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face value of each note or draft discounted, when paid or dishonored by the maker or payee. Of course, when the Notes Receivable Discounted account is debited, the Notes Receivable account would be credited. In order to verify the amount of notes receivable on hand, it is necessary to deduct the balance of the Notes Receivable Discounted account from the balance of the Notes Receivable account.

Contingent Liability. Notes receivable discounted are a contingent liability and this fact should be indicated in the Balance Sheet. Kester says: “For this reason, whenever a business house transfers a note by any method of endorsement (except the qualified), it incurs a contingent liability, which might become a real liability in case the maker of the note should fail to meet the obligation at maturity. Since it is the function of good accounting to present all the facts bearing on the welfare of the business, it is evident that this fact—that of incurring a contingent liability— should be entered in the books of account. Very frequently, however, the importance of this matter is practically ignored, with the result that the contingent liability item is lost sight of altogether.”


It is important that the notes be counted on the same day that the cash is counted for the reason that, like cash, they may move on account of their being readily convertible. Analysis paper is usually used for preparing a list of notes receivable, on account of the amount of information desired.

Listing the Notes Receivable

(NOTE–Since this comprises a Balance Sheet audit for credit purposes, we will quote freely from the Federal Reserve Bulletin of April 1917. That Bulletin was termed “Uniform Accounting" and was intended as a tentative proposal to be adopted by manufacturing and merchandising concerns).

Quoting from the Federal Reserve Bulletin:

“A list of notes receivable outstanding at the end of the fiscal period should be prepared, showing the dates the notes are made, the customers' names, the date due, the amounts of the notes and the interest, if any, contained in the notes. If discounted, the name of the discounting bank should be noted and verification obtained from the bank.

“The outstanding notes must be carefully examined with the notes receivable book, and with the list prepared by or produced to the auditor, the due dates and the dates of making the notes being carefully checked, and when notes have been renewed the original dates

should be recorded. When notes have been paid since
the close of the fiscal year, the cash should be traced into
the books of the company, and, when they are in the
hands of attorneys or bankers for collection, certificates
should be obtained from the depositaries.
“When notes receivable are discounted by banks,
the company has a liability therefor which should appear
on the Balance Sheet. Lists of discounted notes not
matured at the date of the audit should be obtained from
the banks as verification and their totals entered under
secured liabilities if the cash therefor is shown as an
“The value of collateral, if any, held for notes
should be ascertained, as it frequently happens that the
notes are worth no more than the collateral.
“Notes due by officials and employees must always
be stated separately from customers' notes, as must also
notes received for other than trade transactions.
“Notes due from affiliated concerns must not be
included as customers' notes, even though received as
a result of trading transactions. Affiliated companies'
notes should be shown as a separate item of current
assets or as other assets as the circumstances warrant.
They may be fairly included in current assets if the
debtor company has ample margin of quick assets over
its liabilities, including such notes.”


While one of the juniors counted the cash, the other junior prepared a list of the notes receivable owned by the Blank Manufacturing Company as at December 31, 1918. The Federal Reserve Bulletin stipulates that only a list should be made of the notes receivable outstanding at the end of the fiscal period, but it is believed to be better practice to make a complete list of all the notes receivable, whether on hand or outstanding for the reason that the information will be of value later on when calculating the accrued interest and in case any discrepancies are noted. Reference to the illustration on page 69 will show the junior's working sheet on which he prepared a list of the notes receivable.

Reference to page 51 will show that the management had estimated that 2% of the notes receivable will prove worthless. Investigation shows that this estimate is based on previous experience. However, a reserve of this kind would not be a permissible deduction on an income tax return, only actual losses within the year being allowed. Where experience and investigation show that beyond a doubt there will be a certain per cent of notes prove worthless, then it is sound accounting to set up a reserve. This will be discussed further in a later chapter.

THE BLANK MANUFACTURInG CO. J. I. Kin Notes Receivable Indianapolis, Ind. #

No. Date Signature Description I Int. Due date Amount Discounted Remarke
l I Nov. 1, 1918 J. B. Olds Customer 6% Feb. 1, 1919 |$ 845||72

*3 || Dec. 10, 1918 The Oilox Co. Customer 6% | Jan. 10, 1919 || 1000 Endorsed. James Oilander, Mgr.
*4 Aug. 22, 1918 J. A. Bewes & Co. Customer 6% | Nov. 22, 1918 600 Protested-End. By J. A. Hewes.
*5 Dec. 24, 1918 L. W. Shields Gen. Mgr. 5% June 24, 1919 1500
*6 || Oct. 30, 1918 Alberts & Blackmar I Customer 6% | Jan. 30, 1919 || 4275 Dec. 1, 1918 |Merchants' National Bank
*7 | Nov. 18, 1918 R. O. Elmeier Co. 1 Customer 6% | Feb. 18, 1919 || 1485|28 Deo. 1, 1918 - n -

*3 || Paid Jan. 10, 1919--8ee cash book page 391.
*4 ||Note signed by J. A. Hewes & Co., per J. A. Hewes, Pres. Correspondence shows that they promised to make
payment in full on Jan. 1, 1919.

