What Is an IOU? Understanding Informal Debt Acknowledgments
An IOU, derived from the words “I owe you,” signifies a written acknowledgment of debt between two parties. Though it’s an informal document, it establishes that a debt exists. IOUs date back to the 18th century and are still commonly used today. Whether in personal interactions or business transactions, an IOU might eventually be supported by a more formal agreement.
Key Takeaways
- An IOU is a written acknowledgment of debt one party owes to another.
- In business, IOUs may precede more formal written contracts.
- Due to their informality, IOUs can be hard to enforce and usually aren’t negotiable or sellable.
- IOUs are commonly recognized in bookkeeping as accounts receivable.
- IOUs are less formal and legally binding than promissory notes.
How an IOU Works
Typically produced spontaneously, IOUs serve as interim documents pending more formal agreements. No standard format exists, but a basic IOU should include the agreement date, debt amount, repayment date, involved parties, and the borrower’s signature. Often, further details such as interest, payment type, repayment schedule, or nonpayment consequences are omitted.
The informal nature of IOUs raises questions about their enforceability in legal proceedings. Consequently, IOUs are generally not considered negotiable instruments —meaning they can’t be reassigned or traded.
However, downloadable legal templates for IOUs now provide essential guidelines, enhancing the document’s enforceability and judicial credibility.
Example of an IOU
Consider a situation where Smithco Bricks orders raw materials but can’t pay the full amount upfront. They pay a down payment and issue an IOU asserting to pay the remaining sum in 30 days. Given a continuous relationship with their supplier, this arrangement may be acceptable for both parties.
Special Considerations
A bookkeeper may classify an outstanding debt as an IOU. This accounts receivable item is an asset on the balance sheet:
- If owed within a year, it’s a current asset.
- If the payment is due after a year, it’s a long-term asset.
IOU vs. Promissory Note
While IOUs and promissory notes both attest to a debt, promissory notes are more formal and comprehensive. They usually specify repayment details like interest rates, schedules, penalties, and must contain the term “promissory note.” Often signed by both borrower and lender, and sometimes notarized, promissory notes hold more legal weight than IOUs.
A sufficiently detailed promissory note may act as a negotiable instrument. It’s important to know that the statute of limitations for enforcing promissory notes varies by state, typically ranging from three to 15 years.
IOU FAQs
What Is an IOU in Finance?
An IOU acknowledges a debt between two parties, indicating the borrower owes a lender. Although informal and lacking specific terms, it represents a commitment to repay the debt.
What Is an Example of an IOU?
Amanda lends Karen $1,500 for a security deposit, creating a typed document stating Karen owes Amanda $1,500, repayable in three months. Karen’s signature confirms the IOU.
How Do I Write an IOU?
An IOU should include the borrower’s and lender’s names, debt amount, dates, and borrower’s signature. It’s also advisable to include repayment details, an interest rate, and a guarantor if applicable. Online templates can assist.
Is an IOU a Legal Document?
While an IOU can be introduced in court, its binding nature is debatable. Its enforceability largely depends on its detail and specificity.
Does an IOU Need to Be Notarized?
IOUs don’t require notarization, but notarization can add legal weight, similar to a promissory note.
The Bottom Line
An IOU serves as a basic contractual agreement recording debt acknowledgment, thus obligating a debtor to repay a lender. The inherent informality, however, translates to limited enforceability compared to formal debt agreements such as promissory notes. IOUs usually detail small sums and are often used among acquaintances or businesses maintaining periodic transactions.
Related Terms: promissory note, bond indenture, negotiable instrument.
References
- Tomlinson, Bomsztyk, Russ. “Appellate Court Affirms Calculation of Statue of Limitation on Promissory Notes”.
