BUSINESS PAPERS—NEGOTIABLE INSTRUMENTS
The books of original entry, i.e., the journals, having been explained,
the attention of the student will be directed next to the sources
of information on which the entries in the various journals depend.
Accordingly, some of the important papers and methods used in business
will be discussed, after which further accounting principles and
methods will be given adequate treatment.
=Use of the Note Receivable.=—The purpose of sales is the ultimate
conversion of stock-in-trade into cash to provide for the payment of
services and for the purchase of commodities for future sale. This
conversion of stock-in-trade into money may be immediate, as when goods
are sold for cash, or deferred, as when goods are sold on account. In
the latter case the conversion is indirect, because the charge against
the customer must be collected before conversion is complete.
Frequently the “note receivable” acts as an intermediate step in the
process of converting stock-in-trade into cash. It is an instrument in
which the customer formally promises to pay his debt at a fixed time
in the future. The kind of claim represented by a note receivable is,
legally, different from the open account claim; generally speaking,
a note is considered _a better_ claim than an open account. This
is because the note implies a prima facie acknowledgment of the
correctness of the original charge, and in event of suit relieves the
holder from proving the original items of the claim.
Accordingly, when a promissory note is received from a customer, the
open account claim against him ceases to exist and a different kind of
claim evidenced by his promissory note is acquired. Therefore the open
account is credited to show cancellation of the original charge, and
Notes Receivable is debited to show the new claim. It may be well to
remark here that the same instrument which is a _note receivable_ to
the vendor is a _note payable_ to the customer.
In some businesses, it is the policy to encourage customers to give
notes. In such cases it is often advantageous, particularly for the
credit information shown, to set up the note transactions with each
customer under individual names, e.g., “John Doe, Notes Receivable.”
Such a title plainly indicates the nature of the items listed under it;
viz., claims against John Doe, witnessed by his promissory notes. As a
general rule, however, the notes received from any one customer or all
customers are usually relatively small in number and for this reason
they are for the most part brought together under one class title,
Notes Receivable.
=Negotiable Instruments—Their Use and Requisites.=—Notes receivable
belong to a class of business papers termed negotiable instruments, the
distinctive feature of which is that in many ways and for many purposes
they _take the place of money_. The negotiable instrument, usually of
small size but often representing a large sum of money, is used in the
commerce of the world as a _medium of exchange_, in place of heavy and
bulky coin or valuable bank notes which when lost or stolen can be
passed as currency.
From a legal standpoint a negotiable instrument is one which gives a
bona fide holder an absolute right to it, whether the preceding holder
had acquired it lawfully or not. It is in this respect distinguished
from other objects of value, as a horse, for example, the present
possessor of which is the legal owner only if he acquired it in good
faith from one who in turn had acquired it lawfully.
To be negotiable, an instrument must have the following requisites:
1. It must be in writing and signed by the maker or
drawer.
2. It must contain an unconditional promise or order
to pay a fixed sum of money—and the payment must
be made in legal tender.
3. It must be payable on demand or at a time which is
either fixed or can be determined.
4. It must be payable to bearer or to order.
=Negotiable Instruments—Kinds and Definitions.=—Any formal or informal
written promise to pay possessing these essentials is a negotiable
instrument. Examples are: promissory notes—notes receivable and notes
payable—drafts, checks, money orders and, with certain restrictions,
warehouse receipts.
A promissory note may be defined as an unconditional promise to pay a
specified sum of money at a certain time. It usually has a form similar
to the following:
[Illustration: Form 16. Promissory Note]
=The Draft.=—A draft is a written order by one party on a second party
to pay to a third party the amount of money named. To be negotiable,
it must be so drawn as to meet the requirements of negotiability named
above. A draft may have a form similar to the following:
[Illustration: Form 17. A Draft]
It will be noticed that there are three parties to a draft—the drawer,
the drawee, and the payee. The drawer is the person who draws the
draft and whose signature appears at the lower right-hand corner of
the draft. The drawee is the person on whom the draft is drawn, George
S. Perkins, above. He is sometimes called the payer. The payee is the
person who is to receive the payment ordered, James Stanley Jackson &
Co.
To understand the use of the draft as an instrument of business,
suppose the following relations exist between the three parties named
above:
1. George S. Perkins bought goods from Bert V. Robbins
on account for $175.
2. Robbins bought goods from James Stanley Jackson & Co.
to the amount of $125.75 on account.
The problem will be discussed from the standpoint of Bert V. Robbins.
