Bills of Exchange and Promissory Notes
Learning Outcomes
- Understand the meaning of Bills of Exchange and Promissory Notes and also try to grasp their underlying features.
- Understand the accounting treatments relating to issue, acceptance, discounting, maturity and endorsement of bills in the books of drawer and drawee.
- Learn the technique of accounting relating to accommodation bills.
- Learn the special treatment needed in case of insolvency as well as early retirement of bill.
1. Bills of Exchange
- A Bill of Exchange has been defined as an "instrument in writing containing an unconditional order signed by the maker directing 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".
- When such an order is accepted in writing on the face of the order itself, it becomes a valid bill of exchange.
KNOWLEDGE NUGGET
- Drawer: The party which makes the order
- Acceptor: The party which accepts the order
- Payee: The party to whom the amount has to be paid
- The drawer and the payee can be the same
Characteristics of a Bill of Exchange
- 1. It must be in writing.
- 2. It must be dated.
- 3. It must contain an order to pay a certain sum of money.
- 4. The promise to pay must be unconditional.
- 5. The money must be payable to a definite person or to his order to the bearer.
- 6. The draft must be accepted for payment by the party to whom the order is made.
- 7. It should be properly stamped (except in case of bills payable "on demand").
- 8. Payment must be in legal currency of the country.
FOREIGN BILL OF EXCHANGE
- A bill drawn in one country and payable in another is called a Foreign Bill of Exchange.
- It is generally drawn up in triplicate wherein each copy is sent by separate post.
- Section 12 of the Negotiable Instruments Act provides that all instruments, which are not inland instrument, are foreign.
2. Promissory Notes
- A promissory note is an instrument in writing, not being a bank note or currency note containing an unconditional undertaking signed by the maker to pay a certain sum of money only to or to the order of a certain person.
- Under Section 31(2) of the Reserve Bank of India Act a promissory note cannot be made payable to bearer.
Characteristics of a Promissory Note
- 1. It must be in writing.
- 2. It must contain a clear promise to pay.
- 3. The promise to pay must be unconditional.
- 4. The promiser or maker must sign the promissory note.
- 5. The maker must be a certain person.
- 6. The payee must also be certain.
- 7. The sum payable must be certain.
- 8. Payment must be in legal currency of the country.
- 9. It should not be made payable to the bearer.
- 10. It should be properly stamped.
- 11. It does not require any acceptance.
3. Differences — Bill of Exchange and Promissory Note
| Bill of Exchange | Promissory Note |
|---|---|
| A bill contains an order to pay | A promissory note contains only a promise to pay certain sum of money |
| There are generally 3 parties (Drawer, Drawee and Payee) | There are 2 parties (Maker and Payee) |
| A bill is paid by acceptor | A promissory note is paid by maker |
| A bill is drawn by creditor | A promissory note is made by debtor |
| Drawer and payee may be same person | Maker and payee cannot be same person |
| Liability of drawer is secondary and conditional | Liability of maker is primary and absolute |
| Can be accepted conditionally | Cannot be made conditionally |
| Notice of dishonour must be given | Notice of dishonour is not required |
| Must be noted and protested | Noting and protest is not required |
4. Record of Bills of Exchange and Promissory Notes
- A party which receives a Promissory Note or receives an accepted Bill of Exchange will treat it as a new asset under the name of Bills receivable.
- A party which issues a Promissory Note or accepts a Bill of Exchange will treat it as new liability under the heading of Bills Payable.
On Receipt of Bill
- Entry:
JOURNAL ENTRY
Bills Receivable Account Dr.
To Drawee/Maker of the note
Options with the Person Who Receives the Bill
- (i) He can hold the bill till maturity.
- (ii) The bill can be endorsed in favour of another party.
- (iii) The Bill of Exchange can be discounted with bank.
ENTRY FOR ENDORSEMENT
Z Dr.
To Bills Receivable Account
ENTRY FOR DISCOUNTING
Bank Account Dr. (with the amount actually received)
Discount Account Dr. (with the amount of loss or discount)
To Bills Receivable Account
On Date of Maturity
- (a) Bill is honoured:
ENTRY
Bank Account Dr.
