being endorsement received from our debtor)
2. On receiving payment
Cash A/c Dr.
To Bills Receivable A/c
(Being payment received)
3. Dishonour of bill
Endorser Dr.
To Bills Receivable A/c
To Cash A/c (noting charges)
(Being the bill dishonoured & noting charges paid in cash)
journal of bank
1. On discounting the bill
Bills Discounted A/c Dr.
To Drawer
To discount on bills discounted A/c
(Being the bill discounted by drawer)
2. On Receiving payment of the bill
Cash A/c Dr.
To Bills Discounted A/c
(Being payment of the bill received on due date)
3. On dishonour of bill
Drawer Dr.
To Bills Discounted A/c
To Cash A/c
(Being the bill dishonoured and noting charges of Rs….paid)
4. When the bill is received for collection
Bills Receivable A/c Dr.
To Bills for Collection A/c
(Being the bill received from drawer for collection)
5. When bill is collected, two entries are made
(a) Cash A/c Dr.
To Drawer A/c
(For Collecting cash)
(b) Bills for collection A/c Dr.
To Bills Receivable A/c
(For cancelling the original entry)
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