Bills of Exchange
(The “I Owe You” System of Business — Written Promises to Pay)
When you sell goods on credit, how do you make sure the buyer will pay? You make them sign a WRITTEN promise! That written promise = Bill of Exchange. It’s the formal “IOU” of the business world — with legal backing under the Negotiable Instruments Act. This chapter covers the 3 parties, due dates, discounting, endorsement, dishonour, and all accounting entries.
Banky Learns About the “Legal IOU”! 📜
A customer sold goods worth ₹10,000 on credit. Instead of just trusting the buyer’s word, he drew a “Bill of Exchange” — a formal, legal document saying “Pay me ₹10,000 in 2 months.” The buyer ACCEPTED it by signing. Now it’s a legal promise! If the buyer doesn’t pay, the seller can go to court with this document.
Why Should You Know This?
Exam Gold
4–6 questions! Drawer vs Drawee, BOE vs PN, due date + 3 days grace, discounting entries, dishonour entries. Very scoring!
Daily Banking
Bill discounting, bill collection, LC-backed bills — core trade finance operations. Every commercial banker handles these.
Life Wisdom
Even a post-dated cheque is a type of bill! Understanding IOUs helps in personal lending and business dealings.
What Will You Learn?
Key Words — Like Explaining to Your Friend
Definition (Section 5, NI Act): An instrument in writing, signed by the maker, containing an unconditional ORDER to pay a certain sum of money to a certain person, on a certain fixed future date or on demand.
3 Parties: (1) Drawer — the person who WRITES (draws) the bill. Usually the SELLER/CREDITOR. He ORDERS the buyer to pay. (2) Drawee — the person ON WHOM the bill is drawn. Usually the BUYER/DEBTOR. He has to PAY. When he signs “Accepted,” he becomes the Acceptor. (3) Payee — the person who will RECEIVE the money. Often the Drawer himself is the Payee.
For the Drawer: This bill is called Bills Receivable (he will RECEIVE money). It’s an ASSET. For the Drawee: This bill is called Bills Payable (he has to PAY). It’s a LIABILITY.
Key difference from BOE: In a Bill of Exchange, the CREDITOR orders the debtor to pay (it’s an ORDER). In a Promissory Note, the DEBTOR himself promises to pay (it’s a PROMISE). Only 2 parties: Maker (the promisor/debtor) and Payee (receiver). No acceptance needed because the debtor himself is writing it!
| Feature | Bill of Exchange | Promissory Note |
|---|---|---|
| Nature | Unconditional ORDER | Unconditional PROMISE |
| Made by | CREDITOR (seller) | DEBTOR (buyer) |
| Acceptance | Required (drawee must accept) | NOT required |
| Parties | THREE (drawer, drawee, payee) | TWO (maker, payee) |
| On dishonour | Noted by Notary Public | Noting NOT necessary |
The period written on the bill is called the “Term” or “Tenor.” If a bill is drawn on 1st March for 1 month, the term expires on 1st April. But the law gives the drawee 3 extra days of grace. So the actual due date = 1st April + 3 days = 4th April.
If the due date falls on a public holiday? Payment becomes due on the PREVIOUS working day (earlier, not later!).
Cheque has NO days of grace — it’s payable on demand. Bills of exchange and promissory notes get 3 days of grace.
Once the Drawer receives the accepted bill, he has 4 options:
(a) RETAIN: Keep it safely until due date. On due date, present it to drawee and collect cash. Simplest option.
(b) DISCOUNT: Need cash NOW? Go to your bank. The bank gives you cash immediately but DEDUCTS some interest (called “discount”). Example: ₹10,000 bill → bank gives ₹9,800 cash now and keeps ₹200 as discount. Bank will collect ₹10,000 from drawee on due date.
(c) SEND TO BANK FOR COLLECTION: Give the bill to the bank and ask them to collect on due date. Bank collects on your behalf (charges a small fee).
(d) ENDORSE: Transfer the bill to someone else (say your own creditor C). Now C becomes the new holder. You settle YOUR debt to C using this bill.