To Bills Receivable Account
- (b) Bill is dishonoured:
ENTRIES
1. If kept till maturity:
Drawee/Maker Account Dr.
To Bills Receivable Account
2. If endorsed:
Drawee/Maker Account Dr.
To Creditor Account
3. If discounted:
Drawee/Maker Account Dr.
To Bank Account
5. Term of a Bill
- The term of bill of exchange may be of any duration. Usually the term does not exceed 90 days from the date of the bill.
- When a bill is drawn after sight, the term begins from the date of 'sighting'.
- When a bill is drawn after date, the term begins from the date of drawing the bill.
6. Expiry/Due Date of a Bill
- The date on which the term of the bill terminates is called as 'Expiry/Due Date of the bill'.
7. Days of Grace
- Every instrument payable otherwise than on demand is entitled to three days of grace.
8. Date of Maturity of Bill
- The date which comes after adding three days of grace to the expiry/due date of a bill, is called the date of maturity.
9. Bill at Sight
- Bill at Sight means the instruments in which no time for payment is mentioned.
- "At sight" and "presentment" means on demand.
- Days of grace is not added to calculate maturity for such types of bill.
10. Bill after Date
- Bill after date means the instrument in which time for payment is mentioned.
- The expression 'after sight' means:
- In a promissory note — after presentment for sight
- In a bill of exchange — after acceptance or noting for non-acceptance
11. How to Calculate Due Date of a Bill
| Case | Due Date |
|---|---|
| (a) Bill made payable on a specific date | That specific date will be the due date. |
| (b) Bill made payable at a stated number of months after date | The date on which the term shall expire. If the month has no corresponding day, the period shall expire on the last day of such month. |
| (c) Bill made payable at a stated number of days after date | The date which comes after adding stated number of days to the date of bill. The date of Bill is excluded. |
| (d) When the due date is a public holiday | The preceding business day will be the due date. |
| (e) When the due date is an emergency/unforeseen holiday | The next following day will be the date. |
Note: The term of a Bill after sight commences from the date of acceptance whereas the term of a Bill after date commences from the date of drawing.
12. Noting Charges
- A public official known as "Notary Public" presents the bill for payment.
- If the bill is dishonoured, they note the fact of dishonour with the reasons.
- The fee charged for this service is known as noting charges.
- The amount of noting charges is recoverable from the party which is responsible for dishonour.
ENTRY FOR NOTING CHARGES
Y Dr. 1,010
To Bills Receivable Account 1,000
To Bank Account 10
13. Renewal of Bill
- Sometimes the acceptor is unable to pay the amount and requests extension of time.
- In consideration, the acceptor agrees to bear interest for the extended time period.
- A new bill will be drawn and the old bill will be cancelled.
AMOUNT OF NEW BILL
- (i) Where the drawee pays nothing: Total of original bill + interest
- (ii) Where the drawee pays interest at renewal: Amount of Original bill
- (iii) Where the drawee makes part payment: Unpaid part of total + interest
14. Retirement of Bills of Exchange & Rebate
- When the acceptor has spare funds before the maturity date, he may approach the payee to accept cash before maturity.
- The acceptor gets a certain rebate or interest or discount for premature payment.
- The rebate becomes the income of the acceptor and expense of the payee.
Illustration 1
Ms. Sujata receives two bills from Ms. Aruna dated 1st January 2022 for 2 months. The first bill is for ₹10,200 and the second bill is for ₹15,000. The First bill is discounted immediately with the bank for ₹10,000 and the second bill was endorsed in favour of Mr. Sree on 3rd January 2022. Pass the necessary journal entries in the books of Ms. Sujata.
SOLUTION
| Date | Particulars | Dr. (₹) | Cr. (₹) |
|---|---|---|---|
| 01/01/2022 | Bills Receivables A/c Dr. | 25,200 | |
| To Aruna A/c | 25,200 | ||
| 01/01/2022 | Bank A/c Dr. | 10,000 | |
| Discount charges A/c Dr. | 200 | ||
| To Bills Receivable A/c | 10,200 | ||
| 03/01/2022 | Sree A/c Dr. | 15,000 | |
| To Bills Receivable A/c | 15,000 |
16. Accommodation Bills
- Bills of Exchange are usually drawn to facilitate trade transmission, that is, bills are meant to finance actual purchase and sale of goods.
