As stated above, the second group of items under the head of inventory of the liabilities is that of contingent liabilities. It is taken for granted that all items which on the date of the balance sheet have assumed a status of full and direct liability will, of course, appear as such on the books. Here, all that can be said without trespassing on the distinctive field of auditing, is that all such items must appear. For the method of detecting their omission, whether omitted with fraudulent intent or through carelessness and inaccuracy, the student is referred to a standard work on auditing.
We have here to consider, however, a group of items the status of which is one of suspended or indeterminate liability. Expressed otherwise, they are items concerning which it is hoped—it may be even expected—that the business will never incur liability but for which in the event of certain happenings liability must be assumed. There are, of course, degrees of contingency, ranging from almost certainty to negligible remoteness. It would seem that no business man would omit the almost certain type from his books, and in case of doubt prudence demands that decision be rendered in favor of at least the greater probability.
Yet there is often seen a failure to book even the liability on account of goods purchased and shipped, but not received. If it is argued that the liability is not fully established until receipt and acceptance of the goods, every manager knows that non-acceptance of purchases is the exception, not the rule. On the other hand, upon receipt of consigned goods to be sold on account of a principal, no liability except to exercise ordinary care usually attaches to a broker until some part of the goods has been sold by him. Between these two extremes are many shades and degrees of probability, all of which in some cases are recorded as liabilities; in others none are so recorded. The importance of the information as to contingent liability on account of notes receivable discounted and discounted acceptances is now accorded general recognition. As to liability under court judgments awaiting appeal, guarantees of work and product, deposits made on contracts or bids—these and other similar matters will be treated fully in following pages.
These, then, constitute the main problems in connection with liabilities on the balance sheet. The group of current liabilities will now be considered, followed by a discussion of the nature of contingent liabilities.
Current Liabilities
Notes and accounts payable, using the terms broadly, constitute practically all of the current liabilities. Not all notes nor all accounts payable are, however, current items. The term “current” cannot be standardized; it varies and will perhaps always vary according to customs and practices in any particular trade. In the main, the 90-day period may be taken as the average. That is, on the given date of the balance sheet a knowledge of the debts that must be met within the next 90 days is a minimum of necessary information for the purpose of judging business condition, particularly so far as concerns the credit extended to it. When a balance sheet is submitted to the bank as the basis for credit, other data concerning notes payable are usually called for—such as notes given for merchandise, notes negotiated to own banks, notes otherwise disposed of. The Federal Reserve Bulletin for April, 1917, under the title “Uniform Accounting a Tentative Proposal” suggests for balance sheet presentation a list of notes analyzed as to acceptances made for merchandise or raw material purchased; notes given for merchandise or raw material purchased; notes given to banks for money borrowed; notes sold through brokers; notes given for machinery, additions to plant, etc.; notes due to stockholders, officers, or employees. R. H. Montgomery[49] suggests a division of notes into the groups: notes issued for merchandise; notes discounted by own banks; notes sold through brokers; and demand loans. He suggests further that an additional separation into notes accompanied by collateral and notes with which no collateral is given would be desirable.
From the above it is seen that the present tendency of bankers is to insist on a full statement of essential facts needed to pass intelligent judgment as to the exact status of affairs. Even in the case of balance sheets, the accuracy of which has been certified by someone, some bankers require a certificate as to the character of the certifier unless he is well known. More and more is the fact being recognized that legitimate business has nothing to fear and much to gain by making a full and free statement of exact condition, and that the sooner business supported by fraudulent statement is eliminated, the better will it be for legitimate enterprises. In certain cases, however, the interests or purpose of a business would not be well served by the detailed information demanded by the banker and, here as elsewhere, no specific rule can be laid down other than that the purpose should in all cases govern the form and particularly the amount of detail.
Loans from Bank
In connection with advances from the bank it should be noted that the banker does not expect to become a permanent partner in the business, but that one of his legitimate functions is to furnish funds for seasonal fluctuations. Oftentimes a concern does not start with enough capital to carry its load of maximum trade, from the fear that advantageous investment of surplus funds during the dull season will not be possible. It may rightly expect its bank to furnish funds for this purpose when expenses are heaviest, and to await repayment of the loan out of the income, as accounts are collected after the peak of the seasonal trade is passed. This is one of the fields of legitimate banking and the banker has a right to whatever information is necessary to assure himself that his aid is being put to proper use.
General Classification of Notes