MCom I Semester Corporate Accounts Banking Companies Study Material Notes

MCom I Semester Corporate Accounts Banking Companies Study Material Notes: Book Keeping Banks Subsidiary Cash Book Subsidiary Special Features Bank BookKeeping Final Accounts of Banks Schedule operating Expenses Explanation of Some Important Terms Relating Balance Sheet Journal Entries Ledger Accounts Income from Non Performing Assets Old Approach Accrued Classificaiotn Bank advance Providison loss Advance :

CTET Paper Level 2 Previous Year Science Model paper II in Hindi

Accounts of Banking Companies

The banking companies in India are governed by the Banking Regulation Act, 1949. A banking company is defined as any company which transacts the business of banking. Section 5 (b) of the Banking Regulation Act defines banking as the accepting for the purpose of lending or investment, of deposits, of money from the public, to be payable on demand or otherwise and withdrawable by cheque, draft, order or otherwise. Thus, a banking company is that which accepts deposits of money from the public and lends or invests these deposits.

Day-to-day Book-keeping in Banks

A banking company follows the principle of double entry in recording its transactions in the Books of Account. The principal books of account of a banking company are (1) the Cash Book and (2) the General Ledger. The Cash Book is written with the help of paying-in-slips and withdrawal forms. It, thus, gives the summary of the Receiving Cashier’s Counter Cash Book and the Paying Cashier’s Counter Cash Book. The General Ledger contains control accounts for the subsidiary ledgers listed below and accounts of expenses and assets not covered by the subsidiary ledgers. In addition to these two principal books, a number of subsidiary books are also maintained by a bank which are as follows:

Subsidiary Cash Books :

(i) Receiving Cashier’s Counter Cash Book.

(ii) Paying Cashier’s Counter Cash Book.

(iii) Cash Balance Book.

(iv) Cash Reserve Book.

(v) Day Book.

Banking Companies Study Material

Subsidiary Ledgers :

(i) Current Accounts Ledger.

(ii) Saving Bank Accounts Ledger.

(iii) Fixed Deposit Accounts Ledger.

(iv) Fixed Deposit Interest Ledger.

(v) Over Due Fixed Deposit Ledger.

(vi) Recurring Deposit Accounts Ledger.

(vii) Investments Ledger.

(viii) Loan Ledger.

(ix) Cash Credit Ledger.

(x) Bills Discounted and Purchased Ledger.

(xi) Customers’ Acceptances, Endorsements and Guarantee Ledger

(xii) Premises Ledger.

In addition to the above books and ledgers, certain registers are also maintained by a bank though they do not form part of double entry system. They are as follows:

(i) Bills for Collection Register.

(ii) Securities Register.

(iii) Demand Draft Register

(iv) Lockers Register

(v) Safe Deposit Vault Register.

(vi) Bills Register.

(vii) Jeweler Register.

(viii) Standing Order Register.

(ix) Dishonored Cherubs Register.

(x) Document Register.

(xi) Letters of Credit Register.

(xii) Drafts Payable Register.

(xiii) Drafts Issue Register.

Banking Companies Study Material

Special Features of Bank Book-keeping

(1) Slip System of Ledger Posting : In banks, slip system of ledger posting is adopted according to which entries are first made in the accounts of customers on the basis of slips and then a Day Book is written up. Subsequently, entries in the accounts of customers are checked with those in the Day Book. Slips are nothing but loose leaves of journals or cash books on which transactions are recorded as they occur. Three types of slips are used in bank book-keeping- paying-in-slips, withdrawals or cheques and dockets. The first two are written by bank customers whereas the third type of slips (dockets) are prepared by bank staff for such transactions for which there are no original vouchers, e.g. the loan department of a bank prepares vouchers when the interest is due. These slips are the main media in bank accounts. For example, when a customer deposits money, he writes a paying-in-slip. The receiving cashier debits the cash account on the basis of this slip and passes it on to the ledger-keeper for crediting the customer’s account. Similarly, when a customer makes a withdrawal, he writes a cheque, on the basis of which the paying cashier credits cash account and the ledger keeper debits the customer’s account.

