What is a Bill of exchange?

Bill of Exchange-Goods are often sold or bought for cash or on credit. When goods are sold or bought for cash, payment is received immediately. On the other hand, when goods are sold/bought on credit the payment is deferred to a future date. In such a situation, normally the firm relies on the party to form the payment on maturity.

But in some cases, to avoid any possibility of delay or default, an instrument of credit is employed through which the customer assures the vendor that the payment shall be made according to the agreed conditions. In India, instruments of credit have been in use since time out of mind and are popularly referred to as Hundies. The hundies are written in Indian languages and have an outsized variety.

Nowadays these instruments of credit are called bills of exchange or promissory notes. The bill of exchange contains an unconditional order to pay a particular amount on an agreed date while the note contains an unconditional promise to pay a particular sum of money on a certain date. In India, these instruments are governed by the Indian Negotiable Instruments Act 1881.

Meaning of Bill of Exchange

According to the Negotiable Instruments Act 1881, a bill of exchange is defined as an instrument in writing containing an unconditional order, signed by the maker, directing a particular person to pay a particular sum of cash only to, or to the order of a particular person or the bearer of the instrument. The following features of a bill of exchange emerge from this definition.

    • A bill of exchange must be in writing.
    • It is an order to make a payment.
    • The order to make payment is unconditional.
    • The maker of the bill of exchange must sign it.
    • The payment to be made must be certain.
    • The date on which payment is made must also be certain.
    • The bill of exchange must be payable to a certain person.
    • The amount mentioned in the bill of exchange is payable either on-demand or on the expiry of a fixed period of time.
    • It must be stamped as per the requirement of the law.

A bill of exchange is generally drawn by the creditor upon his debtor. It has to be accepted by the drawee (the debtor) or someone on his behalf. It is just a draft till its acceptance is made.

For example, Rahul sold goods to Suresh on credit for Rs. 10,000 for three months. To ensure payment on the due date Rahul draws a bill of exchange upon Suresh for Rs. 10,000 payable after three months. Before it is accepted by Suresh it will be called a draft. It will become a bill of exchange only when Suresh writes the word “accepted” on it and appends his signature thereto to communicate his acceptance.

Parties to a Bill of Exchange

There are three parties to a bill of exchange:

    1. The drawer is the maker of 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 writing the bill of exchange has to sign it as a maker of the bill of exchange.
    2. Drawee is the person upon whom the bill of exchange is drawn. Drawee is the purchaser or debtor of the goods upon whom the bill of exchange is drawn.
    3. The payee is the person to whom the payment is to be made. The drawer of the bill himself will be the payee if he keeps the bill with him till the date of its payment. The payee may change in the following situations:
        1. ) In case the drawer has got the bill discounted, the person who has discounted the bill will become the payee;
        2. ) In case the bill is endorsed in favour of a creditor of the drawer, the creditor will become the payee.

Normally, the drawer and the payee are the same person. Similarly, the drawee and the acceptor is normally the people. For example, Sujata sold goods worth Rs.10,000 to Jyoti and drew a bill of exchange upon her for the same amount payable after three months.

Here, Sujata is the drawer of the bill and Jyoti is the drawee. If the bill is retained by Sujata for three months and the amount of Rs. 10,000 is received by her on the due date then Sujata will be the payee. If Sujata gives away this bill to her creditor Ruchi, then Ruchi will be the payee. If Sujata gets this bill discounted from the bank then the bankers will become the payee.

Advantages of Bill of Exchange

The bills of exchange as instruments of credit are used frequently in business because of the following advantages:

    • Framework for relationships:

A bill of exchange represents a device, which provides a framework for enabling the credit transaction between the seller/creditor and buyer/debtor on an agreed basis.

    • The certainty of terms and conditions:

The creditor knows the time when he would receive the money so also the debtor is fully aware of the date by which he has to pay the money. This is because terms and conditions of the relationships between debtor and creditor such as the amount required to be paid; date of payment; interest to be paid if any, and place of payment are clearly mentioned in the bill of exchange.

    • Convenient means of credit:

A bill of exchange enables the buyer to buy the goods on credit and pay after the period of credit. However, the seller of goods even after the extension of credit can get the payment immediately either by discounting the bill with the bank or by endorsing it in favour of a third party.

    • Conclusive proof:

The bill of exchange is legal evidence of a credit transaction implying thereby that during the course of the trade, the buyer has obtained credit from the seller of the goods, therefore, he is liable to pay the seller. In the event of a refusal to make the payment, the law requires the creditor to obtain a certificate from the Notary to make it conclusive evidence of the happening.

    • Easy transferability:

Debt can be settled by transferring a bill of exchange through endorsement and delivery.

Maturity of Bill

The term maturity refers to the date on which a bill of exchange or a note becomes due for payment. In arriving at the maturity three days, referred to as days of grace, must be added to the date on which the amount of credit expires instrument is payable. 

Thus, if a bill dated March 05 is payable 30 days after the date it, falls due on April 07, i.e., 33 days after March 05 If it were payable one month after the date, the maturity would be April 08, i.e., one month and three days after March 05.

