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.