Bills of Exchange and Promissory Notes

Meaning Of Bill Of Exchange

A Bill of Exchange is a written instrument containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument. It is a crucial financial instrument widely used in business, particularly in credit transactions. Governed by the Negotiable Instruments Act, 1881, in India.

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Key characteristics of a Bill of Exchange:

• It must be in writing.
• It contains an unconditional order (not a request or promise).
• It is signed by the maker (Drawer).
• It directs a certain person (Drawee) to pay.
• The amount must be certain.
• The payment must be in money only.
• The payment must be to a certain person or to the order of a certain person, or to the bearer.
• It is payable either on demand or at a fixed or determinable future time.

A Bill of Exchange needs to be accepted by the Drawee before it becomes a valid financial instrument that can be legally enforced against the Drawee. Acceptance means the Drawee signs the bill to indicate their unconditional agreement to pay the amount specified.

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Parties To A Bill Of Exchange

There are typically three parties involved in a Bill of Exchange:

1. Drawer:

The person who writes or makes the bill. This is usually the creditor (the seller of goods or services on credit) who is to receive the money.

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2. Drawee:

The person on whom the bill is drawn. This is usually the debtor (the buyer of goods or services on credit) who is directed to pay the money. The Drawee becomes the Acceptor after signifying their assent to the order by signing the bill.

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3. Payee:

The person to whom the payment is to be made. The Payee can be the Drawer himself, or a third party (e.g., if the Drawer endorses the bill to someone else).

Answer:

A Bill of Exchange acts as a written acknowledgment of debt by the Drawee and a negotiable instrument for the Drawer.

Promissory Note

A Promissory Note is a written instrument containing an unconditional undertaking (promise), signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument. Like a Bill of Exchange, it is also governed by the Negotiable Instruments Act, 1881.

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Key characteristics of a Promissory Note:

• It must be in writing.
• It contains an unconditional promise to pay.
• It is signed by the maker (Promissor).
• The maker undertakes to pay a certain sum of money.
• The payment must be in money only.
• The payment must be to a certain person or to the order of a certain person, or to the bearer.
• It is payable either on demand or at a fixed or determinable future time.
• It cannot be made payable to the maker himself.
• It does not require acceptance by the maker (as the maker himself is signing the promise).

The key difference between a Bill of Exchange and a Promissory Note is that a Bill of Exchange is an order from the creditor to the debtor to pay, while a Promissory Note is a promise from the debtor to the creditor to pay.

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Parties To A Promissory Note

There are typically two parties involved in a Promissory Note:

1. Maker (or Promissor):

The person who makes or writes the note, promising to pay the amount. This is the debtor (the buyer of goods or services on credit).

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2. Payee:

The person to whom the payment is to be made. This is the creditor (the seller of goods or services on credit).

Answer:

Unlike a Bill of Exchange, there is no Drawee separate from the Maker in a Promissory Note.

Advantages Of Bill Of Exchange

Bills of Exchange offer several advantages to both the Drawer (seller) and the Drawee (buyer) in credit transactions:

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1. Facilitates Credit Transactions:

It provides a written, legal document acknowledging the debt and specifying the terms of payment (amount and date). This gives certainty to credit sales and purchases.

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2. Certainty of Payment:

Once the bill is accepted by the Drawee, it becomes a legally binding obligation for the Drawee to pay on the maturity date.

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3. Easy Transferability (Negotiability):

A Bill of Exchange is a negotiable instrument. The Drawer can transfer the bill to another party (endorsee) by simply endorsing it and delivering it. This allows the Drawer to settle their own debts or use the bill as security.

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4. Source of Finance (Discounting):

The Drawer can get cash immediately by discounting the bill with a bank before its maturity date. This provides liquidity to the Drawer.

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5. Evidence in Court:

In case of dishonour (non-payment), the bill serves as strong evidence in court against the acceptor.

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6. Fixed Maturity Date:

The specific payment date provides clarity for both parties regarding when the payment is due.

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7. Can be used for Remittance:

A bill can be drawn on a debtor in one city and sent to a creditor in another city, avoiding the need to send cash.

These advantages make Bills of Exchange a valuable instrument in trade and commerce, particularly for financing credit sales and managing receivables.

Maturity Of Bill

The Maturity Date of a Bill of Exchange or a Promissory Note is the date on which the amount specified in the instrument becomes legally due and payable.

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Calculation of Maturity Date:

The due date is calculated based on the term of the bill (period after date or period after sight) as mentioned in the instrument. According to the Negotiable Instruments Act, 1881, three days are added to the calculated due date. These three additional days are called Days of Grace.

