Banking Basics

Accounting in Banks

Objectives
At the end of the module, you will be able to:
Define and explain the accounting principles and
concepts.
Explain the conceptual difference between the cash
and accrual methods of accounting.
Explain the rules of debits and credits and their use
as applied to double entry accounting practice
Explain the five basic accounts: Assets, Liabilities,
Ownership Equity, Income and Expenses.
Explain the basic balance sheet equation: Assets,
Liabilities and Ownership Equity.
Explain and demonstrate the posting of accounting

Introduction

What you already know

Financial transactions
Accounts

What you need to know

now
The 5 basic account heads
and the effect of Debit and
Credit transaction on each of
these types
Some accounting jargons

What is Accounting?

Accounting, also referred to as Book Keeping,

is an art of recording, classifying and
summarizing in a significant manner and in
terms of money transactions and events
which are in part at least of financial
character and interpreting the results
thereof.
It is a method to communicate financial
information to interested external parties.
Financial accounting is used for both

Accounting Jargons
Every subject and profession have their own typical jargons.
Accounting is no exception. The following are some of the terms
which one should know to proceed further. Given their strong
inter-relationship, they can not be explained in any specific
order. These are basic definitions only; each of them have been
explained
in more
details later in Journals
this module.
Financial
Transactions
Debit and Credit
Transactions
Posting
Accounts

Accounting Period
Balance Sheet
Income and Expenditure
Account
Receivables
Payables
General Ledger

Assets
Liabilities
Owners Equity
Double Entry Accounting
Subsidiary Ledger
System
This is only a partial list. You can find most of the terms and
their definitions at
http://www.a-z-dictionaries.com/glossaries/Accounting_Glossary

Types of Accounts
An element for the purpose of accounting is that aspect relating
to which we wish to find/know information.
Each element in accounting is identified as an account or an
accounting head.

Capital Account
Furniture Account
Cash Account
Bank Account
Bobs Account
Harrys Account
Salaries Account
Interest on Loans
Account

Types of Accounts
Whatever may be the number of accounting heads/elements an
organizational accounting is divided into; it broadly falls into the
following 3 types of accounts:

Accounts - Elements in
Accounting
Personal
Accounts

Real
Accounts

Natural

Artificial

Tangible

Bobs A/c
Harrys
A/c

MSats A/c
TechMs
A/c

Cash A/c
Bank A/c
Furniture
A/c

Intangibl
e
Goodwill
A/c
Patents
A/c

Nominal
Accounts

Income
Interest
on Loans
A/c
Commissi
on A/c

Expendit
ure
Salaries
A/c
Interest
on
Deposits
A/c

Format of Accounts
All the Account types, including the sample ones we
considered, have the same format.
Capital Account
Balanc
Date Particulars
Debits Credits
e
25000.0
31-Jan-10 By cash

0
Cash Account
30000.0
5-Feb-10
By cash
5000.00
0
Date
Particulars
Debits
Credits Balance
20000.0
25-Feb-10 To self
10000.00

0
25000.0
31-Jan-10 To Capital
25000.00

0
15000.0
Bank
Account
11-Mar-10 To self
5000.00

0
Date Particulars
Debits Credits Balance
20000.0
5-Feb-10 By Receipts
5000.00
0
25000.0
31-Jan-10 To Bank
25000.00

0
30000.0
25-Feb-10 To Capital
10000.00

0
20000.0
The number 5-Feb-10
of accounts
required
by
an
organization
By Receipts
5000.00
0 depends
upon the degree of details it needs. If bank accounts- are
30000.0
maintained at
3
banks,
the
organization
may
prefer
25-Feb-10 To Bank
10000.00

0to have 3

bank accounts to view how much balance is held in each of the

banks.

General and Subsidiary Ledgers

All these accounts were maintained in specially designed books
known as Ledgers. Each account was maintained in a separate
page of the ledger. Under the computerized system, these
accounts are maintained in different tables within the
databases. But the terms still continue to be used.
Broadly, there are 3 types of ledgers:
1. General Ledger
2. Subsidiary Ledgers
3. Profit & Loss Ledger
Their functionalities, however, have not undergone any
changes. All banking software have separate modules for each
of these ledgers.

Assets, Liabilities and Equity

The accounts maintained in the General Ledger and Profit &
Loss ledgers are reflected in the financial statements, Balance
Sheet and Income Statements respectively.
As per the Accounting Rules, each account appearing in
General Ledger has to be classified under any of the following 3
categories:

1. Assets
2. Liabilities
3. Owners Equity
At any point of time, the sum of Liabilities and Owners Equity
has to be equal to Assets. Going forward, we shall see how this
equation is maintained while effecting the financial
transactions.