However, where the date of maturity may be a public holiday, the instrument will become due on the preceding business day. In this case, if April 08, falls on a public holiday then April 07 is going to be the maturity. But when an emergent holiday is said under the Negotiable Instruments Act 1881, by the govt of India which can happen to be the date of maturity of a bill of exchange, then the date of maturity is going to be the subsequent working day immediately after the vacation.

For example, the govt declared a vacation on April 08 which happened to be the day on which a bill of exchange drawn by Gupta upon Verma for Rs.20,000 became due for payment, Since April 08, has been declared a vacation under the Negotiable Instruments Act, therefore, April 09, are going to be the date of maturity for this bill.

Discounting of Bill

If the holder of the bill needs funds, he can approach the bank for encashment of the bill before maturity. The bank shall make the payment of the bill after deducting some interest (called a discount in this case). This process of encashing the bill with the bank is called discounting the bill. The bank gets the amount from the drawee on the due date.

Endorsement of Bill

Any holder may transfer a bill unless its transfer is restricted, i.e., the bill has been negotiated to contain words prohibiting its transfer. The bill is often initially endorsed by the drawer by putting his signatures at the rear of the bill alongside the name of the party to whom it is being transferred. The act of signing and transferring the bill is named an endorsement.

Accounting Treatment

For the one that draws the bill of exchange and gets it back after its due acceptance, it’s a bill receivable. For the one that accepts the bill, it’s a bill payable. In the case of a note for the maker, it’s a bill payable and for the person in whose favour the note is drawn, it’s bills receivable. Bills receivables are assets and Bills payable are liabilities. Bills and Notes are used interchangeably

Dishonour of a Bill

A bill is claimed to have been dishonoured when the drawee fails to form the payment on the date of maturity. In this situation, the liability of the acceptor is restored. Therefore, the entries made on the receipt of the bill should be reversed.

  • Noting Charges:

A bill of exchange should be duly presented for payment on the date of its maturity. The drawee is absolved of his liability if the bill isn’t duly presented. Proper presentation of the bill means it should be presented on the date of maturity to the acceptor during business working hours.

To establish definitely that the bill was dishonoured, despite its due presentation, it’s going to be better to be noted by a notary. Noting authenticates the fact of dishonour. For providing this service, a fee is charged by the notary which is named Noting Charges.

The following facts are generally noted by the Notary:

    • Date, fact and reasons of dishonour;
    • If the bill is not expressly dishonoured, the reasons why he treats it as dishonoured and;
    • The amount of noting charges

It may be noticed that whosoever pays the noting charges, ultimately these got to be borne by the drawee. that’s why the drawee is invariably debited within the drawer’s books. this is often because he’s responsible for the dishonour of the bill and, hence, he possesses in touch with these expenses. For recording the noting charges in his book the drawee opens Noting Charges Account. He debits the Noting Charges Account and credits the Drawer’s Account.

for instance, Azad sold goods for Rs. 15,000 to Bunty and immediately drew a bill upon him on Jan. 01, 2018, payable after 3 months. On maturity, the bill was dishonoured and Rs. 50 were paid by the holder of the bill as noting charges. The journal entries will be recorded in the books of Azad and Bunty as given below under the following circumstances:

    1. When the bill was kept by Azad till maturity.
    2. When the bill was discounted by Azad with his bank immediately @ 12% p.a.
    3. When the bill was endorsed by Azad in favour of his creditor Chitra

Renewal of the Bill

Sometimes, the acceptor of the bill foresees that it’s going to be difficult to satisfy the requirement of the bill on maturity and should, therefore, approach the drawer with the request for an extension of time for payment.

If it’s so, the old bill is cancelled and therefore the fresh bill with new terms of payment is drawn and duly accepted and delivered. This is called the renewal of the bill. Since the cancellation of the bill is mutually agreed upon noting the bill is not required

The drawee may have to pay interest to the drawer for the extended period of credit. The interest is paid in cash or could also be included in the amount of the new bill. Sometimes, a neighbourhood of the quantity due could also be paid and therefore the new bill could also be drawn just for the balance.

For example, a bill of Rs. 10,000 is cancelled on cash payment of Rs. 3,000 and acceptance of a replacement bill for the balance of Rs. 7,000 plus interest as agreed between the parties. The journal entries in the books of the drawer and the drawee will be the same as that of dishonour of the bill.

As for the interest in value, if it’s not paid in cash, the drawer debits the drawee’s account and credits the interest account, and therefore the drawee debits the interest and credits the drawer’s account in his books.

Retiring of the Bill

There are instances when a bill of exchange is arranged to be retired before the maturity by mutual affection between the drawer and therefore the drawee. This happens when the drawee of the bill has funds at his disposal and makes an invitation to the drawer or holder to simply accept the payment of the bill before its maturity. 

If the holder agrees to do so, the bill is said to have been retired. The retiring of a bill draws a curtain on the bill transactions before the expiry of its normal term. To encourage the retirement of the bill, the holder allows some discount called a Rebate on bills for the period between the date of retirement and maturity. The rebate is calculated at a particular rate of interest.

The accounting treatment on the retirement of a bill is analogous to the accounting treatment when a bill is honoured by the acceptor on maturity within the ordinary course.

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