Necessity of the System : The main reasons of adopting this system of posting in banks are as follows:

(1) The bank must keep the customers’ accounts accurate and complete up to the very minute, for a customer may present a cheque any time during bank’s business hours.

(2) As the number of transactions in a bank is very large, the adoption of slip system enables the distribution of work of posting among many persons.

(3) This system ensures smooth flow of accounting work without any interruption.

Advantages of the System : The main advantages are as follows:

(1) Easy Accounting : The posting of ledger and writing up of the Day Book can be carried out simultaneously without any loss of time.

(2) Saving of Time : The bank saves a lot of clerical labour, as most of the slips are filled in by its customers.

(3) Saving of Subsidiary Books : Subsidiary books are avoided as posting is done from slips.

(4) Trustworthy Accounting Records : This system provides an objective evidence of the records as slips are filled in mostly by the customers. Each transaction is recorded by several employees in many books and all books are maintained on self balancing system.

(5) Division of Labour : Due to use of slips, work is divided among many employees. This helps in easy determination of responsibility of each work.

(6) Facility in Audit: As most of the slips are filled by customers, they act as vouchers at the time of audit of the bank.

(7) Proper Evidence : Slips are preserved by the banks and can be used as a proper evidence of a transaction when needed. For example, if a customer claims that his account has been wrongly debited by a certain amount, then bank can satisfy him by showing his cheque or withdrawal slip duly signed by him as an evidence.

Banking Companies Study Material

Disadvantages of the system : The disadvantages are:

(1) Slips may be lost, destroyed or misappropriated as these are loose.

(2) Books can not be verified if subsidiary books are not kept.

(3) Illiterates find difficulty in transactions with the bank as mostly the slips are filled by the customers.

(4) By manipulating the amounts of the slips or destroying the slips, dishonest employees can embezzle.

(5) As the number of transactions in every bank is very large, it is an expensive system, since a date wise record is kept with the help of large number of slips.

(2) Self-Balancing System of Ledgers : All the ledgers of a bank are maintained on self-balancing system. The General Ledger contains Control Accounts or Total Accounts of all subsidiary ledgers, I.e., deposit ledgers, loan ledger, investment ledger etc. The totals of balances of individual accounts are tallied periodically with the balances of Total Accounts, generally at the end of each week. A special book, known as Balance Book, is maintained for this purpose. Thus, this system provides a useful tool of internal check of a bank.

(3) Daily Trial Balance : The general ledger trial balance is extracted and tallied every day.

(4) Double Voucher System : For non-cash transactions, two vouchers are prepared – one debit voucher and the other credit voucher.

Legal Provisions Affecting Final Accounts

1 Capital Structure : Section 12 provides that the subscribed capital of a banking company must not be less than 50% of its authorized capital, and the paid-up capital must not be less than 50% of its subscribed capital. The capital of the banking company can have equity shares only. The voting right of any single shareholder cannot exceed 1% of the total voting rights.

2. Restriction on Payment of Commission, Brokerage, Discount etc. on Issue of Shares : Section 13 restricts the payment of commission, brokerage, discount or remuneration in any form on issue of its shares to 2% of the paid-up value of such shares.

3. Restriction on Payment of Dividend : Section 15 (1) provides that a banking company can not pay dividend on its shares until all its capitalised expenses including preliminary expenses, organisation expenses, share selling commission, brokerage, amounts of losses incurred and any other item of expenditure not represented by tangible assets are completely written off. As per Section 15 (2) a banking company is, however, permitted to pay dividend without writing off the following:

(i) the depreciation in the value of its investments in approved securities where such depreciation has not actually been capitalised or otherwise accounted for as a loss ;

(ii) the depreciation in the value of its investments in shares, debentures or bonds (other than approved

securities) where adequate provision for such depreciation has been made to the satisfaction of its auditors; and

(iii) the bad debts, if any, where adequate provision for such bad debts has been made to the satisfaction of its auditors.

