Learning Objectives
- Understand the meaning, features, and parties involved in a bill of exchange
- Differentiate between bills of exchange and promissory notes
- Learn the concepts of drawing, acceptance, endorsement, and discounting of bills
- Understand the accounting treatment for dishonour and renewal of bills
- Know how to record bill transactions in the books of the drawer and drawee
Key Concepts
Meaning and Parties
A Bill of Exchange is a written instrument containing an unconditional order signed by the maker (drawer) directing a certain person (drawee) to pay a certain sum of money on demand or on a specified future date to the order of a specified person (payee) or to the bearer of the instrument.
Three parties involved:
- Drawer: The person who draws (creates) the bill. Usually the creditor.
- Drawee: The person on whom the bill is drawn. Usually the debtor. After acceptance, the drawee becomes the acceptor.
- Payee: The person to whom the payment is to be made. The drawer and payee can be the same person.
Promissory Note
A Promissory Note is a written promise by the maker to pay a certain sum of money to the payee or bearer on demand or at a future date. It has only two parties: the Maker (who promises to pay) and the Payee (to whom payment is promised). Unlike a bill of exchange, a promissory note does not require acceptance.
Important Terms Related to Bills
- Term of the Bill: The period after which the bill becomes due for payment.
- Due Date: The date on which the bill becomes due for payment. In India, 3 days of grace are added to determine the date of maturity.
- Acceptance: The drawee signs across the face of the bill writing "Accepted" with date and signature, thereby acknowledging the liability.
- Endorsement: The holder of the bill transfers it to another person by signing on its back. The person transferring is the endorser; the person receiving is the endorsee.
- Discounting: The holder sells the bill to the bank before the due date and receives the bill amount less a deduction called discount.
Accounting Treatment
In the books of the Drawer: When the bill is drawn and accepted: Debit Bills Receivable A/c, Credit Debtor's A/c. When the bill is honoured on maturity: Debit Cash/Bank A/c, Credit Bills Receivable A/c. If discounted with bank: Debit Bank A/c and Discount A/c, Credit Bills Receivable A/c.
In the books of the Drawee (Acceptor): When the bill is accepted: Debit Creditor's A/c, Credit Bills Payable A/c. When the bill is honoured: Debit Bills Payable A/c, Credit Cash/Bank A/c.
Dishonour of a Bill
When the drawee fails to make payment on the maturity date, the bill is said to be dishonoured. In the drawer's books: Debit Debtor's A/c, Credit Bills Receivable A/c. If the bill was discounted with the bank, the bank debits the drawer's account, and the drawer records: Debit Debtor's A/c, Credit Bank A/c. Noting charges (fees paid to a notary public for recording the dishonour) are borne by the drawee.
Renewal of a Bill
When the drawee cannot pay on the due date, the drawer may agree to cancel the old bill and draw a new bill for a longer period with interest. The drawee pays the interest amount and a new bill is drawn for the original amount or the amount plus interest as agreed.
Retirement of a Bill
When the drawee pays the bill before the maturity date, it is called retirement. The drawee may receive a rebate (discount) for early payment. In the drawer's books: Debit Cash/Bank A/c and Rebate Allowed A/c, Credit Bills Receivable A/c.
Summary
A Bill of Exchange is a negotiable instrument involving three parties -- drawer, drawee, and payee. After acceptance by the drawee, it becomes a legally binding document. Bills can be retained until maturity, endorsed, or discounted with a bank. On maturity, the bill is either honoured (paid) or dishonoured (not paid). Dishonoured bills require reversal entries and recording of noting charges. Bills can be renewed with interest if the drawee requests an extension, or retired early with a rebate. Proper accounting entries must be recorded in the books of both the drawer and the drawee for each scenario.
Important Terms
- Bill of Exchange
- A negotiable instrument containing an unconditional written order to pay a specified sum on a future date.
- Promissory Note
- A written promise by the maker to pay a certain sum to the payee; has only two parties.
- Endorsement
- Transfer of a bill to another party by signing on its back.
- Discounting
- Selling a bill to a bank before maturity at a value less than the face value (face value minus discount).
- Dishonour
- Failure of the drawee to make payment on the maturity date of the bill.
- Noting Charges
- Fees paid to a notary public for officially recording the dishonour of a bill.
- Days of Grace
- Three additional days added to the term of the bill to determine the date of maturity (in India).
Quick Revision
- Bill of Exchange has 3 parties (Drawer, Drawee, Payee); Promissory Note has 2 (Maker, Payee).
- Date of Maturity = Due Date + 3 Days of Grace.
- Drawer records Bills Receivable; Drawee records Bills Payable.
- Discounting: Drawer receives face value minus bank discount before maturity.
- Dishonour: Reverse the bill entry and reinstate the debtor in the drawer's books.
- Renewal: Cancel old bill, charge interest, draw new bill for extended period.
- Retirement: Early payment by drawee; drawee gets rebate for early payment.
Practice Tips
- Always determine the date of maturity correctly by adding 3 days of grace to the due date.
- Practice recording entries in the books of BOTH the drawer and drawee simultaneously.
- For discounting problems, remember the bank charges discount on the unexpired period of the bill.
- Dishonour after discounting is a key exam topic: the bank debits the drawer, who then debits the debtor.
- In renewal problems, calculate interest carefully and determine whether it is paid in cash or added to the new bill.