Bills of Exchange – Concept of Bills of Exchange

Concept of Bills of Exchange

Though people in business do not like selling their goods on credit, they often need to do so by keeping the high competition of their market in mind. However, selling goods on credit does not mean that this payment of goods is uncertain. A seller needs to keep it in mind that he should ask his purchaser that by when he can expect the payment to be made. In such a case, his buyer may often reply that he needs three to four months of time for making this payment.

Now it depends on this seller if he wants to believe in the words of his purchaser or not. Should he take his purchaser as granted and believe that his buyer will make the payment as promised from before? Well, as far as experience goes, such words have often proved to be false and cheap. It is a universal fact that it is easy and simple to make promises but often proves to be very difficult to abide by it!

In such a case, the best solution open to a seller is to have a written statement regarding the same. Once his debtor agrees, a creditor needs to write a formal instruction to his debtor.This will be for instructing the debtor to make this payment regarding the specified amount of money on the expiry of the specified period. This can be either to him or anyone else as per his instruction and authorization. It is this formal written document which is termed as the “Bills of Exchange.”

Bills of Exchange: Meaning

As per the Section 5 of the Indian Negotiable Instruments Act of 1881, a bill of exchange of a company is a written instrument with an unconditional order being duly signed by the maker. It is aimed at directing a definite person or company to make payments for a certain amount of money either to or the order of a particular person or to the bearer of that instrument.

These bills of exchanges are negotiable instruments which are either owed to bearer or to an order. Further, the section 13 (1) of this act even states a negotiable instrument to be a promissory note, cheque or bill of exchange. This is either payable to a bearer or to a specific order.

A bill of exchange is drawn by a creditor upon his debtor. Through this document, he instructs his debtor to pay a particular amount of money on a claim or after the specified period gets expired. However, it needs to be remembered that unless and until it is accepted by a debtor, it is only a draft. Once it is accepted by the debtor, it is considered as a bill of exchange. Bills of exchange are legally valid documents which even acts as an evidence of debt.

 

Classifications of Bills of Exchange

There are two categories of Bills of Exchange. These classifications are-

1. Bills after date

Such bills of exchange are drawn for a certain period. Payments regarding such bills are made after the specified period gets expired in addition to three days of grace period.

1. Bills at sight

Bills at sight are drawn by a creditor on his debtor with a condition that this bill payment will only be made in its presentation. The drawee is liable to make this payment once the bill is presented to him.

Parties involved in the bills of exchange         

A bill of exchange involves three parties. These are as follows-

1. Drawer

The one who draws a bill is known as its drawer. He is a creditor who has either sold goods or is a lender of financial resources. This drawer is the one who has to realize this payment. While drawing money from a bank, a cheque needs to be drawn. Once the account holder withdraws money from the bank, he is known as the drawer.

2. Drawee

An individual or a party who accepts to make this payment, or is responsible for making this payment is known as its drawee. In the case of withdrawing the same from the bank, it is the bank who acts as its drawee. But in the case of bills of exchange, a person who admits to pay this Bill drawn by a creditor is called ‘drawee.’ Once a draft is made regarding the bills of exchange, it becomes valid once it is accepted by the drawee.

3. Payee

The one who receives this payment is known as Payee. It is a drawer who acts as a payee of a bill in bills of exchange. In case the drawer has endorsed it to someone else, the endorsee will act as the payee of this bill of exchange as it is he who realizes the payment.

Bills of Exchange: Characteristics/ Features

A bill of exchange has several important features. These features are-

1. It is a written document

Bills of exchange are a document which should be in writing. It is a written instrument which can be used only for transferring money and not for other purposes. Further, it is a certificate which can be used as evidence in court. Since it is an authentic and formal source of the document for payment, it is important to have it in writing.

2. It is an unconditional order

The order of payment of bills of exchange is unconditional. It is an instruction made by the drawer, i.e. the creditor to his drawee, i.e. the debtor without having any condition. It acts as a binding upon an accept or of the bill to execute the order.

3. Payment on mentioned date

Since this amount gets matured after the expiry of the certain period, the exact date of payment, i.e. the date of maturity or due date needs to be calculated. For example, if a bill of exchange is drawn on January 1 with a date payable after 3 months from that date, then the date of maturity will be April 4, with 3 grace days included.

4. An order for paying a definite amount

Bills of exchanges are unconditional orders of payment with a specific amount. The amount should be specified both in numbers and words. In case if the drawer orders to make a payment of more or less money, it will not be considered as a bill of exchange.

