Fundamentals of Accounting For Banking Operations - T1GB Accounting 1

Fundamentals of Accounting for
Banking operations
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Objectives
 At the end of this course, you will be able to understand the basics of
accounting used in Banking operations like
 Assets, Liabilities, owner’s equity
 Double entry book keeping
 Accounting entries
 Balance sheet and Profit and Loss
Slide 2
Workshop – 1 How much you own?
 Can you tell how much money

 was with you at 6 in the morning?
 is with you now?
without counting the actual
 Can you now account for the changes?
 Can you count and find the actual holding?
 Can you account for the difference, if any?
Slide 3
How much you own - concepts
Opening Cash
Closing Cash
Payments/
Expenses
Receipts /
Income
Debit Credit
Single entry
Heads of Accounts Reconciliation
book keeping
Slide 4
Why to maintain books of accounts
 Are we gaining or losing – how much ?
 Book keeping or accounting, to keep track of financial transactions to

know
 how well the business is doing, what it owns and what it owes
 In addition
 Which division is giving how much money ?
 Who has to give - how much ?
 To whom we are paying - how much ?
 How was it last year ?
Slide 5
Double entry accounting
 Double-entry accounting is based on a simple concept: each party in a

business transaction will receive something and give something in
return
 In bookkeeping terms, what is received is a debit and what is given is a

credit
 Luca Pacioli, Developer of

Double entry Accounting
(1445 – 1514 or 1517)
Italian mathematician and
collaborator of Leonardo da Vinci
Slide 6
Common terminologies
 TRANSACTION
 Any business activity expressed in terms of money
 What a business receives and what it pays
 DEBTOR
 A person who owes something
 Borrower in a Bank
 CREDITOR
 A person to whom something is owed
 Depositor in a Bank
Slide 7
 ACCOUNT
 A list of transactions falling under the same description
 Each account has a history of changes
 DEBIT and CREDIT

 In book-keeping, receiver of a benefit is debited and giver credited
 To debit an account means to enter a transaction on debit side and to
credit, transaction entered on the credit side of that account
Slide 8
 This system is called double-entry because each transaction is

recorded in at least two accounts
Each transaction results in at least one account being debited and at least one
account being credited, with the total debits of the transaction equal to the total
credits
 The T Account is a representation of a scale or balance
T account
Left Side Right Side

Receive Pay
DEBIT CREDIT
Receive Pay
DEBIT CREDIT
Slide 9
Recording transactions – Double entry accounting
 Cash and credit transactions

 Is exchange of consideration immediate?
 Will one party settle its part later?
 Analyse the transaction

 What the business receives and what it pays in return
 What it receives – to debit side and What it pays – to credit side
 Two fold effect for each transaction
Slide 10
Workshop – 2 Two fold effect
 Analyse the two fold effect of following transaction and write down the
accounting entries you will pass:
1. Bank buys furniture for USD 50,000
Slide 11
Workshop – 2 Solution
 Analyse the two fold effect of following transaction and write down the
What the Bank receives What the Bank pays in return
Furniture worth US $ 50,000 Cash US $ 50,000
Dr Furniture account US $ 50,000

Cr Cash account US $ 50,000
Slide 12
 Analyse the two fold effect of following transactions and write down the
2. Bank accepts FD for USD 5,000 from David Smith
3. Bank gives USD 15,000 as loan to David Green. It credits the proceeds to
his current account
Slide 13
Cash US $ 5,000 Bank has obligation to pay, but only on

maturity. Till then, depositor is creditor and
Bank has issued FD receipt to indicate this
Dr Cash account US $ 5,000

Cr Fixed Deposit account US $ 5,000
Slide 14
3. Bank gives USD 15,000 as loan to David Green. It credits the proceeds
to his current account

Nothing immediately. But David Green Bank pays US $ 15,000 to
has an obligation to pay on the due the current account of David
date. He is a debtor to Bank. Bank has Green
executed loan contract documents with
David Green
Dr Loan account US $ 15,000

