Introduction to accounting / bookkeeping
Jokes:_____________________________________________________________
There once was a business owner who was interviewing people for a division manager position. He decided to select the individual that could answer the question “how much is 2+2?”
The engineer pulled his slide rule and shuffled it back and forth, and finally answered, “ it’s between 3.98 and 4.02”
The mathematician said, “In two hours I can demonstrate it equals 4 with the following short proof”.
The physicist declared, “It’s the magnitude of 1x10’”
The logician paused for a long while and said, “This problem is solvable”’
The attorney stated, “In the case of Svensson vs. the State, 2+2 was declared to be 4”.
The social worker said, “I don’t know the answer, but I’m glad we discussed this important question”.
The trader said, “Are you buying or selling?”
The accountant looked at the businessman, then got out of his chair, went to see if anyonewas listening at the door and pulled the drapes. Then he returned to the business owner, leaded across the desk and said in a low voice, “What would you like it to be?” ________________________________
Every transaction (balance sheet transaction) executed by the bank has to be appropriately registered and booked in the bank’s balance sheet in accordance with the existing accounting regulations and procedures. A transaction is any event that affects the financial position of an entity and that an accountant can reliably record in money terms.
The balance sheet (statement of financial position) is a document that shows the financial status of a business entity, bank included, at a particular instant in time. Actually this is a sort of a snapshot of entity’s performance translated in accounting language. It has two counterbalancing sections. The left side lists the resources of the bank or firm or everything they own and control. The right side lists the claims against the resources. The resources and claims form the balance sheet equation:
Assets
= Liabilities + Owner’s equity / net worth / capital
For every business, including banking, the things than it owns are assets and those that in owes are liabilities. The difference between the two, which is how much more the business owns than it owes, is its equity or net worth. To be more precise, net worth (capital) is the amount of funds that would be available to the stockholders (owners) if the bank (entity) were to liquidate (go out of business or convert everything it owned into cash). This is represented by the original value of its common stock (shares) plus the additional funds, or surplus that it has acquired over the years.
A double-entry accounting system strictly followed by all accountants requires that when they record a transaction, they make at least two entries in their books so that the total assets always equal the total liabilities plus owners’ equity.
How do accountants make their entries? Do the procedures suggest that every transaction must always engage both sides of the balance-sheet equation?
This all depends upon the specific situation. The procedure is strictly determined to meet the requirements of the balance sheet equation as well as the rules of the double entry accounting. Sometimes it involves both the right and the left sides of the equation, sometimes only one side is affected.
Let’s suppose the bank purchases some new hardware for $100,000. The accountants will register this purchase by two entries. The transaction affects the balance sheet equation as follows: it increases one asset, bank’s Equipment, and decreases another asset, Cash, by the same amount. As a result the form of the assets change, but the equation remains. In accountant language we credited asset Cash and debited asset Equipment. In contrast, let’s suppose a customer deposited a sum of $100,000 in a bank. The transaction affects the balance sheet as follows: it increases both assets (Cash) and liabilities (Sight or Time deposits) by the same amount $100,000.
Depending on what is the financial nature of the specific entries (increase or decrease of funds) as well as what side of the balance sheet is affected, accountants are debiting or crediting funds. Based on this debit and credit entries in accounting will have opposite consequences.
For ASSETS debit means adding / increase of funds
Credit means deduction / decrease
For LIABILITIES is visa-versa:
Debit means deduction / decrease
Credit means adding / increase
This could be illustrated by the routine banking practice. Suppose your company has an account with the bank. And thanks to the successful deal the company gets some revenue transfer which affects your bank account. For the bank the funds on your account are liabilities, that’s why in order to inform you about the incoming sum the bank will have to send you credit advice. In contrast, when it deals with payments from your account the bank sends you debit advice.
How do the accountants know which balance item they will have to invoke while posting an entry? Except for knowledge and experience that are of apparent support plus highly computerized procedures, there is a book called Chart of Accounts which guides a bank or organization accountants in this matter. The items in the Chart of Accounts have corresponding code numbers according to major components of the balance sheet allocated in the Chart. For example, number 1 as a rule corresponds to assets, number 2 – liabilities, 3 – own capital, 4 – revenues, 5 – expenses, 6 – taxes. The second figure in the number further specifies the type of assets, liabilities, etc in question. For example number 11 means Cash, 14 – accounts receivable, etc. Specific Chart of Accounts may vary across countries and companies but its principles consolidated in GAAP (Generally Accepted Accounting Principles) remain the same.
An example of a balance sheet recommended by the International Labor Organization (ILO) for banks suggests some key asset items like:
CASH
Currency, including domestic
Balancies with Central Bank
Other currency
LIQUID ASSETS
Domestic treasury bills
Other rediscountable securities
LOANS TO CREDIT INSTITUTIONS
Sight deposits
Money market deposits
Other interbank loans
Debit collections
LOANS TO CUSTOMERS
Non rediscountable bills
ST loans and advances
Term loans
Mortgage loans
Less Loan loss reserves
TANGIBLE ASSETS
Land and building
Equipment
Furniture and fixtures
Construction in progress
Less accumulated depreciation
LIABILITIES
Amounts owed to credit institutions, including domestic Central Bank, other banks
Amounts owed to customers, including:
sight deposits
time deposits
savings deposits
other liabilities including:
interest payable
taxes payable
items in suspense
provisions, including loan loss provisions
CAPITAL
Paid in capital
Capital reserve, etc.