Honour (Met): Drawee pays the full amount on due date. Everyone’s happy. The bill is cancelled.
Dishonour: Drawee is unable or refuses to pay on due date. The drawer must now recover the amount directly from the drawee. Noting charges (paid to Notary Public for recording the dishonour) are also charged to the drawee.
Retirement: Drawee pays BEFORE the due date. The drawer may give a small discount called “Rebate” for early payment.
Renewal: Drawee can’t pay on due date but wants more time. He pays a PART in cash and accepts a NEW bill for the balance + interest. Old bill cancelled, new bill created.
Accommodation Bill: A bill drawn without any actual trade transaction — just for mutual financial help. Both parties know it’s not for real goods. If dishonoured, the drawer can NOT drag drawee to court!
Insolvency: If drawee goes bankrupt, only a portion of the debt is recovered. The rest becomes Bad Debts.
The Full Chapter — Simple Story
📝 Part 1 — The Accounting Entries (Drawer = Seller, Drawee = Buyer)
When bill is DRAWN and ACCEPTED:
Drawer’s books: Bills Receivable A/c Dr. | To Drawee’s A/c Cr. (asset created — I’ll receive money!)
Drawee’s books: Drawer’s A/c Dr. | To Bills Payable A/c Cr. (liability created — I have to pay!)
When bill is DISCOUNTED with bank:
Drawer: Cash/Bank A/c Dr. (amount received) + Discount A/c Dr. (bank’s cut) | To Bills Receivable A/c Cr.
Drawee: No entry (he doesn’t know/care what drawer did with the bill)
When bill is ENDORSED to C:
Drawer: C’s A/c Dr. | To Bills Receivable A/c Cr. (settled my debt to C using this bill)
When bill is HONOURED on due date:
If retained: Drawer: Cash A/c Dr. | To Bills Receivable A/c Cr. Drawee: Bills Payable A/c Dr. | To Cash A/c Cr.
When bill is DISHONOURED:
Drawer: Drawee’s A/c Dr. (+ noting charges) | To Bills Receivable A/c Cr. (bill cancelled, debt revives)
Drawee: Bills Payable A/c Dr. | To Drawer’s A/c Cr. (+ noting charges)
📋 Part 2 — BOE vs Cheque (5 Differences)
| Feature | Bill of Exchange | Cheque |
|---|---|---|
| Drawn on | Any person | Only on a BANK |
| Acceptance | Required | NOT required |
| Days of grace | 3 days allowed | NO grace (payable on demand) |
| Stamp | Must be STAMPED | No stamp needed |
| Dishonour notice | Necessary | NOT necessary |
Section 6 of NI Act: A cheque is a bill of exchange drawn upon a specified banker and payable on demand.
🤝 Part 3 — Accommodation Bill + Bill Books
Accommodation Bill: No real trade. Just mutual help. A draws a bill on B. B accepts. A discounts it at the bank and shares the cash with B. On due date, B pays the bank. If B can’t pay → the bill is dishonoured, but A can’t take B to court because there was no real transaction. It’s risky and considered bad practice.
Bill Books: Two subsidiary journals: (1) Bills Receivable Journal — records all bills receivable (assets). (2) Bills Payable Journal — records all bills payable (liabilities). These are posted to the General Ledger periodically.
Exam-Ready Points
🎯 Must Remember!
- Bill of Exchange (Section 5, NI Act): Written ORDER to pay. Made by CREDITOR. 3 parties. Acceptance REQUIRED. Must be stamped.
- Promissory Note (Section 4, NI Act): Written PROMISE to pay. Made by DEBTOR. 2 parties. NO acceptance needed. Noting NOT necessary.
- Cheque (Section 6, NI Act): A BOE drawn on a BANK, payable ON DEMAND. No stamp, no acceptance, no grace days.
- 3 Parties of BOE: Drawer (writes), Drawee (accepts/pays), Payee (receives money). Drawer often = Payee.
