Chapter 8: Bills of Exchange

The Negotiable Instrument Act, 1881 defines a bill of exchange as, “A 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 sum of money only to, or to the order of, a certain person or to the bearer of the instrument.”

One of the most significant feature of a negotiable instrument is an unconditional order to pay. The drawee cannot add any conditions such as payment will be done only if debtors pay or business makes profit.

A bill of exchange must contain an unconditional order to pay for the following reasons:

1. To avoid any kind of conflict at the time of payment

2. To provide security to the creditor and also bind the debtor to pay the amount.

3. To comply with The Negotiable Instruments Act, 1881.

When the drawee of the bill of exchange is unable to complete the payment on the date of maturity of the bill, it is known as dishonour of the bill of exchange. With this liability of the acceptor is re-established, and he/she becomes a debtor again. To reflect the changes, the receipt of the bill of exchange should be reversed.

The following entries will be made in books of holder/drawer (Nonpayment of noting charges):

Entry in the books of drawee:

Notary public charges a fee for keeping proof of a dishonoured bill. These charges are borne by the drawee of the bill.

The following pieces of information are noted by the notary public.

1. Amount and date of the bill

2. Possible Reason for dishonouring of bill

3. Fees charged for Noting

Entries of noting charges in the books of drawer (Payment done for noting charges):

In the books of drawee:

The following steps discuss the procedure for calculating the bill of exchange maturity date:

1. Determine the due date of the bill as per the terms of bills of exchange.

2. Grace period of three days must be added to the due date to arrive at the maturity date.

For e.g., a bill having a due date of 30 days (a month) is drawn on 1^st August, then the due date is 1^st September. Adding 3 grace periods, we arrive at bill maturity and payment due date, which is on 4^th October.

The calculation of days of the grace period depends on these situations:

1. Known Holidays: If the due date for payment falls on a national holiday or on a Sunday, then payment needs to be processed the following day. The following examples will make it easier to understand.

1. A bill that is drawn on 23^rd December with a due date of 23^rd January, adding the grace period (3 days), the maturity date comes to 26^th January. However, as 26^th January is a national holiday, 25^th January becomes the due date for payment.
2. A bill is drawn on 1^st June with a maturity period of a month; the due date arrived is 1^st July. On adding 3 days of grace, the payment due date is 4^th July. However, if 4^th July is a Sunday, in this case, payment needs to be completed on 3^rd July.

2. Unexpected holidays: If the due date for payment falls on a holiday due to an emergency, then the next day becomes the day on which payment needs to be done. For example, if a bill is drawn on 1^st May with a term of 20 days, then, adding a grace period of 3 days, the payment due date becomes 24^th May. But, if a nationwide strike gets declared on 24^th May, then 25^th May is the new due date for the payment of the bill as per rules.

The points of comparison are as follows:

Retirement of a bill of exchange happens when the holder of the bill of exchange receives a payment from the acceptor before the accepted maturity date of the bill. In such cases, the bill holder provides some discount to the acceptor and such a discount offered is called a “rebate”.

The following are the benefits of retiring a bill of exchange for debtor and creditor:

1. Improves the trust between two parties in a transaction, namely, debtor and creditor.

2. Allows creditors to use the money for further business

3. Rebate provided by creditor becomes the revenue for a debtor

4. More business transactions can be conducted between two parties.

In day-to-day operations, a business receives many bills. Maintaining a journal for all such bills is a cumbersome task. In this case, a specialized book is created which keeps a record of all such bills that are received from the debtors. This book contains all the necessary information, such as bill date, due date, amount, and debtor’s name, and it is summed up on a periodical basis and the balance thus obtained is transferred to the debit side of the bills receivable account.

Maintaining a bills receivable book has the following benefits:

1. All information pertaining to the bills receivable, such as due date, amount, etc., get recorded in one place, thereby making it easy to access the records.

2. Likelihood of fraud is greatly minimized as bills are recorded in one place.

3. Higher level of liability and obligation exists on the person maintaining the accounts. If any error is spotted, it can be rectified easily.

4. Time of the accountant is saved as the recording of transactions is recurring and similar in nature.

5. As it is a particular book only dealing with bills receivable, it is easy to locate all details pertaining to a specific bill of exchange.

Maintaining the bills payable book has the following benefits:

1. Quick, efficient and accurate recording of business transactions.

2. Minimizes the chances of fraud as all the bills are recorded in one place

3. A high degree of accountability and answerability on the part of the accountant is observed as all the transactions get verified by the same person, which leads to easy detection and rectification of errors.

4. As information is documented by an individual, it improves the division of labour and efficiency of the organization.

The procedure of posting to ledger:

The recordings from the Bills Payable Book are posted to the accounts of the creditors who received acceptance from the debtors. These books are then totalled periodically and credited to the Bills Payable Account in the ledger.