Working assignment:_____________________________________________
Translate into Russian words and expressions boldfaced as well as main items in the balance sheet.
Give definitions of the balance sheet and balance sheet equation.
What is a double-entry accounting system?
How do debit and credit entries show themselves in the balance sheet?
What is the essence the Chart of Accounts?
Jokes_______________________________________________________________________
An accountancy student asks a partner to explain ethics in accountancy. me a bill.
The partner thinks for a moment and relates the following.
“Mr. Jones, one of our clients, came to see me last week and paid me a bill of $ 1,000 in cash.
As he left I counted the notes and they came to $ 1,100.
The student said. “I see. The ethics question is do I tell the client?”
“Wrong answer!”
The question is do I tell my partner”._________________________________________
METHODS OF PAYMENT
There are at least four basic methods of payment the bank can provide to its customers:
payment in advance (advance payment)
payment on open account
payment by Bills of Exchange
payment by Letter of Credit (LC)
Payment in advance or cash with order (CWO) is the simplest way to deal with. It avoids risks on small orders and may even be asked for before production begins. However, this form of payment is rare in international trade since it means that an overseas buyer is extending credit to an exporter – when the opposite procedure is the normal method of trade.
Variation of this form of payment is cash on delivery (COD) when your purchase is released upon payment of the invoice. Invoice or commercial invoice is a bill for the goods from the seller to the buyer.
Payments on open account presume that the goods and paying documents are sent directly to an overseas buyer who has agreed to cover the debt within a certain period of time after the invoice date - usually not more than 180 days. This method of payment is popular within the European Community because it is simple and straightforward.
Payments by Bills of Exchange. A Bill of Exchange is legally defined as “unconditional order in writing, addressing by one person to another, signed by the person giving it, requiring the person to which it is addressed to pay on demand or at a fixed determinable future time a certain amount of money, to or to the order of a specific person, or to the bearer”.
In other words an exporter prepares a bill of exchange which is drawn on an overseas buyer, or on the third party as designated in the export contract, for the sum agreed at settlement.
The bill is called a sight draft if it is made out payable at sight, i.e. “on demand”. If it is payable at fixed or determinable future time it is called a term draft.
By using a bill of exchange with other shipping documents through the banking system, an exporter can ensure greater control of the goods since the release of them to the buyer is subject to his acceptance and payment of the bill.
Payments by Letter of Credit (LC) or a documentary credit is the most sophisticated way to ensure the rights of the exporter. In simple terms, is a conditional bank undertaking of payment. Expressed more fully, it is a written undertaking by the bank (issuing bank) given to the seller (beneficiary) at the request, and on the instructions of the buyer (applicant) to pay at sight or at determinable future date up to a stated sum of money, within a prescribed time limit and against stipulated documents such as commercial invoice, certificate of origin, insurance policy or certificate and a transport document of a type appropriate to the mode(s) of transport used. A transport document applicable to a carriage of goods by the see is known as Marne Bill of Lading.
There are four major steps in the general procedure of LC usage.
First – the buyer and the seller conclude a sales contract providing for payment by documentary credit.
Second – the buyer instructs his bank – the issuing bank – to issue a credit in favor of the seller (beneficiary)
Third – the issuing bank asks another bank, usually in the county of the seller, to advise or confirm the credit.
Four – the advising or confirming bank confirms the credit and informs the seller that the credit has been issued.
Both parties engaged in the contract can be sure that their rights and interests are fully protected: sellers’ goods will be released to the buyers provided that full payment in their favor will be effected. In turn buyers will not lose their money since payment will be effected only upon shipment of the goods.
Working assignment:______________________________________________
Give brief characteristics of the major methods of payments used in banking.
Fill in the gaps without consulting the text.
Banks as Financial _______________________
In what sense are banks financial intermediaries standing between ___________________and _________________? A bank is a business and its owners or managers aim to _______________________. A bank makes profits by lending and borrowing. To get money in, the bank offers ___________________terms to potential ___________________. British clearing banks offer ___________________on sight deposits only to important customers, but they usually offer free ___________________to people whose sight deposits or current accounts do not fall below a certain level. They do not ___________________directly for the expenses of clearing and __________________ cheques. And they offer interest on ___________________ deposits.
Next, the banks have to find ___________________ ways to lend what has been borrowed. Most is lent out as advances of overdrafts to households and firms, usually at interest rates ___________________ of the rate simultaneously being paid to the bank customers with time deposits. Some is used to purchase securities such as ___________________. Some is more prudently invested in ___________________assets. Although these do not pay such a ___________________, the bank knows that it can get its money back quickly if people start ___________________a lot of money from their sight deposits. And some money is held as cash, the most ___________________asset of all.
