Start with something you have almost certainly done. You borrow ₹5,000 from a friend and promise to return it next month. Your friend is trusting your word. Now imagine the amount is ₹5,00,000 and the lender is a bank or a supplier who has never met you. A spoken promise is worthless to them. They want the promise in writing, signed, dated, with the amount and the date of repayment clearly stated. That written, signed promise is a promissory note.
The precise meaning
A promissory note is a written instrument in which one person (the maker) unconditionally promises to pay a certain sum of money to another person (the payee) or to their order, on demand or on a specified future date. The maker signs it. The maker is the debtor; the payee is the creditor.
Two features do all the work. First, the promise is unconditional — no "if my shop does well" or "provided my customer pays me." Second, it is signed by the maker, which is what converts a casual assurance into a legally enforceable instrument.
Do not confuse it with a bill of exchange. In a promissory note the debtor makes the promise to pay. In a bill of exchange the creditor orders the debtor to pay, and the debtor accepts that order. The direction of the promise is the whole difference.
Why it matters
A promissory note does three things at once. It creates evidence — if the maker later denies the debt, the signed note settles the matter. It fixes the terms — amount, date, and whether interest is payable — so neither side can renegotiate from memory. And it makes the debt transferable: a note payable "to order" can be endorsed in favour of a third party, so the payee can use it to settle their own obligations instead of waiting for cash.
For a business, this is the machinery of credit sales and credit purchases. When a customer cannot pay immediately, the seller may accept a promissory note. The debt does not vanish; it changes form — from an open book debt (a debtor) into a formal instrument (a bills receivable).
Accounting treatment
The key idea: a promissory note does not create a new profit or loss. It only reclassifies an existing debt. The amount owed stays the same; only the account holding it changes.
In the books of the maker (the debtor who signs the note):
| Event | Account debited | Account credited |
|---|
| Note issued to settle a debt owed | Creditor's Account | Bills Payable Account |
| Note honoured on due date | Bills Payable Account | Cash / Bank Account |
| Note dishonoured | Bills Payable Account | Creditor's Account |
In the books of the payee (the creditor who receives the note):
| Event | Account debited | Account credited |
|---|
| Note received from a debtor | Bills Receivable Account | Debtor's Account |
| Note honoured on due date | Cash / Bank Account | Bills Receivable Account |
| Note dishonoured | Debtor's Account | Bills Receivable Account |
Read the first row of each table together and the logic is plain. The maker's liability to a specific creditor becomes a liability on a bill; the payee's claim against a specific debtor becomes a claim on a bill. Nothing is gained or lost — the balance sheet total is untouched.
A promissory note is not an income or an expense. It is a reclassification of an existing debt. The only entries that touch profit are interest, and any discount or rebate on early settlement.
Interest on the note
If the note carries interest, the maker pays it and the payee earns it. The standard computation is:
Interest = Amount of the note × Rate of interest per annum × Time in years …