Balance Sheet
A Balance Sheet is a financial statement that summarizes a
company's assets, liabilities and shareholders' equity at a
specific point in time. Each entry in Balance Sheet correspond
to an Account in General Ledger.
It typically takes the following form:

Company Name & Address

Assets
Liabilities
Amoun
Description
Description
t
1200.0
Plant and Machinery
Owner's Equity
0
Inventory
Receivables
Total

900.00 Payables
800.00
2900.0
Total
0

Amoun
t
700.00
2200.0
0

2900.0
0

Balance Sheet of a Bank

Sample Balance Sheet XYZ Bank
Liabilities

Assets

Particulars

Amoun Particulars
t

Deposits

2000.00 Cash

Borrowings

200.00 Securities

Shareholder's Equity

100.00 Loans
Other Assets

Total Liabilities and

Equity

2300.00 Total Assets

Amoun
t
50.00
500.00
1500.00
250.00
2300.00

A bank's balance sheet is different from that of a typical

company. You won't find inventory, accounts receivable, or
accounts payable. Instead, under assets, you'll see mostly loans
and investments, and on the liabilities side, you'll see deposits
and borrowings.

Trial Balance
Trial Balance is a replica of Balance Sheet excepting that it has
rows for Income and Expenditure also. Whereas a Balance
Sheet is prepared once a year for the entire organization, a Trial
Balance is prepared at the end of each business day at each
branch of a bank.
Liabilities

Assets

Particulars

Amou Particulars
nt

Deposits

2000.0 Cash
0

50.00

Borrowings

200.00 Bank

500.00

Income

300.00 Loans
Expenditure

Amoun
t

1700.00
250.00

Total Liabilities
2500.0
Total Assets
2500.00
The outstanding
balances
of accounts
maintained
in the
General Ledger are mapped 0in the Trial Balance. Expenditure
account is placed under Assets and Income account is placed
under Liabilities.

Chart of Accounts
A chart of accounts is a listing of the names of the accounts
that an organization has identified and made available for
recording transactions in its General Ledger. The organization
has the flexibility to tailor its chart of accounts to best suit its
needs, including adding accounts as needed.
A chart of accounts will likely be as large and as complex as the
organization itself. An international bank with several divisions
and subsidiary may need thousands of accounts, whereas a
small local bank may need as few as one hundred accounts.
The Trial Balance is a listing of the Chart of Accounts with
outstanding balances. There may be several accounts which
have been defined by the bank, but they do not have any
outstanding balances. Those Account Heads may not appear in
the Trial Balance.

Cash Versus Accrual Accounting

The difference between the two methods is how and when
income / receipts and expenses / payments are recognized.
Cash

Accrual

The
cash
basis
recognizes The accrual basis of accounting,
receipts and payments only when on the other hand, recognizes the
cash changes hands.
receipts and payments when
they are incurred; it does not
Many small operations use the matter when cash is actually
cash basis of accounting for their received or paid.
type of business; no requirement
exists to prepare and report their
financial position to external
users.

All the major business institutions follow the double-entry

accrual accounting system. In this module, we will consider
only this type of accounting.

The Fundamental Accounting Equation

Liabilities + Owners Equity = Assets

It also implies

Liabilities Assets = Owners Equity

To maintain this equilibrium, any change in one element needs
to be counterbalanced by a complementary change in at least
one other element. As the Newton's Third Law of Motion says
that For every action there is an equal and opposite reaction,
the law of accounting demands that Every Debit transaction
must have an equal Credit transaction to nullify the effects of
each other.
It means, solo financial transactions are not permitted in
Accounting Rules. At least 2 transactions, 1 Debit and 1 Credit,
are required to record 1 financial event. This is the basis for the
widely accepted Double Entry Accounting System.
To keep these sets of transactions together, Journal Entries are
used. Entries from the Journal are posted in respective

Rules of Debit & Credit

The rules of debits & credits are different for different types of
accounts.

Personal
Accounts

Real Accounts

Nominal
Accounts

Debit the receiver

of benefits

Debit what comes

in

Debit all expenses

and losses

Credit the giver of

benefits

Credit what goes

out

Credit all incomes

and gains

The Effects of Debits and Credits

Whenever a transaction is posted in any account, basing upon
the rules of debits and credits, the following effects takes place.

Account Type

Debit Effect

Credit Effect

Assets

Increase

Decrease

Liabilities

Decrease

Increase

Shareholder's
Equity

Decrease

Increase

Income

Decrease

Increase

Expenditure

Increase

Decrease

Journal Entries
The following will be the Journal Entries if Bob is depositing
cash in his account.
DATE
PARTICULARS
L. DEBIT
CREDI
F
T
01 Jan

Cash A/c
1000.00
Dr
1000.0
Bobsthe
Deposit
0
It is customary toToplace
Debit A/c
entries first followed by Credit
entries. Dr, Cr and A/c are abbreviations for Debit, Credit and
Account respectively.

Vouchers

Accounting
Lets evaluate the effects of the Journal Entry Bob
depositing cash in his deposit account. Below is the
Trial Balance after the transactions were posted in
respective accounts in General Ledger.

