Bills of Exchange: Meaning, Parties, Types & Accounting Entries

A Bill of Exchange is an important financial instrument used in business transactions to ensure payment between buyers and sellers. It acts as a written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum of money to a specific person (the payee) or to the bearer of the bill, either on demand or at a fixed future date.

Bills of exchange help in facilitating credit sales, provide security of payment, and can be used for discounting to meet immediate cash needs.

What is a Bill of Exchange?

A Bill of Exchange is defined under Section 5 of the Negotiable Instruments Act, 1881. It states:

“A Bill of Exchange is 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.”

In simple terms, it is a promise made in writing by the debtor (drawee) to pay the creditor (drawer) a specified amount, either immediately or on a future date.

Characteristics of a Bill of Exchange

Before discussing the parties and process, it’s important to understand the basic characteristics that make a document a valid bill of exchange.

Characteristic	Description
Written Document	It must be in writing (printed or handwritten).
Unconditional Order	The payment order should not depend on any condition.
Signature of Drawer	It must be signed by the person who draws (makes) the bill.
Definite Amount	The amount payable should be certain and clearly mentioned.
Definite Time	The date or time of payment must be fixed or determinable.
Payee Must Be Certain	The person to whom payment is made must be clearly identified.
Stamped Instrument	It must be duly stamped as per the Stamp Act.

Parties to a Bill of Exchange

Every bill of exchange involves three main parties. Understanding their roles helps in grasping how the instrument operates.

Party	Role	Description
Drawer	Maker of the bill	The person who sells goods or services and draws the bill to receive payment.
Drawee	Payer of the bill	The person who buys goods or services and is directed to pay the amount.
Payee	Receiver of payment	The person who will receive the payment. Usually, the drawer himself or any third party nominated by him.

Example:
If A sells goods to B worth ₹10,000 on credit and draws a bill on B, then:

• A is the drawer (and payee, if payment is to A),
• B is the drawee,
• The bill amount is ₹10,000 payable on a specified date.

Specimen of a Bill of Exchange

Before listing examples, note that a bill must contain specific elements like date, parties, amount, and signature. Here’s a sample format:

Stamp
₹10,000

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

To: Mr. B
(Drawee)
Accepted
(Signature of B)

Sd/- A
(Drawer)

Types of Bills of Exchange

Bills of Exchange can be classified based on payment terms, nature, or purpose. Let’s look at the major types:

Type	Description
Inland Bill	Drawn and payable within the same country.
Foreign Bill	Drawn in one country and payable in another.
Trade Bill	Drawn for business purposes, usually arising out of a credit sale.
Accommodation Bill	Drawn not against a sale but to provide financial help between parties.
Demand Bill	Payable immediately upon presentation.
Time Bill	Payable after a certain period from the date or sight.

Key Terms Related to Bills of Exchange

Before recording entries, understanding these key terms helps in interpreting how bills operate in real transactions.

Term	Meaning
Date of Bill	The date on which the bill is drawn.
Term of Bill	The period after which the bill becomes due for payment.
Due Date	The date on which payment is to be made (includes 3 days of grace).
Days of Grace	Additional 3 days allowed to the drawee for making payment.
Maturity Date	The final date after including days of grace when the bill must be paid.
Endorsement	The process of transferring the right to receive payment to another person by signing on the back of the bill.
Discounting	Selling the bill to a bank before the due date for immediate cash, less discount.
Dishonour of Bill	When the drawee fails to make payment on the due date.
Noting Charges	Fees paid to a notary public for noting dishonour.

Accounting Treatment of Bills of Exchange

When a bill is drawn, accepted, and either retained, discounted, or endorsed, different journal entries are passed.
Below is a summary of common accounting treatments in the books of the drawer and drawee.

(A) When Bill is Drawn and Accepted

In Drawer’s Books	In Drawee’s Books
Bills Receivable A/c Dr.	To Drawee’s A/c
Drawer’s A/c Dr.	To Bills Payable A/c

(B) When Bill is Discounted with Bank

In this case, the drawer receives cash immediately, but at a discount.

Entry	Account
Bank A/c Dr.	To Bills Receivable A/c
Discount A/c Dr.	(with discount amount)

(C) When Bill is Endorsed to a Creditor

If the drawer transfers the bill to his creditor to settle a debt:

Entry	Account
Creditor’s A/c Dr.	To Bills Receivable A/c

(D) When Bill is Dishonoured

If the bill is not paid on due date:

In Drawer’s Books	In Drawee’s Books
Drawee’s A/c Dr.	To Bills Receivable A/c
Bills Payable A/c Dr.	To Drawer’s A/c

Importance of Bills of Exchange

Bills of Exchange play a crucial role in trade and commerce. They formalize credit transactions and ensure legal enforceability of payments.

• Provides security of payment to the seller.
• Facilitates credit transactions between parties.
• Can be discounted with banks to meet cash needs.
• Serves as legal evidence of debt.
• Enables smooth business operations and builds trust between buyers and sellers.

Difference Between Bill of Exchange and Promissory Note

Before studying promissory notes in detail, it’s useful to compare them with bills of exchange to understand their distinct legal nature.

Basis	Bill of Exchange	Promissory Note
Number of Parties	Three – Drawer, Drawee, Payee	Two – Maker and Payee
Nature	Contains an order to pay	Contains a promise to pay
Acceptance	Requires acceptance by drawee	No acceptance required
Drawn By	Creditor	Debtor
Liability	Drawer is secondarily liable	Maker is primarily liable
Use	Used mostly in trade transactions	Used in borrowings or loans

FAQs

Q1. What is a Bill of Exchange?

A1: It is a written, unconditional order directing a person to pay a specific amount to another person or to the bearer.

Q2. Who are the three parties to a Bill of Exchange?

A2: the three parties to a Bill of Exchange are- Drawer, Drawee, and Payee.

Q3. What is the difference between an Inland and a Foreign Bill?

A3: An Inland Bill is drawn and payable within the same country, whereas a Foreign Bill involves two different countries.

Q4. What happens if a bill is dishonoured?

A4: The drawee fails to pay, and the amount is reversed in the drawer’s books. The drawer may recover it with noting charges.

Q5. What are Days of Grace?

A5: Three additional days allowed beyond the due date for the drawee to make payment.

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