Contingent or otherwise;

              94 HASKINS & SELLS December
Contingent or Otherwise
AT Y P I C A L example of a contingent
liability is a note receivable dis-counted.
Jones sells goods to Smith, who
gives a promissory note in part payment
for the goods. Jones wishing to realize on
the note, endorses it and discounts it at his
bank. If Smith pays the note at maturity,
the relationship among Smith, Jones and
the bank is at an end in so far as that trans­action
is concerned.
If Smith fails to pay the note at maturity,
certain complications arise. The bank
may elect to hold Jones as endorser and in
that event Jones would have to pay. But
Jones has a right of action against Smith
which he may enforce and having obtained
judgment may levy against any property
which Smith may have.
From the time Jones discounts the note
at the bank until the date of maturity,
Jones has a contingent liability in connec­tion
with the note. If Smith doesn't pay,
Jones may have to, and Smith may not
pay. This in simple language is the story
of a hypothetical contingent liability.
The accounting principle regarding con­tingent
liabilities now is well settled, at
least in this country. Reference to any
contingent liability appears as a foot-note
on the balance sheet. This principle has
the authority of rather general practice.
In order to understand the full signif­icance
of contingent liabilities, it will be
found helpful to trace the hypothetical
case just described through to the worst
possible conclusion. Assume that Jones
pays the bank and having attempted to
levy execution on a judgment against
Smith, is unable to realize anything. Jones
then has an uncollectible debt. If Jones
has a reserve for doubtful accounts, pre­sumably
the Smith account will be written
off against the reserve.
A reserve for doubtful accounts usually
is regarded as applying against accounts
receivable from customers; not against
notes receivable. The thought of relating
it to notes receivable discounted probably
seldom occurs to anyone. Provisions for
reserves to take care of losses arising
through accounts receivable which may
become uncollectible, if computed scientif­ically,
are based on the experience of a
particular enterprise or on the experience
common to enterprises having the same
characteristics in the line of business to
which the particular enterprise belongs.
Moreover, the experience rate of provision
for reserves tends to approach the ultimate
in point of soundness when it is based on
sales. If provision for uncollectible ac­counts
is computed on the basis of loss
experience in relation to sales, an interest­ing
but somewhat serious question arises
as to whether cognizance need be taken in
a balance sheet by means of a foot-note