What Is an IOU?

An IOU is a document that acknowledges a debt owed. In business, accounts receivable may be informally called IOUs.

The term IOU has a history dating at least to the 18th century and is often viewed as an informal written agreement rather than a legally-binding commitment. However, IOUs are still very much in use. An IOU between two people conducting business may be followed up with a more formal written agreement.

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IOU

How an IOU Works

The informal nature of an IOU means there may be uncertainty about whether it is a binding contract, and the legal remedies may be harder to enforce than a formal contract such as a promissory note or a bond indenture. Due to this uncertainty, an IOU is generally not considered a negotiable instrument.

There is no standard format for an IOU. Criteria such as time, date, interest due, and payment type may or may not be included. Notably, there are legal templates available now for IOUs and these may be easier to enforce since they at least provide an outline of the kind of details that should be included.

Most often, an IOU probably is produced in the heat of business as a sort of memorandum of intent and may be followed up with a more businesslike written agreement.

[Important: The term IOU has become so familiar that it crops up in other contexts. A bond contract is sometimes called an IOU.]

Example of an IOU

Say Smithco Bricks places an order for raw materials and does not have enough cash to pay for the entire order when it is delivered. Instead, it pays a down payment and issues an IOU promising to pay for the rest of the raw materials within 30 days with or without interest. Assuming that Smithco has an ongoing business relationship with the supplier, this might be quite acceptable to both parties.

The term IOU has become so familiar that it crops up in other contexts. A bond contract is sometimes called an IOU.

Special Considerations

IOUs in Bookkeeping

A bookkeeper may record an outstanding debt as an IOU. The IOU is thus an accounts receivable item and is counted as an asset on the balance sheet. If the money is due in one year or less, the IOU as a current asset. If the payment is due more than a year down the road, it is recorded as a long-term asset.

Receivables Exchange

The Receivables Exchange is an online marketplace through which companies can sell IOUs, or at least IOUs that are formal enough to be considered legally-binding documents or accounts receivable. The seller accepts a discounted price in return for immediate payment. The buyer is then entitled to be paid the full amount by the agreed-upon date.

For example, say the Acme Trash company has an outstanding IOU from Riverbend Plastics that requires payment of $500 a month down the line. Acme, in urgent need of cash, goes to the Receivables Exchange and sells the IOU for $450. A month later, the Receivables Exchange collects the full $500 from Riverbend Plastics and pockets a $50 profit.

Key Takeaways

  • An IOU is a written acknowledgment of a debt.
  • In business transactions, an IOU may be followed by a more formal written contract.
  • The term IOU is used in bookkeeping to refer to accounts receivable.