4. Satutory Reserve Fund : Section 17 lays down that every banking company incorporated in India must transfer at least 20% of its annual profits prior to declaration of dividend to Reserve Fund called as Statutory Reserve Fund and should be shown separate from other reserves. The Act also lays down that if a banking company appropriates any sum from this reserve or the share premium account, the fact must be reported to Reserve Bank within 21 days stating the reasons for such appropriation.

5 Cash Reserves : Section 42 of the Reserve Bank of India Act, 1934 requires that a cubed ain with the Reserve Bank of India an average daily balance of at least 3% of its total time and dia. The Reserve Bank has been empowered to raise this reserve up to 15%. According deposit liabilities in India. The Reserve Bank has been menu to Section 18 of the Banking Regulation Act, every non-scheduled bank is also real every non-scheduled bank is also required to maintain similar balances either with itself or R. B. I. or S. B. I.

6. Liquidity Ratio : Section 24 lays down that over and above the requirement under Section 18, every bank is to maintain at least 33.75% (w. e. f. September 1994) but not exceeding 40% of its total time and demand liabilities in cash, gold or unencumbered approved securities. This is known as statutory reserve requirement.

7. Maintenance of Assets in India : The assets in India of every banking company at the close of business on the last Friday of evey quarter must not be less than 75% of its total time and demand liabilities therein.

Final Accounts of Banks

Every banking company (excluding foreign banking companies) is required to prepare its Balance Sheet and Profit and Loss Account as on 31st March of each year in the form set out in the Third Schedule of Banking Regulation Act w. e. f. 1989. The Schedule has been amended by Government of India by a notification on 18th January, 1991 and subsequently on 19th December, 1992. The new formats have come into force with effect from 19th March, 1992. The Balance Sheet is prepared in Form A while the Profit and Loss Account in Form B of Third Schedule. The new formats are given below.

Provisions and Contingencies: There is no separate schedule for provisons and contingencies. This is shown after Operating Expenses. This includes the following:

(i) Provision for Bad and Doubtful Debts

(ii) Provision for Taxation

(iii) Provision for Diminution in the value of Investments

(iv) Transfer to Contingencies and other similar items.

Banking Companies Study Material

Explanation of some important terms relating to Balance Sheet

1 Other Liabilities and Provisions: All items of liabilities other than shown in Schedules 1, 2, 3 and 4 are included in Schedule 5. They are shown in the following sequence :

(1) Bills Payable : They represent instruments like bank drafts, telegraphic transfers, travellers’ cheques, mail transfers payable, pay slips, bankers cheques etc. issued by bank which remain uncashed upto the date of preparation of final accounts.

(II) Inter-Office Adjustments (Net) or Branch Adjustments : This denotes items relating to branches pending adjustment. A banking company usually has a large number of branch offices in different towns. Many transactions take place between the head office of the bank and its branches inter se and necessary entries are passed in the head office books on receipt of periodical statements from the branches. But in the absence of advices from the branches some entries may remain unadjusted in the head office at the close of the accounting year. Such entries are recorded in the Balance Sheet under the sub-heading ‘Inter-Office Adjustments’ or ‘Branch Adjustments’. There can be both debit and credit balances of this item but it is shown at ‘net’ figure in the Balance Sheet. Net credit balance is shown in Schedule 5 whereas net debit balance is shown in Schedule 11.

(III) Accrued Interest : This denotes interest accrued but not due on deposits from customers and borrowings from other banks.

(IV) Other Provisions : This includes certain specific provisions, such as (i) Provision for Taxation, (ii) Provision for Doubtful Debts or Provision for Loss on Advances, (iii) Provision for Depreciation on Current Investments, (iv) Pension Fund, (v) Gratuity Fund, (vi) Medical Fund, (vii) Insurance Fund (viii) Staff Security Deposits.

(V) Other Liabilities : This includes outstanding expenses, creditors, liability towards subsidiaries. proposed dividend, rebate on bills discounted or unexpired discount etc.