Maturity Date = Date of Bill + Term of Bill + 3 Days of Grace

Answer:

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Answer:

Special Situations:

• If the maturity date (after adding grace days) falls on a public holiday (e.g., 15th August, 26th January, Sunday), the instrument is due for payment on the immediately preceding business day.
• If the maturity date falls on a day declared a holiday by the government under the Negotiable Instruments Act by virtue of a special notification (e.g., unexpected bank holiday due to an event), the instrument is due for payment on the next succeeding business day.

Payment must be demanded from the Acceptor (in case of Bill) or Maker (in case of Promissory Note) on the maturity date.

Discounting Of Bill

Discounting of a Bill of Exchange is the process by which the holder of the bill (usually the Drawer or an Endorsee) sells the bill to a bank before its maturity date to get cash immediately.

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The bank purchases the bill and pays the holder the face value of the bill less a certain amount called the Discount. The discount is the bank's charge for providing the service and is calculated based on the bill's value, the remaining period until maturity, and the prevailing discount rate. The bank then becomes the holder of the bill and will present it to the Acceptor for payment on the maturity date.

Amount Received = Face Value of Bill - Discount Charge

$Discount = Face\ Value \times Rate \times \frac{Remaining\ Period}{365}$ (or 360, depending on convention)

The remaining period is calculated from the date of discounting to the maturity date.

Answer:

Accounting Entry in the Books of Drawer (Mr. Sharma):

When the bill is discounted with the bank:

Date	Particulars	LF	Debit (₹)	Credit (₹)
May 4, 2024	Bank A/c Dr.		48,997.26
	Discount A/c (Expense) Dr.		1002.74
	To Bills Receivable A/c			50,000
	(Being bill discounted with bank)

When the Acceptor (Mr. Gupta) pays the bank on the maturity date, there is no entry in Mr. Sharma's books, as he is no longer the holder. However, if the bill is dishonoured, Mr. Sharma becomes liable to the bank.

Endorsement Of Bill

Endorsement of a Bill of Exchange is the act of transferring the ownership of the bill by the holder to another person. The holder becomes the Endorser, and the person to whom the bill is transferred becomes the Endorsee.

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The transfer is made by the Endorser signing their name on the back of the bill and delivering it to the Endorsee. This process is commonly used by the Drawer to settle a debt owed to a creditor or to pass on the right to receive payment.

Parties involved:

• Endorser: The person who endorses and transfers the bill (e.g., the original Drawer, or a previous Endorsee).
• Endorsee: The person to whom the bill is endorsed and who receives the bill. The Endorsee can further endorse the bill to another person.

Answer:

Accounting Entry in the Books of Drawer (Mr. Sharma):

When the bill is endorsed to a creditor (Mr. Kapoor):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Endorsement)	Mr. Kapoor (Creditor) A/c Dr.		50,000
	To Bills Receivable A/c			50,000
	(Being bill endorsed to Mr. Kapoor)

When the Acceptor (Mr. Gupta) pays the Endorsee (Mr. Kapoor) on the maturity date, there is no entry in Mr. Sharma's books. However, if the bill is dishonoured, Mr. Sharma becomes liable to Mr. Kapoor.

Accounting Treatment

The accounting treatment for Bills of Exchange and Promissory Notes involves recording the transactions in the books of the parties involved – the Drawer (seller) and the Acceptor (buyer) for Bills of Exchange, and the Payee (seller) and the Maker (buyer) for Promissory Notes.

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In The Books Of Drawer/Payee (Seller)

When goods are sold on credit, the Drawer/Payee records the sale. When a Bill of Exchange is drawn and accepted, or a Promissory Note is received, the asset 'Debtors' is replaced by the asset 'Bills Receivable'.

1. For Credit Sale of Goods:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Sale)	Debtor's A/c Dr.		[Amount]
	To Sales A/c			[Amount]
	(Being goods sold on credit)

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2. For Receiving the Bill of Exchange (accepted by Debtor):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Bill/Acceptance)	Bills Receivable A/c Dr.		[Amount]
	To Debtor's A/c			[Amount]
	(Being bill received from Debtor)

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3. For Receiving the Promissory Note from Debtor:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Note)	Bills Receivable A/c Dr.		[Amount]
	To Debtor's A/c			[Amount]
	(Being promissory note received from Debtor)

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4. For Payment Received on Maturity (if bill/note retained):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Maturity Date)	Cash/Bank A/c Dr.		[Amount]
	To Bills Receivable A/c			[Amount]
	(Being amount received on maturity of bill/note)

(Entries for Discounting and Endorsement were covered in Sections I5 and I6).

5. For Bill Sent for Collection:

Sometimes, the Drawer sends the bill to the bank a few days before maturity for collection.