Cr Current account of David Green US $ 15,000
Slide 15
 Analyse the two fold effect of following transactions and write down the
4. John Fowler pays USD 7,700 in full settlement of his loan of US$7,000 on
due date of loan
5. John Smith withdraws cash of US$ 1,000 from his Savings Account
6. Bank collects Share capital of US $ 100,000 from 100 shareholders
Slide 16
4. John Fowler pays USD 7,700 in full settlement of his loan of

US$7,000 on due date of loan

Bank receives cash of Bank pays nothing. But the obligation of John
US $ 7,700 Fowler to the Bank is now fully extinguished as
he pays US $ 7,000 towards the original
amount of loan and US $ 700 towards interest
thereon. Bank returns back loan documents
and he is no more a debtor to the Bank

Cr Loan account US $ 7,000
Cr Interest account US $ 700
Slide 17

Bank does not receive anything. But its Bank pays cash US $ 1,000
obligation to pay to John Smith, a
creditor, is reduced by US $ 1,000. What
it owes through John Smith’s Savings
Account is now reduced
Dr Savings account US $ 1,000

Slide 18

Bank receives cash Nothing immediately. But it has an obligation to
pay the 100 shareholders US $ 100,000. Hence
the 100 shareholders are like creditors and share
certificates are issued to them

Cr Share capital account US $ 100,000
Slide 19
Summary of transactions …
Slide 20
Presented as Journal ..
Slide 21
And then to Books of Accounts
Furniture Cash Fixed Loan Current Interest

Deposit Account Account
Opening Bal -100,000 -100,000 +50,000 -50,000 +100,000 NIL

April 1, 2008 -50,000 +50,000 +5,000
-5,000
April 2, 2008 - 7,700 -15,000 +15,000 +700
+ 7,000
April 3, 2008
Closing Bal -150,000 - 62,700 +55,000 -58,000 +115,000 +700
Slide 22
 ASSETS
 Properties of a business
 LIABILITIES
 Amounts due by a business to various persons
 CAPITAL or OWNER’S EQUITY

 Amount due to Owners. Excess of assets over liabilities
 Shown as a liability because a business is treated as separate from its
owners
Slide 23
Accounting equation
 What does a Bank own?
 What does a Bank owe?
DEBIT CREDIT
=
Increases Assets Increases Liabilities
Liabilities
Assets
Loans Deposits
Investments Borrowings
Cash
Property
Owner’s Equity
Slide 24
Accounting equation
Liability
Assets
Owner’s
Equity
Asset Accounts Liability Accounts

Debit Increases Debit Decreases
Credit Decreases Credit Increases
Owner’s Equity Accounts

Debit Decreases
Credit Increases
Slide 25
Workshop – 5 Assets and Liabilities
 Analyse the effect of following transaction on Assets and Liabilities of a

Bank and write down the accounting entries you will pass:
Slide 26
 Analyse the effect of following transaction on Assets and Liabilities of a

Bank and write down the accounting entries you will pass :
Assets Liabilities
What Bank owns What Bank owes
Furniture worth US $ 50,000 Nothing.
Cash reduced by US $ 50,000
Dr Furniture account US $ 50,000

Slide 27
 Analyse the effect of following transactions on Assets and Liabilities of

a Bank and write down the accounting entries you will pass :
his current account
Slide 28
Assets Liabilities
Cash US $ 5,000 Bank has obligation to pay Fixed Deposit

of US $ 5,000 on maturity

Cr Fixed Deposit account US $ 5,000
Slide 29
3. Bank gives USD 15,000 as loan to David Green. It credits the

proceeds to his current account
Assets Liabilities
David Green has an obligation to pay Bank pays US $ 15,000 to

back Loan of US $ 15,000 on the current account of David
due date. Green. It owes this money
under Current Account
Dr Loan account US $ 15,000

Cr Current account of David Green US $ 15,000
Slide 30
 Analyse the effect of following transactions on Assets and Liabilities of

a Bank and write down the accounting entries you will pass :
the due date of the loan
Slide 31
Assets Liabilities
Cash of US $ 7,700 Bank owes nothing.