From the above data it is clear that Robbins has a claim against
Perkins for $175 and owes $125.75 to Jackson & Co. Instead of
collecting the claim against the former and paying his debt to the
latter, he writes out a draft for $125.75 on Perkins, with Jackson &
Co. as payee, thereby requesting (or ordering) Perkins to pay $125.75
to Jackson & Co. This draft he sends to Jackson & Co. and they present
it through their bankers to Perkins. Under ordinary circumstances
Perkins acknowledges the correctness of the draft and writes his
acceptance _on the face of it_, thereby promising to pay the amount
when due. Acceptances are usually worded in the following manner:
Accepted, Oct. 6, 19—
Payable at First National Bank
of Providence
GEORGE S. PERKINS
It should be said that the three-party draft is not usually made
use of without the consent of the drawee previously obtained, as in
the case of a bank check, which is a draft on the bank drawn by the
depositor. Very often in ordinary drafts, particularly when drawn
against an export of goods, the drawer makes out the draft in favor of
himself and indorses it in blank, thus making it transferable to bearer.
=The Accepted Draft.=—When accepted, the draft becomes, to all intents
and purposes, an ordinary promissory note—Perkins’ promise to pay
Jackson & Co. $125.75. Until the draft is accepted by Perkins, it
simply constitutes a request from Robbins to Perkins to pay the amount
named and the draft as such does not bind Perkins in any way. Hence, no
entry is made on the books of account of any of the three parties until
acceptance. Of course, a memorandum is kept of all drafts drawn.
=Illustrative Entries.=—Upon acceptance by Perkins, the following
entries are made:
1. On the books of Jackson & Co., the payee:
Notes Receivable 125.75
Bert V. Robbins 125.75
Robbins’ draft on G. S. Perkins,
accepted by Perkins, payable December 5.
Perkins’ acceptance, in possession of Jackson & Co., constitutes
a claim against Perkins, and Jackson & Co. therefore debit Notes
Receivable. They credit Robbins because this draft was sent to them by
Robbins in payment of Jackson’s open claim against Robbins for $125.75.
2. On the books of Perkins, the drawee:
Bert V. Robbins 125.75
Notes Payable 125.75
Accepted Robbins’ draft at 60 days’ sight,
favor of J. S. Jackson & Co.
This entry cancels Perkins’ liability on open account to Robbins, and
shows as a substitution therefor the amount of his acceptance in favor
of Jackson & Co. at Robbins’ request.
3. On the books of Robbins, the drawer:
James Stanley Jackson & Co. 125.75
George S. Perkins 125.75
To record the cancellation of our liability
to Jackson & Co. on open account, and to
credit Perkins with his acceptance of our
draft on him at 60 days’ sight.
From the point of view of Bert V. Robbins, the acceptance by Perkins
means two things: (1) the cancellation of a part of Robbins’ claim
against Perkins, and for this reason Robbins credits Perkins with
$125.75; (2) the cancellation of Robbins’ debt to Jackson & Co., hence
Jackson & Co. is debited on Robbins’ books for $125.75.
It is important to note here that in case Perkins fails to pay the
note at maturity, Robbins becomes liable to Jackson & Co. Robbins may
therefore be considered the first indorser of the accepted draft. The
discussion of the manner of booking Robbins’ liability contingent upon
Perkins’ failure to pay is deferred to Chapter XLIII.
=Entries After Payment of the Draft.=—Upon payment by Perkins, the
following entries are made:
1. On Perkins’ books, a debit to Notes Payable and
a credit to Cash.
2. On Jackson & Co.’s books, a debit to Cash and
a credit to Notes Receivable.
=Draft and Cash Compared as Instruments of Payment.=—The following
two diagrams may further illustrate the utility of the draft as an
instrument of trade.
1. Showing the settlement of the several claims in _cash_—in case
Robbins had collected $125.75 from Perkins and had paid $125.75 to
Jackson & Co., the payments being made independently in each case:
[Illustration]
2. Showing a settlement by draft—a clearing house method:
[Illustration]
The commercial, three-party draft is little used now. With the larger
function of banks in the conduct of modern business, other kinds
of drafts as discussed below have come into use. The three-party
relationship is the basis of all draft transactions, however, and must
therefore be thoroughly understood.
=Classification of Drafts.=—There are several kinds of drafts, which
may be either sight or time instruments. A draft drawn “at sight”
is a request on the drawee to pay at sight, i.e., immediately upon
presentation to him. The use of the sight draft in making collections
is quite common. A delinquent customer is drawn on at sight and
collection is attempted through the bank. The method is oftentimes
effective because refusal to pay may reflect on the drawee’s credit
with his own bank. Usually no formal book entry is made of such drafts
until paid. A draft drawn, say, “at 60 days’ (or 30 days’) sight” is a
request to pay 60 (or 30) days after presentation. Hence, the dating of
the acceptance of such a draft is of prime importance. Such a draft is,
of course, a time draft.
A draft drawn “60 (or other number) days after _date_” is called a date
draft and is payable 60 days from the date of the instrument—not, as in
the first case, 60 days after presentation or acceptance. It also is a
time draft. It is not necessary, although customary, to present time
drafts for acceptance.
