INTRODUCTION TO BILL OF EXCHANGE

INTRODUCTION

Credit is a very powerful instrument to promote sales, so most of the transactions in most business are usually conducted on a credit basis. When a purchaser makes the purchases on credit, he undertakes to make the payment of the goods purchaser makes the purchases on credit; he undertakes to make the payment of the goods purchases to the seller at a future date. It is possible that the oral promise of making the payment in future may not be fulfilled by the purchaser, so the seller of the goods asks the purchaser to give the undertaking of future payment on a written paper known as a bill of exchange or a promissory note.
In case of non-payment by the purchaser in future, the seller can go to the court for the recovery of the amount of goods sold on credit, because the proof of the amount due from the purchaser is in writing in the form of a bill of exchange or a promissory note.

DEFINITION OF BILL OF EXCHANGE

A bill of exchange has been defined by Section 5 of the Indian Negotiable Instrument Act, 1881 as “an instrument in writing 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.”

DEFINITION OF PROMISSORY NOTE

A Promissory note has been defined by Section 4 of the Indian Negotiable Instruments Act, 1881 as “an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or the order of a certain person, or to the bearer of the instrument.”

DIFFERENCE BETWEEN A BILL OF EXCHANGE AND A PROMISSORY NOTE

BILL OF EXCHANGE	PROMISSORY NOTE
1.       A bill of exchange is an unconditional order to pay.	1.       A promissory note is an unconditional promise to pay.
2.       A bill of exchange is drawn by the creditor and he makes an order on the debtor to make the payment.	2.       A promissory note is written by the debtor wherein he promises to make the payment in future.
3.       A bill of exchange has usually three parties namely the drawer, the drawee and the payee.	3.       A promissory note has only two parties, i.e., the maker and the payee.
4.       A bill of exchange is required to be accepted by the drawee (i.e., debtor) if it is to be a legal document.	4.       A promissory note needs no acceptance because the debtor himself makes the promise to make the payment.
5.       Bill of exchange payable on demand so not requires any stamp duty.	5.       Promissory note payable on demand require as valorem stamp duty.
6.       The liability of the drawer of the bill of exchange is secondary because he is required to make the payment only when the drawee of the bill fails to make the payment.	6.       The liability of the maker of the promissory note is primary and absolute because a promissory note is written by him.
7.       If a bill is dishonoured due to non-payment or non-acceptance, notice of dishonour must be given to all persons liable to pay.	7.       But if a promissory note is dishonoured, notice of dishonour to the maker of the promissory note is not necessary.
8.       A bill of exchange is widely circulated in business.	8.       A promissory note is not as popular as bill of exchange is and is not so common is circulation in business.
9.       A bill of exchange is usually used in settlement of trade debts.	9.       A promissory note is used to borrow money.
10.    A bill of exchange can be accepted conditionally because a bill can have qualified acceptance.	10.    A promissory note can never be conditional.

ACCOUNTING TREATEMENT

For the purpose of accounting treatment, bills of exchange and promissory notes can be treated as bills receivable and bill payable.

Bills Receivable: A bill of exchange is a bill receivable for a drawer because he is to receive payment against it in future and a promissory note is a bill receivable for a promisee because he  promises payment against it. A bill receivable is shown as an Asset in the Balance Sheet (we learned that in final account)

Bill Payable: A bill of exchange is a bill payable for a drawee. (i.e., acceptor of bill) because he is to make the payment against it in future. Similarly, a promissory note is a bill payable for promiser because he promises to make the payment against it.

Thus, a bill of exchange or promissory note can be a bill receivable to one party and a bill payable to another party. In short, bills drawn by us and accepted by others are our bill receivable and bill drawn by others but accepted by us are our bill payable.

PARTIES TO A BILL OF EXCHANGE

There can be three parties attached to a bill of exchange:
1. The Drawer: He is the creditor and writes a bill of exchange on the debtor. He puts his signatures on the bill of exchange.
2. The Drawee or the Acceptor: He is the debtor and a bill is written on him by the drawer ordering him to make a certain payment after a fixed period.
3. The Payee: He is the person to whom payment of the bill is to be made on the maturity date. Sometimes, the drawer and the payee can be one party where payment is to be made to the drawer itself, in that case the number of parties will be reduced to two only.

The drawer or the promisee receiving a bill receivable can treat it in any of the following four ways:

1. Bill Retained: Bill can be kept in the possession till the maturity date and realize the payment against it on the due date.
2. Discounted with the Bank: Bill can be discounted with the bank at any time before its maturity if drawer is in need of money. The bank deducts interest known as “Discount” from the amount of the bill for the period for which it has to wait to get the payment of the bill on the due date.
3. Bill Endorsed: Bill can also be transfer in favour of a creditor in payment of his account. This method of treatment of a bill is known as endorsing over a bill in favour of a creditor.
4. Bill Sent for Collection: Bill can also be send to the bank for collection treating the bank as agent for this work. The bank will give credit to the person sending the bill for collection only when the bill is collected on the due date.

Accounting treatment of bill of exchange can be explained in the following different cases;

1. Bill Honoured: When the bill is honoured on the due date.
2. Bill Dishonoured: When the bill is dishonoured on the due date by non acceptance or by nonpayment.
3. Renewal of Bill: When the old bill is cancelled and a new bill is drawn.
4. Retiring a Bill under Rebate: When the acceptor desire to make payment before its due date.
5. Accommodation bill: When the bill is drawn and accepted or endorsed in mutual understanding, just to help a friend who is in need of money.

Well I know it’s complicated but don’t worry, I will explain all those five 👋cases one☝️ by ☝️one. In my next post, Inshallah I will teach 👩‍🏫you the first one, accounting treatment in case when the bill is honoured on the due date. Along with all four treatments of bill by the drawer.

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