Obligation of John Fowler to Bank is fully
extinguished as he pays US $ 7,000 towards
the original amount of loan and US $ 700
towards interest thereon

Cr Loan account US $ 7,000 Cr Interest account US $ 700
Slide 32
Assets Liabilities
Cash reduced by What it owes through John Smith’s Savings

US $ 1,000 Account is now reduced by US $ 1,000
Dr Savings account US $ 1,000

Slide 33
Assets Liabilities
Cash of US $ 100,000 It has an obligation to pay US $ 100,000 to its
100 share holders. Its share capital has
increased

Cr Share capital account US $ 100,000
Slide 34
 INCOME
 Revenue earned out of business
 EXPENDITURE
 Cost of doing business
 PROFIT and LOSS for a Period

 Profit is revenue left after cost
 Loss is excess of cost over revenue
 These affect Owner’s equity suitably
Slide 35
 The basic accounting equation can be expanded to include all five

financial categories indicating what has been received and given
DEBITS CREDITS
What Bank owns and = What Bank owes and
spends earns
Liabilities
Assets
Owner’s Equity
Profit
Expenditure Income
Interest, Salary paid Interest, Commission
received
Slide 36
 The basic accounting equation can be expanded to include all five

financial categories indicating what has been received and given
DEBITS CREDITS
What Bank owns and = What Bank owes and
spends earns
Liabilities
Assets
Owner’s Equity
Loss
Expenditure Income
Interest, Salary paid Interest, Commission
received
Slide 37
Double entry - rules
Liabilities
Debit Credit
Assets Decreases Increases
Debit Credit Capital

Increases Decreases
Debit Credit
Decreases Increases
Expense (Loss) Revenue (Profit)
Debit Credit Debit Credit

Increases Decreases Decreases Increases
Slide 38
Double entry - Illustration
John Fowler pays USD 7,700 in full settlement of his loan of US$7,000 on
Assets - What Bank owns Liabilities - What Bank owes

Cash of US $ 7,700 Bank owes nothing.
Obligation of John Fowler to Bank is fully
extinguished as he pays US $ 7,000 towards
the original amount of loan
Expense – What Bank spends Income – What Bank earns
US $ 700 as interest on loan

Cr Loan account US $ 7,000
Cr Interest account US $ 700
Slide 39
Reporting Revenue and Expenses
 Cash basis of accounting

 Revenue reported only when cash is received
 Expense reported only when cash is paid
 Does not properly match revenues and expenses
 Accrual basis of accounting

 Revenue reported when earned
 Expense reported when incurred
 Actual Profit or Loss for the period determined
Slide 40
Workshop – 8 Accrual basis of Accounting
 Bank earns USD 700 as interest on loan to John Fowler @ USD 350
per month.
John Fowler pays interest at the end of 2 month loan
What will be the effect of Accrual basis of Accounting for interest?
At the end of first month
At the end of second month
When John Fowler pays interest
Slide 41
Workshop – 8 Solution Accrual basis of Accounting
Bank earns USD 700 as interest on loan to John Fowler @ USD 350
per month.
John Fowler pays interest at the end of 2 month loan
Assets - What Bank owns Income – What Bank earns

At the end of first month
Dr Obligation of John Fowler to pay US $ 350 Cr US $ 350 as interest on loan
towards interest on loan
At the end of second month

Dr Further Obligation of John Fowler to pay US $ Cr US $ 350 as interest on loan
350 towards interest on loan
When John Fowler pays
Dr Cash US $ 700
Cr Obligation of John Fowler to pay US $ 700 (as it
is fully extinguished)
Slide 42
From Books of accounts to Trial Balance
Assets
Liabilities
Owner’s Equity
Revenue
Slide 43
From Trial Balance to Chart of Accounts
Income statement for the 3 day period ended April 3, 2008

Debit Credit
Interest income 700
Other income
Expenses
Excess of income over expense 700

carried over to Balance sheet
Slide 44
From Trial Balance to Chart of Accounts
Balance sheet as on April 3, 2008
Assets Liabilities
Cash 161,700 Fixed Deposits 55,000

