Bill of Exchange

Meaning of Bill of Exchange and Promissory Note

A negotiable instrument is a commercial document in writing, that contains an order for payment of money either on demand or after a certain time. There are of three types, namely, bills of exchange, promissory notes and cheques. Bill of Exchange carries an order to pay the money while Promissory Note contains a promise to pay money.

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Bill of Exchange

A bill of exchange is a binding agreement by one party to pay a fixed amount of cash to another party on a predetermined date or on demand.

Promissory Notes

A promissory note is a written agreement to pay a specific amount at a future date or on demand to a specific party. This could be a set date or a date chosen by the lender. Acceptance is not required in promissory notes because the maker of the promissory notes himself/herself promises to make the payment.

Some key features of promissory notes are as follows,

  • It must be in writing
  • It must contain an unconditional promise to pay.
  • The sum payable must be certain.
  • The promissory notes must be signed by the maker.
  • It must be payable to a certain person.
  • It should be properly stamped.

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Parties to the Promissory Note

  1. Maker or drawer: Also called the promisor, he/she is the person makes or draws the promissory note to pay the specified the amount as mentioned in the promissory note.
  2. Payee or drawee: Also called the promise, he/she is the person in whose favour promissory note is drawn. Usually, the drawer is also the payee.

A Specimen of Promissory Note

Promissory Note Now, as per the specimen above, Mr Shyam Kumar is the maker/drawer of the promissory note and Mr Prem Chand Jain is the payee/drawee of the promissory note.

However, if this promissory note is transferred by Mr Prem Chand Jain in favour of say, Mr Vinod Jain, then Mr Vinod Jain will be the payee.

Learn more about Dishonor of Bills here in detail.

Components of a Promissory Notes

  • Principal amount: It is the amount which is given by the payee and taken/borrowed by the maker of the note.
  • Interest rate: The percentage rate that is multiplied by the principal amount and the period of promissory notes in computing for the interest.
  • Interest: Interest is the revenue/income for the payee for loaning out the principal & is an expense for the maker for borrowing the amount.
  • Maturity date or due date: The date on which final payment is to be done by the maker of the promissory note.
  • Maturity value: The principal amount due at the maturity date of note in case of non-interest bearing promissory note. And the sum of principal and interest due at the maturity date of note in the case of interest-bearing promissory notes.
  • Place of issue: The place where the maker executed the promissory note.

 Types of Promissory Notes

  • Non-interest bearing note: They are promissory notes which do not carry any interest rate with it. The amount that will be paid at the time of maturity is equal to the face value of the promissory note.
  • Interest-bearing Note: Promissory notes which carry an interest rate with it.  The amount that will be paid at the time of maturity is the sum of the face value & interest.

Learn more about Accounting Treatment here in detail.

Accounting Treatment

 In case of a promissory note for the maker or drawer (the person who draws the promissory note to pay the specified the amount), it is a bill payable and for payee or drawee (the person in whose favour the promissory notes are drawn), it is a bill receivable. Bills receivables are assets fand Bills payable are liabilities.

Solved Example for You

Question 1: Promissory notes contains a promise to ………….

  1. get a job
  2. pay whenever you can and whenever you want.
 Answer: The correct answer is option B. 
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