IOU
An IOU is an abbreviation for the phrase "I owe you", is a document confirming the existence of a debt between parties. An IOU is considered an informal deal in written form, however, it is not a strict legal obligation. Having appeared in the 18th century, IOUs are still widely used. In business, an IOU may be accompanied by a more official written contract.
What is an IOU
As a rule, an IOU is concluded at the end of a business meeting in order to consolidate an intention. In addition, it is accompanied by the signing of a more formal agreement.
IOUs do not have a strictly established standard format. However, an IOU should contain basic information, such as the dates of the agreement and repayment of the debt, its amount, the signatures of the borrower and other parties engaged in this process.
Due to the fact that IOUs are mainly informal, there are great doubts about recognition of the legal force of these documents and their weight in legal proceedings. That is why, in order to ensure protection against nonpayment of a debt, it is more reliable to sign some kind of formal agreement that fixes the obligations of the parties, for example, a promissory note or bond indenture, than an IOU.
This informality and uncertainty prevent IOUs from being a negotiable instrument, and does not allow them to be assigned, transferred to another party and traded on an open market. However, uniform legal templates for IOUs are now becoming available, which can greatly simplify IOUs enforcement and litigation.
Despite the fact that an IOU is a legal document, it is the subject of open discussion. The authorities are divided into two camps in this matter. The first believe that IOUs are not binding, but only recognize the fact that the debt exists, while the second group express some doubts about whether it can actually be enforced, nevertheless, thinking that it has a binding nature anyway. To increase the chances of enforcing an IOU, it should be prepared in as much detail as possible. The more details the IOU contains, the easier it is for the court to establish the obligations and rights of the IOU’s participants and make the right decision.
The concept of "IOU" is quite common in the financial environment, and in some cases has other meanings. Thus, the process of issue of bonds is informally called an IOU, as well as accounts receivable, named in the same way.
How to write an IOU
IOUs can be drawn up by either party, printed or handwritten on any piece of paper. The minimum requirements for issuing an IOU include the names of the borrower and lender, the exact amount of the debt, the date of the current agreement, the date the debt is due, and the signature of the borrower's party.
It is also desirable that the following information be included in IOUs:
- debt repayment method (lump sum; in installments);
- installment payment schedule that determines the amount and frequency of payments;
- interest rate, if any;
- guarantors for the debt, if any;
- lender’s signature.
Nowadays, IOU templates are available for download online. As a rule, IOUs do not require a notarization, but some legal authorities consider that a notary's stamp on IOUs makes them more official and therefore more likely to be enforceable. Third party certification somehow formalizes the agreement and also increases the chances of the lender to prevail in court, in the event of a dispute about nonpayment. When notarized, an IOU is more like a promissory note, which is a more formal and binding document.
IOUs versus promissory notes
An IOU and a promissory note are written financial documents about a debt, containing promises by one party to pay another a specified amount on a specified day or date, therefore these agreements are very similar. However, an IOU is less formal and legally binding than a promissory note.
A promissory note contains more details than an IOU that does not provide for the inclusion of debt details, such as interest rate, schedule of payments and their amount, or penalties for nonpayment. The content must contain the term "promissory note". Among other things, the promissory note must be signed by both parties, and in most cases notarized.
To sum it up, an IOU is less specific and strict than a promissory note. As a matter of fact, mortgage or student loan agreements are very often accompanied by promissory notes, the signing of which obliges the borrower to repay the debt.
Examples of IOUs
Let’s say Company X makes an order for raw materials, however, there is not enough cash to fully pay for the order at the time of delivery.
Therefore, the firm makes an initial payment, and then the parties sign an IOU, for which Company X is obliged to pay the remaining raw materials under a 30-day period, which does not include the accrual of interest. In the event that Company X does business with this supplier on a regular basis, this option is perfectly acceptable for both parties.
Another one example. Victor Adams has been friends with Reynold Franco since high school. Circumstances developed in such a way that Victor needs $1,000 in cash as a security deposit on a new house. Victor needs to deposit funds immediately, so he turns to Reynold for help.
Reynold understands that friendship and money are different things, that is why he asks Victor to fix the existence of a debt in writing and describe in detail the terms and amount of this debt.
As a result, Reynold prepared an agreement confirming that Victor owes him, Reynold F., $1,000 and that Victor is obliged to pay this amount by December 31, 2022, that is, after 4 months from the date of this agreement. When the document was signed by the parties, Reynold officially gave Victor an IOU for $1,000.
More about an IOU
The outstanding debt can be registered as an IOU by an accountant. When accounting for an IOU, it is customary to consider an asset on the balance sheet, and, in addition, IOUs refer to an account receivable.
The procedure for recording IOUs depends on time periods. When funds are due within one year, IOUs in accounting are reflected as current assets. However, when the funds are expected to be received in more than one year, they are accounted for as long-term assets.
As a rule, an IOU can be concluded between individuals for small amounts or used also by companies that work with each other on a regular basis.
In fact, the accounting department of the company can reflect any outstanding debt as an IOU, that is, register the accounts receivable as an IOU.