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of sending to bank)	Bill for Collection A/c Dr.		[Amount]
	To Bills Receivable A/c			[Amount]
	(Being bill sent to bank for collection)

When the bank collects the amount on maturity:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Maturity Date or date of bank intimation)	Bank A/c Dr.		[Amount]
	To Bill for Collection A/c			[Amount]
	(Being amount collected by bank on maturity of bill)

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In The Books Of Acceptor/Maker (Buyer)

When goods are purchased on credit, the Acceptor/Maker records the purchase and acknowledges the liability 'Creditors'. When the bill is accepted or the promissory note is made, the liability 'Creditors' is replaced by the liability 'Bills Payable'.

1. For Credit Purchase of Goods:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Purchase)	Purchases A/c Dr.		[Amount]
	To Creditor's A/c			[Amount]
	(Being goods purchased on credit)

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2. For Accepting the Bill of Exchange (drawn by Creditor):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Acceptance)	Creditor's A/c Dr.		[Amount]
	To Bills Payable A/c			[Amount]
	(Being bill accepted in favour of Creditor)

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3. For Making the Promissory Note in favour of Creditor:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Note)	Creditor's A/c Dr.		[Amount]
	To Bills Payable A/c			[Amount]
	(Being promissory note made in favour of Creditor)

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4. For Payment Made on Maturity:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Maturity Date)	Bills Payable A/c Dr.		[Amount]
	To Cash/Bank A/c			[Amount]
	(Being amount paid on maturity of bill/note)

These are the basic entries for the issuance and payment of bills/notes. Other scenarios like dishonour, renewal, or retiring have their own specific accounting treatments.

Dishonour Of A Bill

Dishonour of a Bill of Exchange or Promissory Note occurs when the Acceptor (in case of a bill) or the Maker (in case of a note) fails or refuses to pay the amount due on the maturity date.

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When a bill is dishonoured, the original transaction is reversed. The Acceptor/Maker again becomes a Debtor of the person who was holding the bill at the time of dishonour (Drawer, Endorsee, or Bank).

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Noting Charges

When a bill is dishonoured, the holder usually gets the fact of dishonour legally recorded by a Notary Public. The Notary Public makes a note on the bill (or a paper attached to it) specifying the date of dishonour, the reason for dishonour (if any), and the fees charged. These fees are called Noting Charges.

Noting charges are initially paid by the holder of the bill, but these charges are ultimately recoverable from the party responsible for the dishonour, i.e., the Acceptor/Maker.

Accounting Treatment for Dishonour:

The entry for dishonour aims to reinstate the Debtor (Acceptor/Maker) and cancel the Bill Receivable/Bills Payable. Noting charges, if any, are also accounted for.

In the Books of Drawer (when bill was with him):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Dishonour)	Acceptor's A/c (Debtor) Dr.		[Bill Amt + Noting Charges]
	To Bills Receivable A/c			[Bill Amount]
	To Cash/Bank A/c (Noting Charges Paid)			[Noting Charges]
	(Being bill dishonoured and noting charges paid)

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In the Books of Drawer (when bill was discounted with bank):

The bank will debit the Drawer's account for the bill amount plus noting charges (if paid by the bank). The Drawer reinstates the Debtor for the total amount.

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Dishonour/Bank Intimation)	Acceptor's A/c (Debtor) Dr.		[Bill Amt + Noting Charges]
	To Bank A/c			[Bill Amt + Noting Charges]
	(Being bill discounted dishonoured and amount debited by bank)

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In the Books of Drawer (when bill was endorsed):

The Endorsee (to whom the bill was endorsed) will hold the Drawer liable. The Drawer reinstates the original Debtor and makes the Endorsee a Creditor again.

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Dishonour/Endorsee Intimation)	Acceptor's A/c (Debtor) Dr.		[Bill Amt + Noting Charges - if Endorsee paid]
	To Endorsee's A/c (Creditor)			[Bill Amt + Noting Charges]
	(Being bill endorsed dishonoured and Endorsee informed)

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In the Books of Acceptor (Dishonour):

The Acceptor cancels the Bills Payable liability and reinstates the original Creditor (the person who was the Drawer). Noting charges increase the amount owed to the Creditor.

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Dishonour)	Bills Payable A/c Dr.		[Bill Amount]
	Noting Charges A/c (Expense) Dr.		[Noting Charges]
	To Creditor's A/c (Original Drawer/Holder)			[Bill Amt + Noting Charges]
	(Being bill dishonoured and noting charges payable)

Dishonour leads to the renewal of the debt and potentially further negotiation between the parties.

