The balance of the notes-receivable discounted ac count, represents therefore the face value of the notes receivable which we have passed on to the bank by indorsement, and which have not yet matured, and on which we are contingently liable. The balance of the notes-receivable account does not represent the face value of notes receivable on hand, but the face value of notes receivable on hand and at the bank. The two accounts must always be considered together.
5. Accommodation class of notes which are frequently met are termed accommo dation notes. They are notes or other negotiable in struments which are given by one person for the ac commodation of another. Thus, if John Doe has not established credit in the community and finds him self unable to borrow money upon his own note, he may secure the indorsement thereon of a man of es tablished credit rating. This endorser is said to in dorse for accommodation and the instrument is called accommodation paper.
On some occasions, a man financially sound will in dorse for the accommodation of a friend and, if the person to whom he has given his indorsement should fail in business, the man who has indorsed and who is financially responsible must pay.
Accommodation notes are potential liabilities of the indorser which must be considered in preparing a statement of financial condition. If they are recorded as a liability the corresponding claim against the drawer must be carried as an asset. It is customary, however, simply to append a foot-note to the balance sheet stating the amount of such potential or con tingent liabilities.
6. Accounts receivable.—In the trial balance, there is a debit of $20,000 to "accounts receivable." This is a controlling account, the detail's of which are assumed to be found in a subsidiary ledger. The bal ance in this account therefore, represents an asset of the amount due from customers, evidenced solely by the charge against them in the books.
7. Uncollectible accounts.—In our trial balance, the reader will have noticed an account headed "re serve for bad debts." A reserve is an allowed offset against some account that is probably overstated. This account indicates that in previous years an off set has been allowed to cover probable incollecti bility of accounts and notes due us.
As there is no reason to doubt the accuracy of these previous estimates, we need only a further provision now for the possible expected loss on the sales which had been made in the last year. These losses are appropriately chargeable to the period in which the sales were made. They are a deduction from the sales of that period rather than a loss to the period in which they occurred. It is better accounting to take the loss on the books in tile period to which it belongs rather than in the period in which it comes to our notice. The amount of this loss is of course, indeterminate and we must estimate what part of our income for the year under examination will not be collected.
Two methods of doing this are open: Either (1) we may examine each existing debt and pass judg meat upon its collectibility, or (2) we may tabulate the results of previous years and estimate that future loss will continue at the same rate. The latter method is the usual one followed.
The procedure, therefore, will be to ascertain the amount of our accounts and notes receivable created, estimate that, according to past ex perience, we shall lose 1.82 per cent, in round num bers $10,200. As we have already appropriated $5, 400 to cover the amount expected to be lost on ac counts, we need appropriate out of the current year's income only $4,800 which will bring the reserve up to the figure required by past experience. This reduc tion in income is indicated by a charge in the economic summary column.
8. Expected discounts on uncollected is probable that a certain number of customers will take advantage of the discount offer which we will suppose is 2 per cent for cash within ten days. At the time the statements are prepared, if the total amount indicated by the accounts receivable is not to be collected, it may be desirable to provide for the amount which will be lost on account of discount, as well as the amount which will be lost from bad debts.
Obviously no discounts will be taken upon accounts older than the number of days in our discount pe riod. All discounts offered on invoices less than ten days old are rights held by these customers and con stitute an offset to the accounts receivable.