Prev.
Balan
ce
2000

Trial Balance

Liabilities

Assets

Particulars

Amou Particulars
nt

Amoun
t

Deposits

3000.0 Cash
0

1150.00

Borrowings

200.00 Bank

600.00

Other Liabilities

400.00 Loans
Furniture

Income

300.00 Expenditure

Prev.
Balan
ce
150

1700.00
200.00
250.00

Total
Assets 3900.0
Notice that
the Deposits 3900.0
Account Total
as well
as Cash Accounts have
Liabilities
0
0
increased thereby increasing the Total Liabilities and Total
Assets of the Bank.

Accounting
Similar is the case after the Debit and Credit vouchers
were posted to pay the monthly rent. Below is the
Trial Balance after the transactions were posted in
respective accounts in General Ledger.

Prev.
Balan
ce
3000

Trial Balance

Liabilities

Assets

Particulars

Amou Particulars
nt

Amoun
t

Deposits

14500. Cash
00

1150.00

Borrowings

200.00 Bank

600.00

Other Liabilities

400.00 Loans
Furniture

Income

300.00 Expenditure

1700.00

Prev.
Balan
ce
250

200.00
11750.0
0

Notice that the Deposits Account as well as Expenditure

Total
15400. Total Assets 15400.
AccountsLiabilities
have again increased
00thereby increasing the
00 Total
Liabilities and Total Assets of the Bank.

Accounting
In both the previous cases, we saw that the transactions were
increasing the Total Liabilities and Total Assets of the branch.
That was because, in both the cases, while one transaction was
posted in a account under the Assets, the other was posted in
an account under Liabilities.
There may be instances where a Journal Entry will not change
the Total Liabilities and Total Assets figures.
Consider the following Journal Entry. The branch is purchasing
some office furniture for Rs. 500/- by paying cash.
DATE

PARTICULARS

01 Jan

Furniture A/c
Dr
To Cash A/c

L.
F

DEBIT

CREDI
T

500.00
500.00

Accounting
Below is the Trial Balance after the transactions were
posted in respective accounts in General Ledger.
Trial Balance
Liabilities

Assets

Particulars

Amou Particulars
nt

Deposits

14500. Cash
00

650.00

Borrowings

200.00 Bank

600.00

Other Liabilities

400.00 Loans
Furniture

Income

300.00 Expenditure

Amoun
t

Prev.
Balan
ce
1150
Prev.
Balan
ce
250

1700.00
700.00
11750.0
0

Notice that both the Debit and Credit transactions have been
Total
15400.
Total While
Assets
posted in
the accounts under
Assets.
the15400.
balance is Cash
00
00
Account Liabilities
has decreased, the balance
in Furniture Account
has
been increased by an equal amount thereby keeping the Total
Assets unchanged.

Accounting
So far we have considered only Simple Journal Entries effecting
2 accounts only. Compound Journal Entries involve transactions
in more than 2 accounts.
Lets consider a transaction in Suspense Account to
demonstrate Compound Journal Entries.
John, an employee of the bank asks for a Travelling Advance of
Rs. 10,000/-. The exact expenditure on travel is not known at
this point of time.
So the following Simple Journal Entry will be passed to credit
Johns
with Rs. 10,000/DATE account
PARTICULARS
L. DEBIT
CREDI
F
T
01 Jan

Suspense A/c
Dr
To Johns A/c

10000.0
0

10000.
00

Accounting
The resulting Trial Balance will look like the following.
Prev.
Balan
ce
14500

Trial Balance
Liabilities

Assets

Particulars

Amou Particulars
nt

Amoun
t

Deposits

24500. Cash
00

1150.00

Borrowings

200.00 Bank

600.00

Other Liabilities

400.00 Loans
Furniture
Suspense A/c

Income

300.00 Expenditure

1700.00

Prev.
Balan
ce
0

200.00
10000.0
0
11750.0
0

Notice that the Suspense Account is newly created with this

Total
25400. Total Assets 25400.
transaction.
Liabilities
00
00

Accounting
When John will submit the bill, the Suspense Account entry will
get wiped out and 3 accounts will be effected.
Lets say, John is submitting bills for Rs. 7000/-. He has to
refund the excess amount over the bill, i.e., Rs. 3000/-.
The following Journal Entry will be passed. This is an example of
a Compound Journal Entry.
DATE

PARTICULARS

L.
F

DEBIT

CREDI
T

15 Jan

Expenditure A/c
7000.00
Dr
3000.00
Johns A/c
10000.
Dr
00
The actual Travelling
Expense is Debited to Expenditure
To Suspense
A/cto Johns deposit account.
Account. Excess advance
is Debited
The total Debit amount is credited to the Suspense Account.

Accounting
The resulting Trial Balance will look like the following.
Prev.
Balan
ce
24500

Trial Balance
Liabilities

Assets

Particulars

Amou Particulars
nt

Amoun
t

Deposits

21500. Cash
00

1150.00

Borrowings

200.00 Bank

600.00

Other Liabilities

400.00 Loans
Furniture
Suspense A/c

Income

300.00 Expenditure

1700.00
200.00
0.00
18750.0
0

Prev.
Balan
ce
10000
Prev.
Balan
ce
11750

Total
Assets
22400.
Notice that
the Suspense22400.
AccountTotal
is newly
created
with this
Liabilities
00
00
transaction.