Loans 58,000 Savings A/Cs 49,000
Furniture 150,000 Current A/Cs 115,000
Share capital 150,000
Net Profit B/f 700
Total 369,700 Total 369,700
Slide 45
Traditional Classification of accounts
 Personal
 Accounts relating to amounts given to or taken from Persons
 Individuals, Firms, Companies
 Real
 Accounts relating to tangible accounts
 Can be seen or felt - Cash, Furniture
 Nominal
 Accounts of items which are not tangible
 Interest, Salary, Rent, Telephone expense
Slide 46
3 Golden rules
 Personal accounts:
 Debit the Receiver and
 Credit the Giver
 Real accounts :
 Debit what comes in and
 Credit what goes out
 Nominal accounts:
 Debit expenses / losses and
 Credit incomes / gains
Slide 47
Workshop – 9 Re-write books of accounts
 Pass accounting entries on the basis of 3 Golden rules:
his current account
Slide 48
1) Bank buys furniture for its new office for US$ 50,000
 Furniture account debited with US$ 50,000

 Cash account credited with US$ 50,000
 Furniture account and Cash account are Real accounts and the
cardinal Rule for Real accounts is Debit what comes in and Credit what
goes out. In this case, furniture has come in and cash has gone out.
Hence furniture account is debited and cash account is credited.
Slide 49
2) Bank accepts fixed deposit of US $ 5,000 from David Smith.
 Cash account debited with US $ 5,000

 Fixed Deposit account of David Smith is credited with US $ 5,000
 Cash account is a Real account while Fixed Deposit account of David

Smith is a Personal account. In this case, cash has come in and David
Smith has given it for his Fixed Deposit. Cardinal rule for Real account
is Debit what comes in and for a Personal account it is, Credit the giver.
Hence Cash account is debited and Fixed Deposit account of David
Smith is credited.
Slide 50
3) Bank gives a loan of US $ 15,000 to David Green. It credits the

proceeds to his current account.
 Loan account of David Green is debited with US $ 15,000
 Current account of David Green is credited with US $ 15,000
 Loan account and Current account are Personal accounts. Cardinal
rules for Personal accounts are Debit the receiver and Credit the giver.
 When Personal accounts are involved, the other side is Real or
Nominal account.
 Loan is generally given by way of cash (Real account – Debit what
comes in, Credit what goes out) and Customers deposit cash into
current accounts. In the above example, we have compressed the two
transactions into one and hence it superficially looks as though the
rules have not been followed
Slide 51
4) John Fowler pays by cash US$7,700 in full settlement of his loan of

US$7,000 on the due date of the loan.
 Cash account debited with US$ 7,700

 Loan account credited with US$ 7,000
 Interest account credited with US$ 700
 Cash account is Real account, Loan account is Personal account and

Interest account is Nominal account. For Real accounts, what comes
in should be debited. Cash has come in and hence Cash account is
debited. For Personal accounts, the giver should be credited. The giver
is the customer and hence his Loan account is credited. For Nominal
accounts, all incomes are to be credited and hence interest account is
credited.
Slide 52
5) John Smith withdraws cash of US$ 1,000 from his Savings Account
 Savings account of John Smith debited with US$ 1,000

 Cash account credited with US $ 1,000
 Savings account is a Personal account while Cash is a Real account.

Accordingly, the receiver is debited and what goes out is credited.
Slide 53
6) Bank collects Share capital of US $ 100,000 from 100 shareholders
 Cash account debited with US$ 100,000.

 Share capital account credited with US$ 100,000
 Cash account is a Real account and hence when cash comes in, it is
debited. Share capital is a Personal account and hence the givers are
credited.
Slide 54
Accounting – an information process
Identification Identification Identification

of Users of Users of Users
User Information User Information

Needs Needs
Accounting
External Users System
Investors Economic Data

Creditors and Activities
Internal Users
Regulators
Customers Owners
Managers User
Reports
Employees Decisions
Slide 55
Computerised accounting cycle
1. Operations are recorded
No
2. Accounting entries are JOURNAL
produced
Savings Loan Income

Account
3. Account balances 12345 89876 Interest
updated
Current Deposit Expense
Account
21768 95837 Salary
4. Reports are produced