5. Payment for an endorsee or drawer

The creditor who draws a bill of exchange is known as its drawer which will be realizing the bill payment on the date of maturity. In case this drawer endorses the bill to someone else, it is the endorsee who will be realizing the payment. However, if this bill has been sent to the bank for collection, it is the bank who will gather the payment.

6. Needs to be duly signed by the drawer

It is important that the bill of exchange is signed by the drawer. Since it is considered as an order, it is important that the individual who is ordering to get paid, signs on it. Unless and until a bill of exchange is supported with a signature, it is not considered as a legally valid document.

Sample of a bill of exchange

Constituents of the Bills of Exchange

The important elements of bills of exchange are as follows-

1. Stamp

It is important that a bill of exchange should bear a stamp or needs to be drafted on a stamped paper issued by the court. These stamps are fixed as per the specified amount of a bill. A stamped bill of exchange becomes a legal document. Thus, once a bill of exchange is made on a stamped paper, the drawee becomes legally accountable for making the payment.

2. Date and place of payment

The date on which a bill of exchange is drawn should be stated clearly so that the date of maturity can be calculated. It is on this date that the due date is calculated from. Other than the date, even the place of payment should be made specific. It is generally the address of that drawer, as mentioned in the bill of exchange.

3. Amount

The drawer needs to draw the bill as per a definite amount. The amount should be written correctly both in numbers and figures.

4. Drawee’s name and acceptance

The name of the debtor needs to be specified clearly on a bill. Unless and until it is accepted by the drawee, it will not be considered as a valid bill of exchange. Until the time it is accepted, the written instrument is known as a draft. This draft is payable only after a specific time.

5. Grace period

It is important that while calculating the date of maturity in regard to a bill, three days of grace time is added for the drawee. Though this trend had initially begun for the convenience of a debtor, it has gradually become an accepted norm leading to the formation of a law. It has been stated in the Indian Negotiable Instruments Act of 1881, that a drawee must get 3 days of grace time after the actual date of maturity in regard to a bill.

6. Date of maturity or the due date

A due date is that day when the payment in regard to a bill of exchange needs to be made by its drawee. If defined in simpler terms, it is that day in a year when a bill gets matured for payment.

7. Value received

The terms ‘Value received’ are mentioned on every bill of exchange. This states that a debtor has already received the value of which he has accepted this bill.             These bills are drawn in exchange for some consideration like- exchange of some good for something. Thus, these bills of exchange are drawn on borrowers who have received their value like- assets, goods or cash already from their creditor.

Bills of Exchange: Advantages

There are several advantages of availing bills of exchange. These are as follows-

1. Convenient to purchase

The rise of bills of exchange has led to the facilitation of credit purchases. This bill makes a purchaser assure his seller that he will make the necessary payment on the specified date as per the bill.

2. A proof of debt

These bills of exchange are accepted by drawees all over the world. This acceptance is itself a proof that a debtor is indebted and owes the specified amount of money to his creditor. In this way a bill of exchange acts as a proof ofa debt.

3. Legal document

Laws throughout the world have accepted bills of exchange as a legal written instrument. Thus, if a debtor fails to pay back the money within his due date, a creditor can easily file a suit against his debtor.

4. Benefits of endorsement

If the drawer himself owes money to some creditor, he can endorse this bill directly in the name of his creditor. This way, a bill of exchange benefits a drawer to repay his debt.

5. Economy of money circulation

These bills of exchange are a form of credit money. Thus, while fulfilling payments through bills, the money currently in circulation remains unused. Since these bills are easily accepted by traders, it is economical.

6. Easy to remember

Bills of exchange are payable after the specified date gets expired along with a grace period of three days. Since the debtor himself agrees to make his payment on the date of maturity through these bills, there is no need of any reminders for the drawee.

7. Financial planning

The creditor is assured that he will have the bill payment on the specified date by his debtor. Thus, he can easily make his financial plan accordingly without worrying about any financial crisis.

8. Benefits of discounting

If a situation arises, where a drawer is in sudden need of funds, he can easily get his bill of exchange discounted with a bank and have his funds much before the date of maturity.

Links of Previous Main Topic:-

• Meaning of bank reconciliation statements
• Adjustments additional information in preparation of final accounts
• Balance sheet in final accounts without adjustments
• Meaning of trial balance
• Balancing of ledger accounts
• Subsidiary books or sub division of journal
• The concept of debit and credit
• Origin of transaction
• Meaning of gaap
• Book keeping

Links of Next Book-Keeping Topics:-

• Promissory note
• Accounting treatment of bills of exchange
• Endorsement of the bill
• Discounting of the bill
• Retiring a bill under rebate
• Dishonour and noting of the bill
• Renewal of the bill
• Part payment of the bill