Draft a specimen accounting policy concerning advances of a bank. | (1) Provisions for doubtful advances have been made to the satisfaction of auditors : In respect of identified advances based on a periodical review and after taking into account the portion of advances guaranteed by DICGC & ECGC and similar statutory bodies. In respect of general advances as a percentage of total advances taking into account guidelines issued by the Government of India and RBI. (2) Provisions in respect of doubtful advances have been deducted from advances to the extent necessary and the excess has been included under “other liabilities and provisions”. (3) Provisions have been made on a gross basis. Tax relief which will be available when the advance is written off will be accounted for in the year of write off. | ||||
Acceptances, endorsement and other obligations* | A bank has a more acceptable credit as compared to that of its customers. On this account, it is often called upon to accept or endorse bills on behalf of its customers. In such a case, the bank undertakes a liability towards the party which agrees to receive such a bill in payment of a debt or agreed to discount the bill after the same has been accepted by the bank. As against this liability, the bank has a corresponding claim against the customer on whose behalf it has undertaken to be a party to the bill, either as an acceptor or as an endorser. Such liabilities which are outstanding at the close of the year and the corresponding assets are disclosed as contingent liability in the financial statements. As a safeguard against the customer not being able to meet the demand of the bank in this respect, usually the bank requires the customer to deposit a security equivalent to the amount of the bill accepted on his behalf. A record of the particulars of the bills accepted as well as of the securities collected from the customers is kept in the Bills Accepted Register. A bank may not treat this book as part of the system of its account. In such a case no further record of the transactions is kept until the bill matures for payment. If the bill, at the end of its term, has to be retired by the bank and the amount cannot be collected from the customer on demand, the bank reimburses itself by disposing of the security deposited by the customer. | ||||
NPA | An asset is classified as non-performing asset (NPA) if dues in the form of principal and interest are not paid by the borrower for a period of 90 days. If any advance or credit facilities granted by a bank to a borrower becomes non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exist certain advances/credit facilities having performing status. Income from the non-performing assets can only be accounted for as and when it is actually received. In concept, any credit facility (assets) becomes non-performing when it eases to generate income. The RBI has issued guidelines to commercial banks regarding the classification of advances between performing and non-performing assets. A term loan is treated as a non-performing assets (NPA) if interest and/or instalments of principal remains over due for a period of more than 90 days. A cash credit/overdraft account is treated as NPA if it remains out of order for a period of more than 90 days. An account is treated an ‘out of order’ if any of the following conditions is satisfied : (a) the outstanding balance remains continuously in excess of the sanctional limit/drawing power. (b) though the outstanding balance is less than the sanctioned limit/drawing power— (i) there are credits continuously for more than 90 days as on the date of balance sheet or (ii) credits during the aforesaid periods are not enough to cover the interest debited during the same period. Bills purchased and discounted are treated as NPA if they remain overdue and unpaid for a period of more than 90 days. Necessary provision should be made for non-performing assets after classifying them as sub-standard, doubtful or loss asset as the case may be. | ||||
Classification of activities (with two examples) as suggested in AS 3, to be used for preparing a cash flow statements. | AS 3 (Revised) on Cash Flow Statements requires that the cash flow statement should report cash flows by operating, investing and financing activities. (i) Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. Cash receipts from sale of goods and cash payments to suppliers of goods are two examples of operating activities. (ii) Investing activities are acquisition and disposal of long-term assets and other investments not included in cash equivalents. Payment made to acquire machinery and cash received for sale of furniture are examples of investing activities. (iii) Financial activities are those activities that result in changes in the size and composition of the owner’s capital (including preference share capital in the case of a company) and borrowings of the enterprise. Cash proceeds from issue of shares and cash paid to redeem debentures are two examples of financing activities. | ||||
