In India, the Negotiable Instruments Act 1981 governs the provisions for bills of exchange. As per this act, the bill of exchange is defined as “ an instrument in writing containing an unconditional order signed by the maker, directing a certain person to pay a certain some of money only to the order of the certain person or to the bearer of the instrument”
Based on this definition the following features of a bill of exchange are noticed:
(a) It’s an instrument in writing.
(b) It contains an unconditional order.
(c) It’s signed by the maker.
(d) It’s drawn on a specific person
(e) There is an order to pay a specific sum of money
(f) It must be dated and stampe
Specimen of a bill of exchange:
|Stamp Address of Drawer Date|
Three months after date pay to a sum of 50,000 (Fifty Thousands only) for the value received.
To B accepted (B’s signature & stamp)
Parties to Bill of Exchange
The parties involved in transaction that uses bill of exchange as a mode of settlement are:
(a) Drawer: He is a person who draws the bill. Typically, he is the seller or a creditor.
(b) Drawee: He is the person on whom the bill is drawn. Normally, he is the buyer or debtor. He has to pay the amount of the bill to the drawer on the due date.
(c) Payee: He is the person to whom the amount of bill is payable. He may be the drawer himself or the creditor of the drawer.
(d) Endorser: Person who transfers rights of payment.
(e) Endorsee: He is the person in whose favour the bill is endorsed by the drawer. He is usually the creditor of the drawer.
(f) Bearer: Person in possession of bearer bill.
Holder and Holder in Due Course
According to Sec 8 of the Negotiable Instruments Act a Holder is “Any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereon”. It indicates the person who is legally entitled to receive the money due on the instrument is called the ‘Holder’.
Holder in Due Course
According to Sec 9 of the Negotiable Instruments Act, the holder in due course is a particular kind of holder. The person of a negotiable instrument is called holder if he/she satisfies the following conditions:
(a) He/she has obtained the instrument for valuable consideration.
(b) He/she became the holder of the instrument before the maturity of the instrument.
(c) He/she must acquire the instrument bona fide and having no cause to believe that, any defect existed in the title of the person from whom he derived his title.
Dishonour of Bill
Dishonour of a Bill means that the acceptor refuses to honour his commitment on due date and for this, payment of the bill on presentation does not take place.
To provide a legal evidence of dishonour, the fact of dishonour is to be noted on the bill by ‘Notary Public’. The fact of dishonour which he is recording is called ‘noting’ and the amount charged by him for his services are called ‘noting charges’. These charges are to be paid by the holder of the bill on the date of default. Actually the acceptor of the bill is liable for the dishonour, the noting charges paid by the holder are to be reimbursed by the acceptor.
The Journal Entries for dishonor of a bill are as follows:
(a) When bill is retained till due date:
|Books of Drawer||Books of Acceptor|
|Acceptor A/c Dr.|
To Bills Receivable A/c To Cash A/c (Acceptor account is debited with the amount of the bill and the amount of noting charges paid in cash)
|Bills Payable A/c Dr.|
Noting Charges A/c Dr.
To Drawer A/c (Drawer account is credited with the amount of the bill and the amount of the noting charges to be reimbursed through the drawer)
(b) When bill is discounted from the bank:
|Books of Drawer||Books of Acceptor|
|Acceptor A/c Dr.|
To Bank A/c (amount of the bill plus the noting charges paid by the bank are debited to Acceptor Account credited to Bank Account)
|Bills Payable A/c Dr.|
Noting Charges A/c Dr.
To Drawer A/c (Drawer account is credited with the amount of the bill and the amount of the noting charges paid by the bank to be reimbursed through the drawer)
Discounting of Bills
If the holder of a bill receivable cannot wait till the date of maturity of the bill and needs cash before the date due, then he can get the bill discounted from the bank. At the time of discounting it, the bank pays cash after deducting the discount from the value of the bill. The discount which is to be deducted depends upon the rate of interest and the remaining period of the bill and is calculated as follows.
Discount = Amount of the bill × Remaining period to maturity × Rate of interest
For example, if a bill of 10,000 due for payment on 15.03.2012 is discounted on 15.01.2012 at 24% p.a., the amount of discount is calculated as under:
Amount of Bill = 10,000
Rate of interest = 24%
Remaining period of the bill = 2 months
Cash received on Discounting = `(20,000-400) = `19,600
Discount is an expenses for the holder receiving the payment and gain to the bank.
Journal Entries in the books of drawer and drawee at the time of discounting and payment on due date are as under:
|Books of Drawer||Books of Drawee|
|1. At the time of cash received from Bank on discounting of bills:|
Bank(or Cash) A/c Dr.
Discount A/c Dr.
To Bills Receivable A/c
(For bills, discounted from bank)
Discounting of bill:
No entry is passed in the books of Drawee for discounting of the bill.
|2. Payment of bill by drawee to Bank on due date:|
No entry is passed in the books of the drawer because the bill is duly honoured by the drawee.
|Payment of the bill on due date :|
Bills Payable A/c. Dr.
To, Cash (or Bank) A/c.
(For payment of the bill to bank)
|3. Transfer of discount to Profit and Loss Account:|
Profit & Loss A/c Dr.
To Discount A/c
Tenure, Days of Grace and Date of Maturity or Due Date of Bills
The bill is payable at sight, on demand after sight, after date etc. The period between the date of drawing of the bill and the period it becomes due is called Tenure of the Bill.
