Define trade bills

Trade bills in accounting refer to negotiable financial instruments that document a transaction between a buyer and a seller. These instruments are used to facilitate the financing of trade and are commonly employed in domestic and international commerce. There are two main types of trade bills: bills of exchange and promissory notes.

Types of Trade Bills

1. Bill of Exchange:

   • Definition: A written order from the seller (drawer) to the buyer (drawee) to pay a specified sum of money on a specific date to the seller or to a third party (payee).
   • Characteristics:
     • It involves three parties: the drawer, the drawee, and the payee.
     • It is a formal, legally binding document.
     • It can be used to extend credit to the buyer.
   • Example: A supplier delivers goods to a retailer and issues a bill of exchange requiring the retailer to pay for the goods within 60 days.

2. Promissory Note:

   • Definition: A written promise from the buyer (maker) to the seller (payee) to pay a specified amount of money either on demand or at a future date.
   • Characteristics:
     • It involves two parties: the maker and the payee.
     • It is a formal, legally binding document.
     • It represents a promise to pay rather than an order to pay.
   • Example: A borrower signs a promissory note to repay a loan to a lender over a specified period.

Key Features of Trade Bills

• Negotiability: Trade bills can be transferred from one party to another. The holder in due course can claim the amount specified in the bill.
• Credit Instrument: They provide a means for businesses to obtain credit and defer payment.
• Discounting: Trade bills can be discounted with financial institutions, allowing the holder to receive immediate cash before the bill’s maturity date.
• Legal Evidence: They serve as legal proof of the debt and terms agreed upon between the parties.

Usage in Accounting

• Accounts Receivable: When a business sells goods or services on credit and receives a trade bill, it records this as accounts receivable.
• Accounts Payable: When a business accepts a trade bill for goods or services purchased on credit, it records this as accounts payable.
• Discounting and Endorsing: Businesses can discount trade bills with banks to receive immediate funds or endorse them to suppliers or creditors.

Example of Journal Entries

1. Issuing a Bill of Exchange:

   • When the seller issues a bill of exchange:
     • Debit Accounts Receivable
     • Credit Sales Revenue

2. Accepting a Bill of Exchange:

   • When the buyer accepts a bill of exchange:
     • Debit Purchases (or relevant expense account)
     • Credit Accounts Payable

3. Discounting a Bill of Exchange:

   • When the seller discounts the bill with a bank:
     • Debit Bank (net amount received)
     • Debit Discount Expense (discounted amount)
     • Credit Accounts Receivable (face value of the bill)

Trade bills are vital tools in trade finance, helping businesses manage cash flow and credit efficiently.