Bills of Exchange and Promissory Notes: Complete Guide for CA Foundation (Accounting)

Bills of Exchange and Promissory Notes are fundamental Negotiable Instruments used in commercial transactions to facilitate credit and settle debts. For CA Foundation students, mastering the accounting treatment—including drawing, acceptance, discounting, endorsement, renewal, and retirement—is critical for scoring high in the Accounting paper.

Under the Negotiable Instruments Act, 1881, these instruments are legally binding documents that allow for the transfer of rights to receive money.

Quick Answer for Featured Snippets:
A Bill of Exchange is an unconditional order in writing signed by the maker (drawer) directing a certain person to pay a sum of money, whereas a Promissory Note is an unconditional undertaking (promise) in writing signed by the maker to pay a certain sum of money to a certain person.

Legal Definitions & Key Differences

1. Bill of Exchange (Section 5)

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.

2. Promissory Note (Section 4)

An instrument in writing (not being a bank note or a cheque) containing an unconditional undertaking, signed by the maker, engaged to pay on demand, or at a fixed or determinable future time, a certain sum of money, to, or to the order of, a certain person, or to the bearer of the instrument.

Comparison Table

Parties Involved in Bill Transactions

• Drawer: The person who makes/writes the bill (the creditor).
• Drawee: The person on whom the bill is drawn and who is directed to pay (the debtor). Once they sign, they become the 'Acceptor'.
• Payee: The person to whom the payment is to be made.
• Endorser: The person who transfers the bill to another by signing on the back.
• Endorsee: The person to whom the bill is transferred.

Accounting Mechanics: Key Scenarios

1. Discounting of Bills

When the Drawer needs cash immediately before the maturity date, they can sell the bill to a bank at a price lower than the face value.

Formula (LaTeX):
$\text{Discounting Charges} = \text{Face Value} \times \text{Rate} \times \frac{\text{Unexpired Period}}{12}$

Journal Entry (In Drawer's Books):
Dr. Bank A/c (Net amount received)
Dr. Discounting Charges A/c
    Cr. Bills Receivable A/c

2. Dishonour of Bills

If the Drawee fails to make payment on the due date, the bill is said to be dishonoured.

Journal Entry (In Drawer's Books):
Dr. Drawee A/c
    Cr. Bills Receivable A/c
(Note: If the bill was endorsed or discounted, the Drawer must also settle with the Endorsee or Bank first.)

3. Renewal of Bills

When the Drawee cannot pay, they may request the Drawer to cancel the old bill and draw a new one for an extended period, usually involving interest.

Steps for Renewal:

1. Cancel the old bill: Treat it as a dishonour.
2. Charge Interest: Record interest due from the Drawee.
3. Draw new bill: Record the new Bill Receivable.

4. Retirement of Bills

When the Drawee pays the bill before the actual due date to avail a discount (called Rebate).

Formula (LaTeX):
$\text{Rebate} = \text{Amount Due} \times \text{Rate} \times \frac{\text{Period of Early Payment}}{12}$

Accommodation Bills

These are bills drawn and accepted not for a genuine sale/purchase, but to help one or both parties raise funds (mutual accommodation). There is no underlying commercial transaction. One party draws the bill, another accepts it, and it is then endorsed to a third party to get cash.

Practice Questions

Short Form Questions

Q1. Distinguish between a Bill of Exchange and a Promissory Note.
Model Answer: 1. Nature: Bill is an 'Order'; Note is a 'Promise'. 2. Parties: Bill has 3; Note has 2. 3. Liability: Drawer is secondary; Maker is primary.

Q2. A bill for ₹5,000 is discounted with the bank at 12% p.a. The bill was due on 31st March, but it was discounted on 31st January. Calculate the discounting charges.
Model Answer: Period = 2 months.
$\text{Discounting Charges} = 5,000 \times \frac{12}{100} \times \frac{2}{12} = ₹100$.

Case Study: Renewal and Dishonour

Scenario: On 1st Jan 2024, X draws a bill on Y for ₹20,000 for 3 months. On the due date, Y requests renewal. X agrees to renew the bill for 2 months by charging 10% interest p.a. However, the new bill is also dishonoured on its due date. X incurs ₹200 noting charges.

Solution Summary (X's Books):

1. Dishonour Old Bill: Dr. Y A/c, Cr. B/R A/c (₹20,000).
2. Interest for Renewal: Dr. Y A/c, Cr. Interest A/c ($20,000 \times 10\% \times 2/12 = ₹333$).
3. New Bill: Dr. B/R A/c, Cr. Y A/c (₹20,333).
4. Dishonour New Bill: Dr. Y A/c, Cr. B/R A/c (₹20,333) and Dr. Y A/c, Cr. Cash/Bank (₹200 for noting charges).

Common Mistakes & CA Exam Tips

• Confusion in Parties: Always double-check if you are the Drawer (Creditor) or Drawee (Debtor).
• Interest Calculation: Ensure the interest for renewal is calculated on the original amount plus any interest already due, or as specified in the question.
• Dishonour after Endorsement: If a bill was endorsed to 'Z' and then dishonoured, the Drawer's first entry is to reinstate the Drawee and remove the liability to 'Z'.
• Exam Tip: In long numerical questions, always prepare a "Statement of Interest" or "Statement of Rebate" to show your working clearly to the examiner.

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