What economic services does the bank provide? It is transforming ___________________ loans to the bank into bank loans to a wide range of people – governments wishing to finance a ___________________, firms borrowing to build a new factory, and individuals borrowing to start a new business or to buy a new home. The bank is using its specialist ___________________to acquire a ___________________ portfolio of investments though depositors merely observe that they get an interest rate on their time deposits or free chequing facilities. Without the existence of the intermediary, depositors would have ___________________the time nor the expertise to decide which of these loans or investments to make. That is the economic service that the bank as an intermediary provides.
Translate into English:
История о ювелире-банкире хорошо иллюстрирует роль современных банков. Предоставляя населению ссуды, золотых дел мастера получали возможность создавать деньги. Они делали это, вновь выпуская в обращение золото, которое раньше лежало у них в подвалах. Выбор величины резервов подразумевает компромисс между прибыльностью и платежеспособностью. Слишком большая сумма предоставленных кредитов делает ювелира неспособным удовлетворить все требования на золото, чересчур маленькая означает отсутствие прибыли.
Современные коммерческие банки - это финансовые посредники, извлекающие прибыль. Они привлекают средства через свои депозиты или берут взаймы напрямую и затем используют эти средства для предоставления ссуд.
Вместе банки облегчают осуществление платежей в экономике. Система клиринга чеков способствует более быстрой их оплате в масштабах страны.
Банки держат менее 10 центов резервов на каждый доллар обязательств по своим депозитам. Как и ювелиры, банки создают деньги, когда предоставляют ссуды. Они делают это или посредством сокращения своих кассовых резервов, или увеличивая суммы своих депозитов.
Translate into Russian.
Future Banking (by Kate Stalter/ www.money.usnews.com/ june 29, 2015)
When Fifth Third Bancorp said recently that it would close 100 branches and sell properties intended for branches, the Cincinnati–based bank was candid about the reason.
In a statement, Fifth Third CEO Kevin Kabat said, “Consumer demographics and our customers’ preferred channels are undergoing significant changes. Technology continues to impact our service delivery and revenue generation tactics and strategies”.
Fewer Americans are setting foot in bank branches these days, opting to conduct transactions with mobile apps or ATMs. New companies, like Moven, only offer mobile and ATM access, but provide debit cards, account linking and an easy way to send money to friends.
Customers’ views of banking are changing fast, with fewer people seeing the value of visiting a bank branch. In its 2015 North America Consumer Digital Banking Survey, which included more than 4,000 adults in the U.S. and Canada, consulting and technology management firm Accenture found that 81 percent of consumers said they would not switch banks if their local branch closed. Only two years ago, that number was 48 percent.
In addition, 38 percent sad good online banking services were the top reason for staying with a bank. That come in ahead of location and lo fees, both being named at the top reason 28 percent of the time.
Here are some banking-industry changes consumers are likely to see in the next few years:
Fewer branches. “Branch traffic is fallen, and banks will have to figure out how to adapt to this”, sais Wayne Busch, managing director for banking in Acceture.
The Fifth Third branch closures, which the bank expects to complete by mid-2016, may be an early sign of what’s ahead. “That’s just one small piece in a very big story that’s unfolding”, says Jason O’Donnel, chief investment officer at Bluestone Financial Institutions Fund in Wayne, Pennsylvania. The fund focuses on small and midsize community banks.
“You are going to see a lot few branches, and huge consolidations, with fewer banks. The branches that we will have will look and feel very different. In another five or 10 years, the average branch will be 50 percent smaller than the branch sizes we see now, and we’ll see more use of kiosks and other technologies”, O’Donnell says.
Fewer banks. Smaller community banks are facing headwinds as the industry races to implement new technologies. At the same time, megabanks are dealing with the increased regulation and the yearly Federal Reserve stress tests.
That may leave regional banks, perched between the tiniest and the largest institutions, in a good position.
Although the pace of bank consolidation slowed for several years after the financial crisis, Busch and O’Donnell both expect mergers and acquisitions to pick up in the coming years.
Some smaller banks may become acquisition targets because of their particular niche. “A real change is that variety of different organizations are competing not to the Bank of America or Chase, but to pursue one or two segments of value” Busch says.
O’Donnell notes that smaller banks may get rolled into midsize banks. Those mergers and acquisitions will give the midsize banks increased capabilities to take market share from larger firms, O’Donnell predicts. “This will be a “middling” of the industry, with a lot fewer banks. The acquisition pace has picked up considerably over the last several quarters. As consumers, one of the benefits is that we’ll get better service in a bunch of ways”, e says. banks
“True community banks with under $500 million in assets, are dead banks walking”, O’Donnell adds. “Some of this regulation has actually pushed ts way down to these banks”.
That’s hurt small banks profitability. “The beneficiaries are the guys in the middle. They’re big enough to absorb some of these extra regulatory expenses, but small enough that they don’t have to worry about the federal government suing them every other month”, he says.