- When bills are used for the purpose of raising finance, they are known as accommodation bills.
- When bills are used for such a purpose, they are known as accommodation bills.
17. Bills of Collection
- When a person sends a bill to bank with instructions that the bill should be retained till maturity and should be realised on that date, it is known as "Bill sent for collection".
18. Bills Receivable and Bills Payable Books
- Bills receivable and bills payable books are journals (Day Books) to record in a chronological order the details of bills receivable and bills payable.
- When large number of bill transactions take place in an organization, it is convenient to maintain these books.
BILLS RECEIVABLE BOOK (Folio No...)
| Date of receipt | Voucher No. | Party from whom Received | Accept or | Date of Bill | Due Date | Place of Payment | Amt. | L.F. | Mode of Disposal |
|---|
BILLS PAYABLE BOOK (Folio No...)
| Date of Acceptance | Drawer | Payee | Date of Bill | Due Date | Place of Payment | Amt. | L.F. | Mode of Disposal |
|---|
Summary
- A Bill of Exchange is 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".
- A Promissory Note is an instrument in writing, not being a bank note or currency note containing an unconditional undertaking signed by the maker to pay a certain sum of money only to or to the order of a certain person.
- A party which receives a Promissory Note or receives an accepted Bill of Exchange will treat it as a new asset under the name of Bills receivable.
- A party which issues a Promissory Note or accepts a Bill of Exchange will treat it as new liability under the heading of Bills Payable.
Test Your Knowledge
True and False
- 1. Bills payable account is a nominal account. False
- 2. Promise to pay is included in a bill of exchange. False
- 3. Days of rebate are added to the due date to arrive at the maturity date. False
- 4. Discount at the time of retirement of a bill is a gain for the drawee. True
- 5. Foreign bill is drawn in the country and payable outside the country. True
- 6. Promissory note is different from bill of exchange because the amount is paid by the maker in case of former and by the acceptor in the later. True
- 7. A has drawn a bill on B. B accepts the same and endorses the bill to C. False
- 8. A bill given to a creditor is called bills payable. True
Multiple Choice Questions
| 1. On 1.1.2022, A draws a bill on B for ₹1,20,000 for 3 months' maturity date of the bill will be: | (a) 1.4.2022 (b) 3.4.2022 (c) 4.4.2022 |
| 2. On 16.6.2022 P draws a bill on Q for ₹1,25,000 for 30 days. 19th July is a public holiday, maturity date of the bill will be: | (a) 19th July (b) 18th July (c) 17th July |
| 3. PQ draws a bill on XY for ₹1,30,000 on 1.1.2022. XY accepts the same on 4.1.2022 for period of 3 months after date. What will be the maturity date of the bill: | (a) 4.4.2022 (b) 3.4.2022 (c) 7.4.2022 |
| 4. A draws a bill on B. A endorsed the bill to C. The payee of the bill will be | (a) A (b) B (c) C |
| 5. A bill of ₹1,20,000 was discounted by Saras with the banker for ₹1,18,800. At maturity, the bill returned dishonoured, noting charges ₹200. How much amount will the bank deduct from Saras's bank balance at the time of such dishonour? | (a) ₹1,20,000 (b) ₹1,18,800 (c) ₹1,20,200 |
| 6. X draws a bill on Y for ₹3,00,000 on 1.1.2022 for 3 months after sight, date of acceptance is 6.1.2022. Maturity date of the bill will be: | (a) 8.4.2022 (b) 9.4.2022 (c) 10.4.2022 |
| 7. X sold goods to Y for ₹5,00,000. Y paid cash ₹4,30,000. X will grant 2% discount on balance, and Y request X to draw a bill for balance, the amount of bill will be: | (a) ₹98,000 (b) ₹68,000 (c) ₹68,600 |
| 8. On 1.1.2022, X draws a bill on Y for ₹5,00,000 for 3 months. X got the bill discounted 4.1.2022 at 12% rate. The amount of discount on bill will be: | (a) ₹15,000 (b) ₹16,000 (c) ₹18,000 |