Drafts may be “commercial” or “bank” according as the drawee is a
merchant or a bank, respectively. B. V. Robbins’ draft on Perkins shown
above is a merchant’s draft. A bank draft is a request by one bank on a
correspondent bank to pay a given amount of money to a named payee. A
customary method of remitting money is by the purchase and remittance
of a bank draft, for the issuing of which banks usually charge a
fraction of a per cent. To illustrate its use, take the following
situation:
L. W. Roberts of Denver owes Field & Co. of Chicago $210 on account.
Roberts goes to his Denver banker and buys a bank draft which may read
as follows:
[Illustration: Form 18. A Bank Draft]
Before sending this draft to Field & Co., Roberts indorses it in favor
of Field & Co., who upon its receipt deposit it with their own bank and
through it secure its collection from the Second National Bank. Roberts
pays his bank for the draft $210 plus exchange.
Drafts may be foreign or domestic. They are domestic when they are
drawn and payable within the same state or country; otherwise they
are foreign. According to the present usage, the term “draft” is used
whenever the parties concerned live within the United States, although
they may reside in different states, and the term “bill of exchange” is
applied to all such instruments where some of the parties live abroad.
=The Trade Acceptance.=—The Federal Reserve Board defines a trade
acceptance as “a bill of exchange drawn by the seller on the purchaser
of goods sold and accepted by such purchaser.” The chief characteristic
of this document as contrasted with the ordinary draft is the showing
on its face of the origin of the transaction giving rise to the draft,
usually by means of the following statement: “The obligation of the
acceptor hereof arises out of the purchase of goods from the drawer.”
The following requirements to make a trade acceptance eligible for
rediscount by the federal reserve banks have been laid down by the
Federal Reserve Board:
1. It must have arisen out of an actual commercial
transaction, usually the purchase and sale of
commodities.
2. It must have been drawn under a credit opened for
the purpose of conducting or settling accounts
resulting from business transactions involving the
shipment or storage of goods.
3. At the time of presentation to a federal reserve
bank for discount or as collateral for the loan of
money, it must have a maturity of not more than
three months exclusive of days of grace.
Trade acceptances are promissory notes just as are any other accepted
drafts. Because they comprise a very liquid asset, it is not unusual to
record them in an account, Trade Acceptances, and so distinguish them
from other notes and drafts. If they are few in number, they are more
usually recorded as Notes Receivable.
=Checks.=—A check is a draft on a depositary bank. It is an
individual’s order to his bank of deposit to pay a named or designated
payee a certain sum of money. Two illustrations are given below,
somewhat different in form but identical in nature. In the first,
likeness of the check to a draft is very evident.
[Illustration: Form 19. Forms of Checks]
The _certified check_ is usually an individual’s or firm’s check
bearing the certification of the bank’s cashier that the check is good.
This certification is evidenced by writing across the face of the check
these or similar words:
Good
when properly indorsed
FIRST NATIONAL BANK
F. G. MOFFITT, CASHIER
Such a certification makes the bank responsible for its payment.
A cashier’s check is a bank’s own check drawn on itself in favor of a
third party and signed by its cashier. As a medium of exchange it ranks
higher than the check of a private person, due to the superior credit
of the bank and to the fact that the bank is usually more generally
known in a community.
=Other Negotiable Instruments.=—_Express_ and _postal money orders_ are
drafts payable at sight, drawn respectively by one express agent on
another and by one postmaster on another.
A warehouse receipt is a receipt from a warehouse, elevator, or other
storage concern acknowledging the receipt of goods or property. Such
a receipt usually contains the contract agreements entered into by
the parties, covering the conditions according to which the goods are
accepted for storage. The warehouse receipt is usually negotiable, or
partially so, in that title to the property may pass with its transfer.
=Principles Governing the Writing of Commercial Paper.=—Ordinary
prudence requires commercial paper to be drawn in a way that will make
forgery difficult if not impossible. To this end the following two
rules should be observed:
1. Leave no blank spaces, particularly where the
amount is written. This is not so important when
the amount is perforated, with a perforated star at
each side.
2. Write the indorsement at the top margin. Unless
this is done, some statement might be inserted
which would change materially the effect of the
signature; e.g., the payer might later write above
the signature that the check is accepted in full
payment for a definite bill.
=Kinds of Indorsement.=—An indorsement is usually for the purpose of
transferring title. There are several kinds of indorsement, as follows:
1. A _blank_ indorsement, which consists only of
the payee’s signature; this renders the instrument
payable to bearer.
2. A _full_ indorsement, which reads as follows:
“Pay to the order of .........,” giving the
name of the indorsee, i.e., the person to whom
the instrument is transferred, and followed by
the signature of the indorser, who before his
indorsement was the payee.
3. A _qualified_ indorsement, which is either a
blank or full indorsement with the words “without
recourse” added to it. This kind of indorsement
transfers title with no liability attaching to the
transferor in case of non-payment by the maker at
maturity.
4. A _restrictive_ indorsement, giving the name
of the party to whom the check is transferred, the
words “for collection” or “for collection and
deposit” being added and followed by the signature.
This indorsement does not transfer title but merely
appoints the person or bank named as agent for the
purpose of collection.