CA > Foundation > Paper 1 – Skim Notes

Chapter 6: Bills of Exchange and Promissory Notes

Overview

  • Understanding the meaning and features of Bills of Exchange and Promissory Notes.
  • Account for various transactions involving Bills of Exchange like issue, acceptance, and endorsement.
  • Learn the accounting technique for accommodation bills.
  • Understand the treatment of insolvency cases and early retirement of bills.

Key Topics

Bills of Exchange

  • Defined as an instrument containing an unconditional order signed by the maker and directing payment to a specific person.
  • Characteristics include being written, dated, an unconditional promise to pay a specific sum, and properly stamped.
  • Parties involved include the drawer (maker), the acceptor (who pays), and the payee (who receives).
  • Foreign Bills of Exchange serve international trade, drawn in one country and payable in another, usually sent in triplicate.
  • Endorsement allows transfer of the bill to others, allowing previous endorsers to be liable upon dishonor.

Deep Dive

  • Bills facilitate trade credit, thereby enhancing business liquidity.
  • Complexity arises in dealing with foreign bills and their treatment under local laws.
  • The primary liability lies with the acceptor, while endorsers have secondary liabilities.

Promissory Notes

  • Defined as a written, unconditional undertaking by one person to pay a certain sum to another.
  • Characteristics include being written, specific, signed by the maker, and not payable to bearer.
  • Differentiated from Bills of Exchange by having only two parties: maker and payee, with a primary liability for payment.
  • Maturity does not require acceptance, unlike bills which do.
  • Must be properly stamped and paid in legal currency.

Deep Dive

  • Promissory notes cannot be made payable to bearer, enhancing security for payees.
  • Use of promissory notes in personal finance and business loans as alternatives to traditional bank loans.
  • Regulatory constraints under banking laws to prevent misuse.

Differences Between Bill of Exchange and Promissory Note

  • A Bill contains an order to pay, while a promissory note contains a promise to pay.
  • A bill involves three parties, whereas a promissory note involves two parties.
  • Bills are paid by the acceptor, while promissory notes are paid by the maker.
  • Liability structure is secondary in bills (drawer) and primary in promissory notes (maker).
  • Bill of Exchange requires notice on dishonor, while promissory notes do not.

Deep Dive

  • Understanding these differences is crucial for correct accounting practices.
  • Legal implications differ for default or disputes arising in bills vs. promissory notes.
  • Promissory notes can be easier for personal transactions, while bills favor more complex arrangements.

Accounting for Bills and Promissory Notes

  • Received bills are recorded as Bills Receivable, while issued bills are categorized as Bills Payable.
  • Accounting entries for receiving and creating bills differ based on transaction type.
  • Discounting bills involves understanding loss of value at maturity when cash is received earlier than stated.
  • Renewal of bills entails canceling old bills and creating new ones, often accompanied by interest calculations and further accounting entries.

Deep Dive

  • Establishing systems for monitoring outstanding bills can enhance accounts receivable management.
  • Mismanagement of bills can lead to significant financial discrepancies.
  • Integration of technology can streamline accounting entries related to bills.

Terms and Expiry of Bills

  • Term is specified, usually not exceeding 90 days; calculations differ from sight and date bills.
  • Days of grace extend maturity, impacting repayment schedules and accounting.
  • Noting charges are incurred upon dishonor, which need correct accounting treatment.
  • Maturity dates require understanding of applicable days for correct financial obligations.

Deep Dive

  • Understanding financial terms and implications of maturity dates can greatly affect cash flow management.
  • Different types of bills may have varied implications for businesses in managing credit risk.
  • Training and awareness can minimize errors in calculating due dates or understanding financial responsibilities.

Insolvency and Bills of Exchange

  • Insolvency leads to bills being dishonored; accounting entries must reflect this loss.
  • Recovery from the estate of insolvent parties can affect overall accounting practices of entities.
  • Maintaining a deficiency account is crucial for adjusting unrecoverable amounts from insolvency situations.

Deep Dive

  • Tracking insolvency cases in accounts receivable systems enhances risk management capabilities.
  • Implementing robust compliance procedures can protect businesses during insolvency situations.
  • Educating staff about insolvency laws improves transaction handling in accounting practices.

Accommodation Bills

  • Used when parties need short-term financing and can pass on immediate obligations.
  • Joint acceptance allows parties to raise finance through discounted bills from banks.
  • Accounting entries need to reflect mutual agreements regarding discounts and repayments.

Deep Dive

  • Accommodation bills can be pivotal in managing liquidity crises for small businesses.
  • Understanding the nuances of mutual agreements between parties is essential for transparency.
  • Documenting every transaction accurately prevents disputes over terms later.

Bills for Collection and Record Keeping

  • Bills can be sent for collection, allowing banks to handle payment at maturity without discounting.
  • Bills receivable and payable books aid in tracking numerous transactions efficiently.
  • Proper recording ensures organizational integrity and compliance with financial regulations.

Deep Dive

  • Implementing a digital ledger for managing bills can enhance operational efficiency.
  • Data analytics in accounts can reveal insights for improving credit policies.
  • Empowering staff with correct tools can streamline accounting processes and reduce errors.

Summary

Bills of Exchange and Promissory Notes are financial instruments facilitating trade and managing credit. A Bill of Exchange serves as a written order to pay, involving multiple parties, while a Promissory Note is a set promise to pay by two parties. Understanding their specific characteristics and differences is crucial for accurate financial reporting and accounting treatment. Key aspects include their accounting entries, terms of validity, handling in insolvency situations, and mechanisms like accommodation bills. Efficient record-keeping and knowledge of applicable regulations further enhance the management of these instruments in a business environment.