Income Balance
statement sheet
Slide 56
Rules for Accounting – GAAP, IASB
 Innumerable rules – laid down by many

 Independent regulatory bodies
 Governments
 Generally Accepted Accounting Principles

 US GAAP framed by Financial Accounting Standards Board of US
 Canadian GAAP, UK GAAP
 International Accounting Standards Board of UK – widely accepted

 Independent, privately-funded accounting standard-setter
 Central Banks and International bodies

 Provisions, Contingencies, Valuations
Slide 57
Accounting period
 Balance sheet is static, like a snapshot.

 also cumulative
 Profit and Loss is prepared for a period

 At the end, balance, after appropriations, is taken over to Balance sheet.
For the Financial Year ended

As on March 31,
March 31, 2008
2008
Income
Asset
Expenditure
Liability
Profit/Loss
Contingents
Slide 58
Cash and accrual basis
 Record transactions only when cash changes hands.
 Record financial effect when activity happens

 Whether cash received or not
 All Banks generally use the accrual accounting method
 Cash method selectively used when small amounts involved
For the Financial Year ended March For the Financial Year
31, 2008 ended March 31, 2008
Income – Cash received Income for the period even if not yet due
Expenditure – Cash paid Expenditure for the period even if not yet due
Slide 59
Banking related Accounting aspects
 Profit Vs Cash flow
 Amortisation and accrual
 Asset value determination

 Provision
 Depreciation
 Revaluation
 Marking to market
 Reserves
 Off Balance sheet
Slide 60
Profit Vs Cash flow
 Balance sheet and Profit and Loss statement show funds flow
 Banks need to have projections of Cash movement, in time buckets
 How much Cash is supposed to come in and go out

 Today, Tomorrow, Within 3 days, one week, one month, 3 months …
Slide 61
Contingents
 Contingents
 Depends on an uncertain even taking place
 Will it happen?
 When will it happen?
Slide 62
Quiz - 1
 Discuss what is contingent in the following. Will the Bank like it to

happen and what it should do to be prepared?
1. A Bank has committed, in writing, to give a loan of USD 1million to its

Customer.
A: The ball is now in the Customer’s court.

The customer may or may not avail and if decides to avail,
it could be tomorrow or after a week or after a month.
It is not sure whether the customer would avail this and if yes, when?
A case of a future Asset, a loan, which the Bank may gladly like to
happen as it leads into its regular business of loan.
So, it should only take care of Cash flow
Slide 63
Quiz - 2

2. A Bank has guaranteed to the Government that it would pay the

Government USD 10 million, if the Bridge built by its Customer for the
Public does not withstand the laid down traffic load for the next ten
years
A:
What is not certain here is that whether the even itself would
happen or not.
And if it happens, would the Bank’s customer immediately pay
USD 10 million to the Bank so that the Bank need not meet this
obligation out of its funds?
It would not gladly welcome the event. It would rather prefer that
the Guarantee is never invoked. Besides its own cash flow, the
cash flow strain on its customer should also worry the Bank.
There is an element of Credit risk in this, which might not have
been fully considered earlier.
Slide 64
Quiz - 3

4. A Bank has agreed with a customer to Buy GBP 1 million and sell USD
2 million in return, two months after date.
A: In the meanwhile if the market rates for GBP is not 2 USD, will the
Customer come on the right day and give GBP 1 million?
If the Customer fails to turn up to honour his part of the commitment

– giving the Bank GBP 1 million, then the Bank also need not sell
Also a welcome event for the Bank as it would have already planned
counter steps. If only it were not to happen, it may affect plans of the
Bank. Anticipating this, the Bank would have arranged to sell
GBP 1 million to another Customer, on the same delivery date or very
close to that. It would now be put to difficulty on the second front.
Besides cash flow, there is an element of Forex risk here.
Slide 65
Off Balance sheet
 GAAPs guide regarding On and Off Balance sheet items

 Above and Below the line
 Notes forming part of Financial statements
 Country specific rules regarding extent of Off Balance sheet items