Renewal Of The Bill

Renewal of a Bill of Exchange occurs when the original bill is dishonoured (or cancelled before maturity) at the request of the Acceptor who is unable to pay on the due date. A new bill is then drawn and accepted for the amount due (usually including interest for the extended period) and sometimes after partial payment of the old bill.

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The process typically involves:

1. Cancelling the old bill (often done by treating the original bill as dishonoured).
2. Charging interest by the Drawer for the extended credit period.
3. Receiving partial payment from the Acceptor (optional).
4. Drawing a new bill for the balance amount (original amount + interest - partial payment) and getting it accepted by the Acceptor.

Accounting Treatment for Renewal:

Let's assume a bill for ₹10,000 accepted by Mr. Gupta is renewed on the maturity date. Mr. Gupta pays ₹4,000 cash and interest of ₹200, and accepts a new bill for 2 months for the balance. Original bill was held by Drawer (Mr. Sharma).

In the Books of Drawer (Mr. Sharma):

1. For Dishonour of Old Bill:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Maturity Date)	Mr. Gupta (Debtor) A/c Dr.		10,000
	To Bills Receivable A/c			10,000
	(Being old bill dishonoured)

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2. For Interest Due:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Renewal)	Mr. Gupta (Debtor) A/c Dr.		200
	To Interest A/c (Income)			200
	(Being interest due on renewal)

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3. For Partial Payment Received:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Renewal)	Cash/Bank A/c Dr.		4,000
	To Mr. Gupta (Debtor) A/c			4,000
	(Being cash received as partial payment)

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4. For Receiving New Bill:

New Bill Amount = Original Bill ₹10,000 + Interest ₹200 - Partial Payment ₹4,000 = ₹6,200.

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of New Bill)	Bills Receivable A/c Dr.		6,200
	To Mr. Gupta (Debtor) A/c			6,200
	(Being new bill received from Mr. Gupta)

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In the Books of Acceptor (Mr. Gupta):

1. For Dishonour of Old Bill:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Maturity Date)	Bills Payable A/c Dr.		10,000
	To Mr. Sharma (Creditor) A/c			10,000
	(Being old bill dishonoured)

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2. For Interest Payable:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Renewal)	Interest A/c (Expense) Dr.		200
	To Mr. Sharma (Creditor) A/c			200
	(Being interest payable on renewal)

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3. For Partial Payment Made:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Renewal)	Mr. Sharma (Creditor) A/c Dr.		4,000
	To Cash/Bank A/c			4,000
	(Being cash paid as partial payment)

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4. For Accepting New Bill:

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of New Bill)	Mr. Sharma (Creditor) A/c Dr.		6,200
	To Bills Payable A/c			6,200
	(Being new bill accepted in favour of Mr. Sharma)

Renewal essentially replaces the old obligation with a new one, adjusting for any payments or interest.

Retiring Of The Bill

Retiring of a Bill of Exchange occurs when the Acceptor pays the amount of the bill before its maturity date. This is usually done at the request of the Acceptor and requires the agreement of the holder of the bill.

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When a bill is retired, the holder may allow the Acceptor a reduction in the amount payable. This reduction is called Rebate or Discount for Early Payment. The rebate is similar to interest but is allowed for the period from the date of payment to the maturity date.

Amount Paid = Face Value of Bill - Rebate

$Rebate = Face\ Value \times Rate \times \frac{Period\ from\ payment\ to\ maturity}{365}$ (or 360)

Accounting Treatment for Retiring a Bill:

Let's assume a bill for ₹10,000 accepted by Mr. Gupta, maturing on 4th July 2024, is retired on 4th June 2024, with a rebate allowed by the holder (Mr. Sharma) at 12% p.a.

Rebate Calculation: Period from 4th June to 4th July = 30 days (June) + 4 days (July) = 34 days.

Rebate = ₹10,000 $\times \frac{12}{100} \times \frac{34}{365} \approx ₹111.78$

Amount paid by Mr. Gupta = ₹10,000 - ₹111.78 = ₹9,888.22.

In the Books of Drawer (Mr. Sharma - Holder):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Retirement)	Cash/Bank A/c Dr.		9,888.22
	Rebate on Bills (Expense/Contra Income) A/c Dr.		111.78
	To Bills Receivable A/c			10,000
	(Being bill retired by Acceptor under rebate)

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In the Books of Acceptor (Mr. Gupta):

Date	Particulars	LF	Debit (₹)	Credit (₹)
(Date of Retirement)	Bills Payable A/c Dr.		10,000
	To Cash/Bank A/c			9,888.22
	To Rebate Received (Income/Contra Expense) A/c			111.78
	(Being bill retired before maturity and rebate received)

Retiring a bill benefits the Acceptor by reducing the amount payable and benefits the holder by receiving cash earlier.