| 9. Mr. Jay draws a bill on Mr. John for ₹3,00,000 on 1.1.2022 for 3 months. On 4.2.2022, John got the bill discounted at 12% rate. The amount of discount will be: | (a) ₹9,000 (b) ₹6,000 (c) ₹3,000 |
| 10. XZ draws a bill on YZ for ₹2,00,000 for 3 months on 1.1.2022. The bill is discounted with banker at a charge of ₹1,000. At maturity the bill return dishonoured. In the books of XZ, for dishonour, the bank account will be credited by: | (a) ₹1,99,000 (b) ₹2,00,000 (c) ₹2,01,000 |
| 11. On 1.1.2022, XA draws a bill on YB for ₹1,00,000. At maturity YB request XA to renew the bill for 2 months at 12% p.a. interest. Amount of interest will be: | (a) ₹2,000 (b) ₹1,500 (c) ₹1,800 |
| 12. A bill of exchange is drawn by a | (a) Creditor (b) Debtor (c) Debenture holder |
| 13. At the time of drawing a bill, the drawer credits | (a) Bills Receivables A/c (b) Bills Payable A/c (c) Debtor's A/c |
| 14. A promissory note is made by a | (a) Seller (b) Purchaser (c) Endorsee |
| 15. A bill of exchange contains | (a) An unconditional order (b) A promise (c) A request to deliver the goods |
| 16. A promissory note contains | (a) An unconditional order (b) A promise (c) A request to deliver the goods |
| 17. The rebate on the bill shows that | (a) It has been endorsed (b) It has been paid after the date of maturity (c) It has been paid before the date of maturity |
| 18. Notary Public may charge his fee from the | (a) Holder of bill of exchange (b) Drawer (c) None |
High-Yield Interactive Quiz — Bills of Exchange and Promissory Notes
Q1. A Bill of Exchange contains:
Correct Answer: B. A Bill of Exchange is an "instrument in writing containing an unconditional order signed by the maker directing a certain person to pay a certain sum of money".
Q2. How many parties are generally there in a Bill of Exchange?
Correct Answer: B. There are generally 3 parties in a bill of exchange — Drawer, Drawee and Payee.
Q3. A promissory note is made by:
Correct Answer: B. A promissory note is made by the debtor (maker) to the creditor (payee). It contains a promise to pay.
Q4. How many days of grace are added to the due date of a bill?
Correct Answer: C. Every instrument payable otherwise than on demand is entitled to three days of grace.
Q5. At the time of retirement of a bill before maturity, the rebate is:
Correct Answer: B. The rebate becomes the income of the acceptor and expense of the payee. It is a consideration of premature payment.
Q6. Noting charges are paid to:
Correct Answer: C. Noting charges are paid to Notary Public who presents the bill for payment and notes the fact of dishonour.
Q7. In case of dishonour of a discounted bill, the drawee's account is debited and which account is credited?
Correct Answer: B. If the bill was discounted with the bank, the entry is: Drawee/Maker Account Dr. To Bank Account.
Q8. A foreign bill of exchange is drawn in:
Correct Answer: B. A foreign bill of exchange is one which is drawn in one country and is payable in another.
Q9. Under Section 31(2) of the RBI Act, a promissory note:
Correct Answer: B. Under Section 31(2) of the Reserve Bank of India Act, a promissory note cannot be made payable to bearer.
Q10. Bills used for raising finance are called:
Correct Answer: C. When bills are used for the purpose of raising finance, they are known as accommodation bills.
Q11. In a promissory note, the liability of the maker is:
Correct Answer: B. In a promissory note, the liability of the maker is primary and absolute. In a bill of exchange, the liability of the drawer is secondary and conditional.
Q12. On 1.1.2022, A draws a bill on B for ₹1,20,000 for 3 months. What is the maturity date?
Correct Answer: C. Due date = 1.4.2022 (3 months from 1.1.2022). Maturity date = 1.4.2022 + 3 days grace = 4.4.2022.