Classification of advances in the case of a Banking Company. | Banks have to classify their advances into four broad groups: (i) Standard Assets—Standard assets is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset is not a NPA as discussed earlier. (ii) Sub-standard Assets—Sub-standard asset is one which has been classified as NPA for a period not exceeding 12 months. In the case of term loans, those where instalments of principal are overdue for period exceeding one year should be treated as sub-standard. In other words, such an asset will have well-defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the bank will sustain some loss, if deficiencies are not corrected. (iii) Doubtful Assets—A doubtful asset is one which has remained NPA for a period exceeding 18 months. In the case of term loans, those where instalments of principal have remained overdue for a period exceeding 18 months should be treated as doubtful. A loan classified as doubtful has all the weaknesses inherent in that classified as sub-standard with added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. (iv) Loss Assets—A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspectors but the amount has not been written off, wholly or partly. The classification of advances should be done taking into account (i) Degree of well defined credit worthiness and (ii) Extent of dependence on collateral security. The above classification is meant for the purpose of computing the amount of provision to be made in respect of advances and not for the purpose of presentation of advances in the balance sheet. Classification of Bank advance on the basis of assets performance for determining loss provision. The bank should classify its assets in four categories: (a) Standard asset – Which do not have any problem & does not carry abnormal risk. It is not a NON-PERFORMING ASSETS (NPA). (b) Substandard asset – Asset which has been classified as NPA for a period not exceeding 12months. The asset has some credit weakness. Bank will incur some loss if these deficiencies are not corrected. For e.g.– Term loan instalment overdue for more than one year, any loan agreement whose interest & principal terms are renegotiated come under this category. (c) Doubtful asset – Asset remaining NPA exceeding 18 months.(12months) (d) Loss assets – It is an asset where loss is identified the auditors (internal or external) or RBI inspection. There is a very little chance of recovery. Provisions to be made on the above category of assets: (a) For loss assets 100% provision (b) For doubtful assets:- (i) 100% provision Unsecured portion (ii) 20% – 100% provision of secured portion As per the following guidelines:
(c) Substandard assets – 10% provision (Addl . 10% Provision in case of Educational and personal Loan.) (d) Standard assets – 0.40% provision shall be made | ||||
Cash flow statement | Cash flow statement is a statement of inflows and outflows of cash and cash equivalents. It starts with the opening balance of cash and cash equivalents at the start of the accounting period. It then gives in a summary form, the inflows and outflows relating to the following three classifications of activities : (i) Operating activities : They are the principal revenue producing activities of the enterprise. (ii) Investing activities : They deal with the acquisition and disposal of long-term assets and long term investments. (iii) Financing activities : They reflect changes in the size and composition of capital in the case of a company this would preference capital and borrowings of the enterprise. The cash flows arising from extraordinary items are disclosed separately under each of the above three classifications. Likewise where the amount of significant cash and cash equivalent balances held by an enterprise are not available for use by the enterprise, the same should be disclosed separately together with a commentary by the management. | ||||
CFS vs. FFS | Differences between cash flow statement and fund flow statement (i) Cash flow statement deals with the change in cash position between two points of time. Fund flow statement deals with the changes in working capital position. (ii) Cash flow statement contains opening as well as closing balances of cash and cash equivalents. The fund flow statement does not contain any such opening and closing balance. (iii) Cash flow statement records only inflow and outflow of cash. Fund flow statement records sources and application of funds. (iv) Fund flow statement can be prepared from the cash flow statement under indirect method. However, a cash flow statement cannot be prepared from fund flow statement. (v) A statement of changes in working capital is usually prepared alongwith fund flow statement. No such statement is prepared along with the cash flow statement. | ||||
Reinsurance | If an insurer does not wish to bear the whole risk of policy written by him, he may reinsure a part of the risk with some other insurer. In such a case the insurer is said to have ceded a part of his business to other insurer. The reinsurance transaction may thus be defined as an agreement between a ‘ceding company’ and ‘reinsurer’ whereby the former agreed to ‘cede’ and the latter agrees to accept a certain specified share of risk or liability upon terms as set out in the agreement. A ‘ceding company’ is the original insurance company which has accepted the risk and has agreed to ‘cede’ or pass on that risk to another insurance company or a reinsurance company. It may however be emphasised that the original insured does not acquire any right under a reinsurance contract against the reinsurer. In the event of loss, therefore, the insured’s claim for full amount is against the original insurer. The original insurer has to claim the proportionate amount from the reinsurer. There are two types of reinsurance contracts, namely, facultative reinsurance and treaty reinsurance. Under facultative reinsurance each transaction has to be negotiated invididually and each party to the transaction has a free choice, i.e., for the ceding company to offer and the reinsurer to accept. Under treaty reinsurance a treaty agreement is entered into between ceding company and the reinsurer whereby the volume of the reinsurance transactions remain within the limits of the treaty. A re-insurance business transaction may be defined as an agreement between a ceding company and re-insurer, whereby the former agrees to cede and the latter agrees to accept a certain specified share of risk or liability upon terms as set out in the agreement. The accounting entries pertaining to re-insurance business ceded to and by an insurance company may be explained with the help of an example given below: (X insurance company cedes re-insurance