- Due Date = Term period + 3 days of grace. Holiday → PREVIOUS working day.
- Bills Receivable = For the DRAWER (asset). Bills Payable = For the DRAWEE (liability). Both are REAL accounts.
- 4 options for drawer: Retain, Discount (get cash from bank − discount), Send for Collection, Endorse (transfer to creditor)
- Discounting entry (Drawer): Cash Dr + Discount Dr | To B/R Cr. Drawee has NO entry for discounting.
- Endorsement entry (Drawer): Creditor’s A/c Dr | To B/R Cr
- Honour: Drawee pays on due date. Dishonour: Drawee fails to pay → debt revives + noting charges.
- Noting charges: Paid to Notary Public for recording dishonour. Charged TO the drawee.
- Retirement: Payment BEFORE due date. Drawer may give rebate (discount for early payment).
- Renewal: Can’t pay → part cash + new bill for balance + interest. Old bill cancelled.
- Accommodation Bill: No real trade. Mutual help. Can’t sue in court on dishonour.
- Insolvency: Drawee bankrupt → partial recovery. Unrecovered = Bad Debts.
- Drawee is MAKER of a bill = NOT true. Drawer is maker. Drawee is ACCEPTOR.
📝 Past Exam Questions
Memory Tricks
🧠 Trick 1 — BOE vs PN
(Creditor orders debtor)
PN = “EMPLOYEE PROMISES to pay” 🙋
(Debtor promises creditor)
🧠 Trick 2 — 3 Parties
Drawer = DRAWS the bill (seller)
Drawee = Must PAY (buyer)
Payee = Gets PAID (often = drawer)
🧠 Trick 3 — Due Date
1 March + 1 month = 1 April + 3 = 4 April
Holiday? Go BACK, not forward! ⬅️
🧠 Trick 4 — 4 Options (RDCE)
R = Keep it till due date 📦
D = Sell to bank for cash now 🏦
C = Ask bank to collect on due date 📮
E = Transfer to your creditor 🔄
🧠 Trick 5 — Receivable vs Payable
I have to PAY = my LIABILITY! 😰”
Drawer = Bills Receivable (asset)
Drawee = Bills Payable (liability)
🧠 Trick 6 — Dishonour
Drawer: Drawee A/c Dr (debt back!)
+ Noting charges (Notary fee)
To B/R Cr (bill cancelled)
🧠 Trick 7 — Accommodation Bill
No real goods traded
No appearance difference from real bill
Can’t sue in court if dishonoured!”
🧠 Trick 8 — Cheque = Special BOE
Drawn on BANK only
Payable ON DEMAND
NO stamp, NO acceptance, NO grace!”
The Whole Chapter in One Picture
Last-Minute Flash Cards
⚡ Chapter 8 Done! Everything in 8 Lines:
- BOE (Section 5): Written ORDER by creditor. 3 parties (Drawer, Drawee, Payee). Acceptance needed. Stamp needed.
- PN (Section 4): Written PROMISE by debtor. 2 parties (Maker, Payee). No acceptance. No noting.
- Cheque (Section 6): BOE on a bank, payable on demand. No stamp, acceptance, or grace days.
- Due Date: Term + 3 days grace. Holiday → previous working day.
- B/R = Drawer’s asset. B/P = Drawee’s liability. Both are Real accounts.
- 4 Options: Retain, Discount (cash − discount), Collect (bank collects), Endorse (transfer to creditor).
- Honour = paid. Dishonour = debt revives + noting charges. Retirement = early pay + rebate. Renewal = new bill + interest.
- Accommodation Bill: No real trade. Can’t sue. Insolvency → partial recovery → bad debts.
Banky says: “BOE = Boss ORDERS! PN = Employee PROMISES! Cheque = Express BOE on bank! Due date = Term + 3 grace days. RDCE = what to do with a bill. Got it!” 🎉📜
Next: Chapter 9 — How banks actually record their accounting entries (it’s different from normal businesses!)