Bills of Exchange

When goods are sold on credit, the seller may want a written, legally enforceable promise of payment on a future date. That instrument is a bill of exchange. The Negotiable Instruments Act defines it 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."

Its features: it must be in writing, contain an unconditional order (not a request) to pay, be signed by the drawer, specify a certain sum and a certain date, and be accepted by the drawee.

There are three parties to a bill:

• Drawer — the person who makes the bill and orders payment (the creditor/seller).
• Drawee — the person on whom the bill is drawn and who accepts it to pay (the debtor/buyer). After acceptance the drawee is the acceptor.
• Payee — the person who receives the money (often the drawer himself).

A close cousin is the promissory note — a written promise (not an order) by the maker to pay a certain sum to a certain person. The key differences: a bill contains an order and has three parties and needs acceptance; a promissory note contains a promise, has only two parties (maker and payee) and needs no acceptance. Two important dates also matter: the bill's tenure (its period) and its date of maturity = due date + 3 days of grace.

Once the drawer holds an accepted bill (a bill receivable), he can do one of four things with it. The accounting differs for each, but the acceptance entry is common: in the drawer's books, Bills Receivable A/c Dr / To Drawee; in the drawee's books, Drawer A/c Dr / To Bills Payable A/c.

• 1. Retention till maturity — the drawer simply keeps the bill and collects cash on the due date: Cash/Bank A/c Dr / To Bills Receivable A/c.
• 2. Discounting with a bank — the drawer needs money early, so he gets the bill discounted (the bank pays him the bill value minus a discounting charge). Entry: Bank A/c Dr (net) and Discounting Charges A/c Dr (the loss) / To Bills Receivable A/c. The discounting charge is the drawer's expense (interest for early money).
• 3. Endorsement — the drawer transfers the bill to his own creditor in settlement of a debt: Creditor A/c Dr / To Bills Receivable A/c. The bill now belongs to the endorsee.
• 4. Sending for collection — the drawer hands the bill to his bank to collect on his behalf near maturity.

In every case the drawee's books are unaffected by what the drawer does with the bill — the drawee still owes the same amount and pays whoever holds the bill at maturity. This is the elegance of a negotiable instrument: it can change hands freely, while the obligation to pay stays fixed on the acceptor.

Not every bill is paid smoothly. Several end-of-life events have set treatments.

• Dishonour — the acceptor fails to pay at maturity. The earlier acceptance entry is reversed: in the holder's books, Drawee A/c Dr / To Bills Receivable (or Bank, if it had been discounted/endorsed). If the bill had been discounted, the drawer must repay the bank; if endorsed, he must settle the endorsee — and in turn the drawee again owes the drawer.
• Noting charges — to obtain legal proof of dishonour, the bill is "noted" by a notary public for a small fee. These noting charges are borne ultimately by the acceptor (the defaulter), so they are added to the amount the drawee owes.
• Renewal — if the acceptor cannot pay but wants more time, the old bill is cancelled and a new bill drawn for a further period. Because the drawer waits longer, he usually charges interest, which is added to the new bill (or paid in cash).
• Retirement — the opposite case: the acceptor pays the bill before its due date. To reward this, the drawer allows a small rebate (discount), so the acceptor pays slightly less than the face value.

So a bill can be honoured, dishonoured, renewed or retired — each with a clear, logical entry that always preserves the basic truth: the acceptor owes a fixed sum, adjusted only for noting charges (added), interest on renewal (added) or a rebate on early retirement (deducted). With bills of exchange, credit trade gains a disciplined, enforceable backbone.