business to Y insurance company and Z insurance company cedes re-insurance business to X insurance company.) Accounting entries pertaining to re-insurance business ceded to and by X insurance company in the above example may be given as follows : 1. Re-insurance Premium (on re-insurance ceded) Account Dr. To Y Insurance Company (Being premium on re-insurance business ceded to Y insurance company recorded) 2. Z Insurance Company Dr. To Re-insurance Premium (on re-insurance accepted) Account (Being premium on business ceded by Z insurance company recorded) 3. Y Insurance Company Dr. To Claims (on re-insurance ceded) Account (Being claims receivable from Y Co. for part of insurance business ceded) 4. Claims (on re-insurance accepted) Account Dr. To Z Insurance Company (Being claims on re-insurance business accepted from Z Company recorded 5. Y Insurance Company Dr. To Commission (on re-insurance ceded) Account (Being commission due on re-insurance business ceded to Y insurance company recorded) 6. Commission (on re-insurance accepted) Account Dr. To Z Insurance Company (Being commission due on re-insurance business ceded to Z Company debited) | ||||
Reserve for unexpired risk**** | In most cases policies are renewed annually except in some cases where policies are issued for a shorter period. Since insurers close their accounts on a particular date, not all risks under policies expire on that date. Many policies extend into the following year during which the risk continues. Therefore on the closing date, there is unexpired liability under various policies which may occur during the remaining term of the policy beyond the year and therefore, a provision for unexpired risks is made at normally 50% in case of Fire Insurance and 100% of in case of Marine Insurance. This reserve is based on the net premium income earned by the insurance company during the year. | ||||
Common size statements**** | It facilitates the comparison of two or more business entities with a common base. In case of balance sheet, Total assets or liabilities or capital can be taken as a common base. These statements are called “Common Measurement” or “Component Percentage” or “100 percent” statements. Since each statement is reduced to the total of 100 and each individual component of the statement is represented as a % of the total of 100 which invariably serves as the base. Thus the statement prepared to bring out the ratio of each asset of liability to the total of the balance sheet and the ratio of each item of expense or revenues to net sales known as the Common Size statements. | ||||
computation of “premium income,” “claims expense” and “commission expense” in the case of an insurance company. | Premium income : The payment made by the insured as consideration for the grant of insurance is known as premium. The amount of premium income to be credited to revenue account for a year may be computed as : Rs. Premium received on risks undertaken during the year (direct & re-insurance accepted) – Add : Receivable at the end of year (direct & re-insurance accepted) – Less : Receivable at the beginning of year (direct & re-insurance accepted) – Less : Premium on re-insurance ceded: – Paid during the year – Add : Payable at the end of year – Less : Payable at the beginning of year – Premium income – Claims expenses : A claim occurs when a policy falls due for payment. In the case of alife insurance business, it will arise either on death or maturity of policy that is, on the expiry of the specified term of years. In the case of general insurance business, a claim arises only when the loss occurs or the liability arises. The amount of claim to be charged to revenue account may be worked out as under : Rs. Claims settled during the year — direct & re-insurance accepted – (including legal fees, survey charges etc.) Add : Payments to co-insurers – Less : Received from co-insurers and re-insurers – Net payment – Add : Estimated liability at the end of the year – (After deducting recoverable from co-insurers and re-insurers) Less : Estimated liability at the beginning of the year – (after deducting recoverable from co-insurers and re-insurers) Claims expense – Commission expenses : Insurance Regulatory and Development Authority Act, 1999 regulates the commission payable on policies to agents. Commission expense to be charged to revenue account is computed as follows : Rs. Commission paid (direct & re-insurance accepted) – Add : Commission payable at the end of the year – (direct & re-insurance accepted) Less : Commission payable at the beginning of the year – (direct & re-insurance accepted) Commission expense – | ||||
Rebate on bill discounted** | Rebate on Bills Discounted When a bank discount a bill of exchange than the total discount is earned but out of this some discount can be for next year. In that case, the unexpired portion of discount is carried forward through the following entry: Discount Account Dr. To Rebate on bills discounted In the next year this entry will be reversed | ||||
Surrender value of life insurance policy* | The investment portfolio of a bank would normally consist of both approved securities (predominantly government securities) and other securities (shares, debentures, bonds etc.). Banks are required to classify their entire investment portfolio into three catogories : held-tomaturity, available-for-sale and held-for-maturity. Securities acquired by banks with the intention to hold them upto maturity should be classified as ‘held-to-maturity’. Securities acquired by banks with the intention to trade by taking advantage of short–term price interest rate movements should be classifed as held-for trading/maturity. Securities which do not fall within the above two categories should be classified as available-for-sale’. |
Monday 26 September 2011
BBI-FRA-theory concept notes
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