*5 This note should be investigated. Chief Accountant says it was authorized by Board of Directors.
"6-7| These notes discounted. Verified at bank. Both endorsed by The Blank Manufacturing Co., per E. D. Carpenter, Pres.


2 Sept. 25, 1918 Robert Burns Customer 6% Jan. 25, 1919 3200

(IA—Working Sheet, J. I. King, junior accountant.)

NOTE TO STUDENT—Each accountant prepares working papers showing detailed results of his 'work. Note that each uses a different system for numbering sheets. Instead of special ruled forms as above, ordinary analysis paper may be used if desired. SECURITIES

Securities like notes receivable should be audited as soon as possible after the beginning of the audit and if possible, on the same day that the cash is counted.


Investments are of two classes, speculative and non-speculative. When securities are purchased with the intention of holding them until such time as the market value may increase and enable the holder to sell at a profit, the investment is to be considered speculative. But when securities are purchased and held because of the income they produce, the investment is non-speculative.

Accounting for Speculative Investments. When securities are purchased either on a margin or by payment in full with the expectation of selling at any time when the market price is favorable, the investment is made, not because of the income the securities will produce, but because of the expectation of making a profit through a sale. In other words, these securities in a sense become the stock-in-trade of the investor and like any other stock-in-trade should be recorded at cost. An account may be opened with each class of security purchased or a summary account may be opened with Securities and a subsidiary record may be kept. The cost price of these securities includes broker's fees and any other expenses in connection with the purchase of the stock. To record these investments at their par value is wrong because it anticipates a profit or a loss at the time of the purchase, when in reality the profit or loss is realized only at the time of sale.

Accounting for Non-Speculative Investments. Nonspeculative investments are of two kinds: Those intended as temporary producers of income and those intended to be held until maturity. The latter are to be considered as permanent investments.

Temporary Investments. Investments intented as temporary producers of income should undoubtedly be recorded at cost price and should be carried on the books at the market price at the time of the purchase. It is not possible to scientifically amortize the discount or premium on such securities because it is not known how long they will be held, and since it is not the intention of the investors to hold these securities until maturity, it will readily be seen that the only thing to do is to debit the account with Securities at actual cost price. When interest is collected it should be credited to an account with Interest on Investments. It is this account that indicates the amount of the income from the investment during the period. SECURITIES 71

In case the securities are sold at a profit or loss, there are two methods of procedure: the first is to credit the Securities account at the selling price regardless of what it may be. The difference between the cost price and the selling price of the securities would be the amount of profit or loss and is either an addition to or a deduction from income in the Profit and Loss statement. The second method is to credit the account with Securities with the cost price and to debit or credit a nominal account for the profit or loss resulting from the sale. The latter practice is to be commended because it distinguishes between real and nominal accounts. This is the same method of accounting as is advocated in connection with the sale of fixed assets.

Permanent Investments. There is a lack of uniformity in regard to the method of recording permanent investments. The accounting procedure becomes more complicated when securities are purchased with the intention of holding them until maturity. These securities may be recorded either at cost price or at their par value. If they are recorded at par, separate accounts should be carried for the discount or premium and another account for the interest. If the securities are recorded at cost, no separate accounts with Discount and Premium need be opened, but an account with Interest is kept to show the income.

Amortization of Bond Discount and Premium. If the bonds are recorded at par value, an account with Discount and Premium is charged or credited with the difference between the cost price and the par value. This account should then be amortized over the life of the bonds. There are two methods for making this distribution. These are known as the “straight line” and the “scientific” methods.

Straight Line Method. The straight line method consists in dividing the amount of premium by the interest periods the bonds have to run, the quotient being the amount to be amortized periodically. This method commends itself because of its simplicity and ease of operation but it is not scientifically COrrect.

Scientific Method. The scientific method is based upon compound interest calculations, the premium being looked upon as the amount of the present worth of the annuity, taking into consideration the rate of interest and the time in interest periods the bond has to run.

The scientific method is the better one as the interest is not overstated in the first periods as would be the case with the straight line method. However, the straight line method is allowed by the Department of Banking of the state of New York for valuing the investments of saving banks.

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