TYPES OF INSTRUMENTS OF CREDIT

 5.2 TYPES OF INSTRUMENTS OF CREDIT

Selling goods on credit has become a very common phenomenon in business. The producer takes raw material on credit and supplies the finished goods to the wholesalers on credit. The wholesalers in dm provide the credit facilities to the retailers. The retailers also sell on  credit to some of the ultimate consumers. Credit may  also be granted by a moneylender, a bank or a financial institution. Credit is generally provided by obtaining a written documeol called 'Instrument of Credit'. They serve as a proof for existence of credit. The most commonly used instruments of credit are :

i) Bills of Exchange, 

ii) Promissory Notes, and 

iii) Hundies. 

5.2.1 Bill of Exchange

When a seller grants credit to his customers, he would like to have some written commitment from the buyer to pay the amount on a specified date, otherwise the payment may rlol be made on time. Such a written undertaking generally takes the form of a bill of exchange or a promissory note. A bill of exchange is drawn by the seller (a creditor) on the buyer a debtor) asking him to pay the specified amount after a specified period to him, or Itis order, or to a person named in the bill. According to the Negotiable Instruments Act 1881, a bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a person to pay a certain sum of money only to, or to the ordcr of a certain person, or to the bearer of the instrument.

The above definition makes it clear that there are three parties to a bill of exchange. They are : 

i) Drawer: a person who draws the bill 

ii) qrawee: a person who accepts the bill

iii) Payee: a person who is to receive the payment

Suppose A sells goods to B and draws on him a bill for Rs. 1,000 for two months payable to C. In this example 'A' is the drawer, 'B' is the drawee and 'C' is the payee. In most of the cases, however, the drawer himself is the payee. 

Look at Figure 5.1 for the specimen of a bill of exchange. In this case Mukesh draws a bill on Nagesh for 2 months for Rs. 1,000, payable to himself. 

When the bill of exchange is drawn it is sent to the drawee for his acceptancc. The drawee has to affix his signatures across the bill as a mark of his acceptance and return it to drawer.

Thus, a bill of exchange has the following features : 

 i) It must be in writing. 

ii) It must contain an order. 

iii) The order must be unconditional. 

iv) It must be signed by the maker of the instrument. 

v) It is made by the creditor. 

vi) It must be for a specified amount and specified period. 

vii) It should be duly accepted by the debtor. 

5.2.2 Promissory Note

As stated earlier a written undertaking by the buyer to make payment on a specified data can take the form of a bill of exchange or as promissory note. You have learnt that a bill of exchange is drawn by the seller and accepted by the buyer. A promissory note, on the other hand, is writtng by the buyer promising the seller to pay a specified amount after a specified period to him, or his order. It can be defined as "an instrument in writing (not being a hank note or a currency note) containing an unconditional underraking, signed by the maker to pay a certain sum of money to, or to the order of a certain person, or to the bearer of the instrument". 

In case of a promissory note there are only two parties. They are : 

i) Maker: A person who makes the note and piomises to pay the amount. 

ii) Payee: A person who is to receive the amount. 

Suppose A sells the goods to B and B writes a promissory note in favour of A. In this example B is the maker and A is the payee. You should note that no acceptance is required in case of a promissory note because it is made by the person who has to make the payment. Look at Figure 5.2 for the specimen of a promissory note. In this case Nagesh promises to pay Rs. 1,000 to Mukesh.

hus, a promissory note has the following features : 

i) ' It must be in writing. 

ii) , It must be an undertaking to pay, 

iii) The undertaking must be unconditional. 

iv) It must be signed by the maker of the instrument. 

V) It is made by the debtor. 

vi) It must be for a specified amount and period. 

5.2.3 Distinction between Bill of Exchange and Promissory Note 

Keeping in view the features of a bill of exchange and a promissory note, following distinctions can be made between the two :

A bill of exchange is a bill receivable (Bm) for the drawer or the payee and a bill payable (BP) for the drawee.-Similarly, a promissory note is a bill receivable for the payee and a bill payable for the maker. A bill receivable is an asset for the business whereas a bill payable is a liability. For accounting purposes, no distinction is made between bill of exchange'nnd the promissory note.  

5.3 TERM AND DUE DATE OF A BILL

A bill is generally written for a fixed period of time, say, two months (60 days), three months (90 days), etc. The period of a bill is called 'Term' or 'Talor'of the bill. The date on which the bill falls due is called the 'due date' or the 'date of maturity'. The due date is calculated by adding three days of grace to the actual period of the bill. For example, a bill drawn on April 1 for a period of three months will become due for payment on July 4 (add three months andthree days of grace to April 1, you arrive at July 4).

If the due dare is a public holiday, the bill becomes due on the previous working day. In the above example, if July 4 were to be a public holiday, July 3 would be treated as the due date.