Days of Grace In case the bill is payable on demand, it becomes due immediately on presentation for payment. In the same way if the bill is not payable on demand becomes due on the third day from the date of maturity. These three days are called Days of Grace. For example, if a bill is drawn on 1.4.2013 for 4 months, the due date or date of maturity will be 4.8.2013. The same can be computed as under:
Date of Maturity
Date of Maturity is also known as Due Date. The date on which the amount of the bill becomes payable is called ‘Due Date’ or ‘Date of Maturity’. To compute due date, three days (called Grace Period) are included to the date of maturity of the period of the bill.
The date of maturity of the period of bills depends on whether (a) the bill is payable on date or bill is payable on sight. If the bill is payable on date, the date of maturity is computed by including tenure of bill to the making of the bill.
Date of maturity can be understood with the help of the following example:
However, If the bill becomes due at sight, the date of maturity is counted by including tenure of the bill to the date of acceptance of the bill. In that case, the due date of the bill is calculated as follows:
The due date of the bill after including grace period of 3 days is 16.03.2014 if the bill is payable at date and 19.3.2014 if the bill is payable at sight.
For computing the date of maturity, following points should be noted:
1. Days of grace are allowed on bills payable on maturity of a fixed period. In case of bills payable on demand, amount is required to be paid on presentation and no grace period is allowed.
2. If period of the bill matures on a date which is not there in the month in question, then the due date is taken as the last date of the month. For example, if a bill is drawn on 31.1.2013 and the period of the bill is 3 months, the period bill becomes payable on 30.4.2013 and after including grace days, due date is 3.5.2013.
3. In case the expiry date of a bill falls on a holiday, the bill becomes payable on the preceding day. But when the maturity date is a bank holiday or a Sunday and the second day of grace is also a holiday, the bill is payable on the next working day.
4. The tenure of the bill can be explained in months or in days. The due date of bill should be computed considering this fact in mind. Hence, if S draws bill on A on 31.1.2013 of one month, the maturity date of the bill is computed as follows :
However, if tenure of the bill is 30 days , the expiry date of the bill is computed as follows :
Hence, tenure of one month and 30 days are different.
Types of Bills of Exchange
(a) Trade bill: This bill is drawn to settle a trade transaction.
(b) Accommodation bill: This bill is used without a trade transaction and is for mutual benefit. If Mr. X is in need of money, he draws a bill on his friend Mr. Y who accepts it. This bill is then discounted with bank (bank will pay money before due date) and the money is shared between X and Y. On the due date, Y will pay to the bank and X will pay Y his share. Law generally does not recognise such bills.
Operating Cycle of the Trade Bill of Exchange
We will see the cycle in case of a trade bill of exchange. There is a trade transaction to begin with. The seller will then draw a bill on the buyer who will accept it and return it back to the seller. The seller has four options:
(a) Retain the bill with him till maturity and then present the bill to the buyer to claim the money on that date.
(b) Discount the bill with the bank if urgent money is needed. The bank will deduct discounting charges and pay the drawer. The bank will collect the bill from the drawee on due date.
(c) Endorse the bill to his creditor to settle his liability towards the creditor. Here, on the due date the creditor of the drawer will receive money from the drawee.
(d) Send the bill to the bank for collection. Here, the bank will keep the bill with them till maturity, collect the payment on the due date and credit it to the A/c of the drawer. Bank charges commission for such activity.
The bill of exchange, being a credit instrument, means a right to claim for the drawer and an obligation to pay for the drawee. For the drawer, the bill is Bill Receivable (often referred to as B/R) since he has to get the money on due date. This is a monetary asset shown under current assets in books of the drawer. For the drawee, the bill is Bill Payable (often referred to as B/P) since he has to make the payment on the due date. This is shown under current liability in the books of the drawee.
For endorsee, it represents a monetary asset (B/R).
If on the due date the payment of the bill is not done, it is said to have dishonoured. When bill is dishonoured, the old claims of trade transaction is reopened.
A person, by whom any amount is payable himself prepares and signs a written undertaking to pay. Here the credit document is called a ‘Promissory Note’. It’s a written document and contains an undertaking or promise to pay. As per Indian Negotiable Instrument Act, a ‘Promissory Note’ is “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 to, or to the order of, a certain person.” The person to whom the amount is payable is called Promisee or Payee.
A specimen of Promissory Note which is prepared by Mr. A.Chakraborty in favour of Mr.R.K.Nandy is as follows:
| 15,000 |
J-49, B.N. Marg,
I, promise to pay Mr. R. K. Nandy after 3 months on order, the sum of 15,000 (Rupees Fiteen Thousands only) for value Received.
Date : 16/03/2013 A.Chakraborty
Essential features of Promissory Note
Essential features of Promissory Note are as follows:
(i) It is a written document and adequately signed by the maker or promisor.
(ii) It must contain an undertaking or promise to pay a definite amount given in both figures and words.
(iii) The amount is payable either on demand or on the maturity of a fixed period.
(iv) The amount is payable either to a prescribed person or to his/her order.
The person to whom the amount should be payable is known promisee or payee.
Difference between Bills of Exchange and Promissory Note
The differences between these two items are as under:
Methods of Accounting
Let us see what accounting entries are passed in the books of the drawer, drawee and the endorsee. These entries may be thoroughly understood. Here entries only regarding bill transactions are listed. The trade transaction that precedes the bill of exchange will be accounted for in the usual manner, hence the entries are not given here.
(a) When the drawer retains the bill till maturity
(b) When the drawer discounts the bill with bank before maturity