Definition
The Negotiable Instruments Act, 1881 defines a Bill of Exchange as “ an instrument in writing containing an unconditional undertaking, 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 the bearer of the instrument”.
It means Bill of Exchange is an order where one person made on it to another person in writing to pay a certain sum of money unconditionally mentioned on the instrument. If the order is accepted by the person on whom the bill was prepared , the document is a bill of exchange.
Essentials of Bill of Exchange
The essentials of bill of exchange are enumerated as follow:
- It should be in writing
- It contains an order of the seller to the purchaser to make the payments in future.
- It should be an unconditional order. A conditional order may not be made payable.
- The maker or the seller is known “Drawer” and the bill must be signed by him, otherwise it will be invalid
- The purchaser or the person on whom the bill is made, known as “drawee” and a drawee must be person in the eye of law.
- Amount should be paid in money alone, not in the goods
- The person to whom the payment of the bill is to be made made is known as “Payee” and he must be a certain person or the bearer of the bill.
Parties of Bill of Exchane
Three important parties are involved in a Bill of exchange, they are:
The Drawer:
The person who has issued the bill of exchange is known as a drawer. In export-oriented business, exporter draws the bill to the importer. Here, the exporter is drawer and importer is drawee.
Accounting treatment in the books of drawer:
- Transaction No-1: Assume, ABC ltd sold goods to XYZ Ltd for $ 25,000 on credit. The journal entry for this company is:
XYZ Ltd. | DR | 25,000 |
Sales A/c | CR | 25,000 |
(Goods sold on credit)
- XYZ Ltd draws a bill on ABC ltd for 90 days. The journal entry is:
Bills Receivable A/c | DR | 25,000 |
XYZ Ltd A/c | CR | 25,000 |
(Acceptance received from XYZ Ltd)
- On the due date acceptor honors the bill, The journal is
Cash A/c | DR | 25,000 |
Bills Receivable A/c | CR | 25,000 |
(Received cash on presentation of the bill.)
The Drawee:
On whom the bill of exchange is drawn is drawee. On whom exporter draws the bill, is known as drawee. Usually, drawee is the debtor who owes money to the exporter (creditor).
Accounting treatment in the books of Drawee:
- Purchased goods from ABC Ltd.
Purchase A/c | DR | 25,000 |
ABC Ltd. | CR | 25,000 |
(Goods purchased on credit)
- Acceptance is given to ABC instead of cash payment. The journal entry is:
ABC Ltd. | DR | 25,000 |
Bills Payable A/c | CR | 25,000 |
(Acceptance is given to ABC)
- Acceptance is met (paid on due date). The journal entry is:
Bills Payable A/c | DR | 25,000 |
Cash A/c | DR | 25,000 |
(Acceptance is paid in cash)
The Payee:
In a bill of exchange payee is the person to whom money is payable. The bill can be drawn by the exporter to the drawer (himself) if it is retained by him up to the maturity date or his banker.
Types of Bill of Exchange
(a) Sight Bill of Exchange:
Payment to be made by the drawee on presentation of the bill of exchange. This type of bill is also known as the demand bill of exchange.
(b) Usance Bill of Exchange:
This type of bill is prepared for a particular tenor and have a maturity date. Payment to be made on the maturity date.
(c) Clean Bill of Exchange:
When the relative shipping documents do not accompany with the bill of exchange, it is known as the clean bill of exchange. Here Bill of Lading is sent directly to the importer to enable him to take delivery of the cargo.
(d) Documentary Bill of Exchange:
When related shipping documents such as Bill of Lading, marine insurance policy, invoice, and other documents are sent along with the Bill of Exchange, is known as Documentary Bill of Exchange. This is a normal form of export trade.
Specimen of Bill of Exchange
Stamp 266, Kamla Nagar, Hisar June 28,2014 RS 50,000/- Three months after date, pay to me or order the sum of rupees fifty thousand only for value received. To, M/S. Siams Brothers S/d——– Kolkata Nikhil |
Conclusion
This is the documents are given to the bank either for collection or negotiation. When importer gets the documents on acceptance, it is called Documents against Acceptance. Again, when the importer gets the documents only on payment, it is called Documents against Payment.
This document is drawn by the exporter after shipment is made. Usually, exporter draws the bill to his own order or that of his bank. Subsequently, he (exporter) endorses the bill in favor of his bank. In this respect, the exporter may request to his bank to collect or purchase the bill.