 How many times Net worth
 Prevents major damage when suddenly forced to meet contingent liabilities
Balance sheet as on April 3, 2008
Assets Liabilities
Cash 161,700 Fixed Deposits 55,000
Loans 58,000 Savings A/Cs 49,000
Furniture 150,000 Current A/Cs 115,000
Share capital 150,000
Net Profit B/f 700
Total 369,700 Total 369,700
Contingent Liabilities 325,000
Slide 66
Summary
 In double entry book keeping, debit and credit entries are passed
simultaneously to balance each other
 Debit entries increase an asset. Credit entries increase liabilities and

owners equity
 Credit entries decrease an asset
 Debit entries decrease liabilities and owners equity
 Assets = Liabilities + Owner’s equity

 Assets + Expenses = Liabilities + Owner’s equity + Income
Slide 67
Summary
 Banks follow Fundamental concepts of Accounting and further

guidelines of respective GAAPs
 Most of the banks follow Accrual basis of accounting for Income and
expense recognition. For minor amounts, they also follow Cash basis
 Cash flow is critical for Bank operations
 Determining and reporting correct value for Assets is important
 Off Balance sheet items are as important as On Balance sheet
Slide 68

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Fundamentals of Accounting for

 Assets, Liabilities, owner’s equity

 Double entry book keeping

 Balance sheet and Profit and Loss

 Can you tell how much money

 Can you now account for the changes?

 Can you count and find the actual holding?

 Can you account for the difference, if any?

 Are we gaining or losing – how much ?

 Book keeping or accounting, to keep track of financial transactions to

 Double-entry accounting is based on a simple concept: each party in a

 In bookkeeping terms, what is received is a debit and what is given is a

 Luca Pacioli, Developer of

 DEBIT and CREDIT

 This system is called double-entry because each transaction is

 The T Account is a representation of a scale or balance

Left Side Right Side

 Cash and credit transactions

 Analyse the transaction

 What it receives – to debit side and What it pays – to credit side

 Two fold effect for each transaction

1. Bank buys furniture for USD 50,000

1. Bank buys furniture for USD 50,000

What the Bank receives What the Bank pays in return

Furniture worth US $ 50,000 Cash US $ 50,000

Dr Furniture account US $ 50,000

2. Bank accepts FD for USD 5,000 from David Smith

2. Bank accepts FD for USD 5,000 from David Smith

What the Bank receives What the Bank pays in return

Cash US $ 5,000 Bank has obligation to pay, but only on

Dr Cash account US $ 5,000

What the Bank receives What the Bank pays in return

Dr Loan account US $ 15,000

6. Bank collects Share capital of US $ 100,000 from 100 shareholders

4. John Fowler pays USD 7,700 in full settlement of his loan of

What the Bank receives What the Bank pays in return

Dr Cash account US $ 7,700

What the Bank receives What the Bank pays in return

Dr Savings account US $ 1,000

6. Bank collects Share capital of US $ 100,000 from 100 shareholders

What the Bank receives What the Bank pays in return

Dr Cash account US $ 100,000

Furniture Cash Fixed Loan Current Interest

Opening Bal -100,000 -100,000 +50,000 -50,000 +100,000 NIL

Closing Bal -150,000 - 62,700 +55,000 -58,000 +115,000 +700

 CAPITAL or OWNER’S EQUITY

 What does a Bank own?

 What does a Bank owe?

Asset Accounts Liability Accounts

Owner’s Equity Accounts

 Analyse the effect of following transaction on Assets and Liabilities of a

1. Bank buys furniture for USD 50,000

 Analyse the effect of following transaction on Assets and Liabilities of a

1. Bank buys furniture for USD 50,000

Dr Furniture account US $ 50,000

 Analyse the effect of following transactions on Assets and Liabilities of

2. Bank accepts FD for USD 5,000 from David Smith

2. Bank accepts FD for USD 5,000 from David Smith

Cash US $ 5,000 Bank has obligation to pay Fixed Deposit

Dr Cash account US $ 5,000

3. Bank gives USD 15,000 as loan to David Green. It credits the

David Green has an obligation to pay Bank pays US $ 15,000 to

Dr Loan account US $ 15,000