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Promissory Notes and Bills of Exchange

"Credit transactions need written promises - meet the negotiable instruments."

When goods are sold on credit, the seller needs assurance of payment. Promissory Notes and Bills of Exchange are legal documents that provide this assurance.

What are Negotiable Instruments?

Definition: Written documents that guarantee payment of money, either on demand or at a future date, and can be transferred by endorsement.

Types:

  1. Promissory Note
  2. Bill of Exchange
  3. Cheque

Promissory Note

Definition: A written promise by one party (maker) to pay a certain sum of money to another party (payee) at a specified future date or on demand.

Format:

₹10,000                                     Mumbai, 1st January 2024

Three months after date, I promise to pay Mr. Ramesh or order 
the sum of Rupees Ten Thousand only, for value received.

To: Mr. Ramesh                              Stamp
    ABC Street                              
    Mumbai                                  Mohan (Signature)
                                           (Maker)

Parties to Promissory Note

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Example:

  • Mohan buys goods worth ₹10,000 from Ramesh on credit
  • Mohan signs a promissory note promising to pay ₹10,000 after 3 months
  • Mohan = Maker (will pay)
  • Ramesh = Payee (will receive)

Bill of Exchange

Definition: A written order by one party (drawer) directing another party (drawee) to pay a certain sum to a third party (payee) at a specified future date or on demand.

Format:

₹15,000                                     Delhi, 5th February 2024

Three months after date, pay to me or my order the sum of 
Rupees Fifteen Thousand only, for value received.

To: Mr. Suresh                              Stamp
    XYZ Road
    Delhi                                   Ramesh (Signature)
                                           (Drawer)

Accepted: Suresh (Signature)
          (Drawee)

Parties to Bill of Exchange

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Example:

  • Ramesh sold goods worth ₹15,000 to Suresh on credit
  • Ramesh draws a bill on Suresh for ₹15,000 payable in 3 months
  • Suresh accepts the bill
  • Ramesh = Drawer & Payee (will receive payment)
  • Suresh = Drawee (will pay)

Comparison: Promissory Note vs Bill of Exchange

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Key Terms

1. Maturity Date

Definition: The date on which payment becomes due.

Calculation:

  • "After date": Add period to date of bill + 3 days of grace
  • "After sight": Add period to date of acceptance + 3 days of grace

Example:

  • Bill dated 1st Jan, "3 months after date"
  • Due date: 1st Jan + 3 months + 3 days = 4th April

2. Days of Grace

Historical: 3 days were added to due date Current: Days of grace abolished in India (except for Government bills)

So now: Due date = Date + Period (no grace days)

3. Discounting of Bill

Meaning: Selling the bill to a bank before maturity date to get immediate cash.

Bank charges: Discount (interest for the period until maturity)

Example:

  • Bill value: ₹10,000, Due in 3 months
  • Bank charges 12% p.a. discount
  • Discount = ₹10,000 × 12% × (3/12) = ₹300
  • Cash received: ₹10,000 - ₹300 = ₹9,700

4. Endorsement

Meaning: Transferring the bill to another person by signing on the back.

Example:

  • Ramesh holds a bill receivable from Suresh for ₹10,000
  • Ramesh endorses it to Mohan (to settle his debt to Mohan)
  • Now Mohan holds the bill, Suresh will pay Mohan

5. Renewal of Bill

Meaning: When drawee cannot pay on due date, a new bill is drawn for extended period.

Usually: Interest charged on extended period

6. Dishonor of Bill

Meaning: When drawee refuses or fails to pay on maturity.

Consequences:

  • Drawer records bad debt or demands payment
  • Noting charges (bank/notary fees) charged to drawee

Advantages of Bills

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Quiz: Promissory Notes and Bills

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