Rebate on Bills Discounted : It refers to the unearned portion of discount received on bills discounted by a bank. Banks discount hundreds of bills every day and receive full discount for the period of bills at the time of their discounting. But, in practice, it frequently happens that some of these bills do not mature for payment by the end of the accounting year. The amount of discount received on such bills in respect of the unexpired period (i.e. period falling after the close of the year) is called ‘Rebate on Bills Discounted’ or Unexpired Discount. For example, on 1st February, 2006, a bill of Rs. 10,000 is discounted by a bank @ 12% p.a. The date of maturity (considering the days of grace also) is 30th April, 2006. The bank closes its accounts on 31st March. In this example, the bank receives a discount of Rs. 300 (10,000 x 1x), out of which interest for two months is for the year 2005-06 and for one month for the year 2006-07. Thus, one-third of Rs. 300 interest received, i.e., Rs. 100 is the income of 2006-07. In the year 2005-06, this amount is unexpired discount and should be carried forward by passing an adjustment entry. In this example, the following entries are passed by the bank :

1 On 1st February 2006 on discounting the bill :

Bills Discounted Account                Dr                            10,000

To Customer’s Current Account                                                                   9,700

To Discount Received Account                                                                     300

2. At the end of the year on 31st March 2006:

Discount Received Account           Dr                              100

To Rebate on Bills Discounted Account

Note: The amount of rebate on bills discounted will be deducted from the item ‘Interest and Discount’ Schedule 13. In the balance sheet it is shown under the heading ‘Other Liabilities and Provisions’ in Schedule 5.

(3) The entry (2) is reversed at the beginning of next accounting year. Thus, on 1st April 2006, the following entry will be passed : Rebate on Bills Discounted Account

Dr                             100

To Discount Received Account                                                                       100

Illustration 1. Following is the extract from the Trial Balance of the Bank of India Ltd, as on 31st March 2006:

Rebate on bills discounted on 1st April 2005              Rs. 2,500

Discount received on bills discounted                          Rs. 6,325

Bills discounted are as follows:

(1) Rs. 60,000 @ 5%, due date 30th April 2006.

(2) Rs. 40,000 @ 6%, due date 31st May 2006.

(3) Rs. 80,000 @ 6.5%, due date 30th June 2006.

On the basis of above information, give the necessary journal entries and prepare ledger accounts for the year 2005-06.

Banking Companies Study Material

2 Money at Call and Short Notice: It refers to inter-bank loans repayable either on demand or at a short notice of few hours or days. Usually money is borrowed by one bank from another for a very short period varying between one day and 30 days. Banks having surplus money advance such loans to those banks who need money. There is a regular and a large business on this account. Banks who need money contact the brokers for arranging the necessary money. Brokers who are well informed about the day-to-day position of the various banks act as intermediary and charge brokerage for their service usually @ 1/2% from both the banks. The rate of interest fluctuates every day some times very sharply and is higher on loans at short notice than on loans at call. The rate is usually very high.

3. Advances : Advances are shown in bank balance sheet at number 4 under assets and details are given in Schedule 9. This schedule shows details of advances in A, B and C sections. In section A, all advances are classified in three heads as follows: (i) Bills purchased and discounted, (ii) Cash credits, overdrafts and loans repayable on demand and (iii) Term loan including overdue instalments.

In section B, total advances are classified according to the nature of security as follows:

(i) Secured by tangible assets

(ii) Covered by Bank/Government guarantees

(iii) Unsecured.

Section C of Schedule 9 is classified into two sub-sections – CI and C II.C I section shows advances in India whereas C II section shows advances outside India. Advances in India are classified on sectorial basis as follows:

(i) Priority Sector-This is notified by R. B. I. G) Public Sector-This consists of Governments and other Government undertakings including government companies.

(ii) Banks – Banking sector including cooperative banks are under this head.

(iv) Others – This consists of non-priority advances to the private, joint and cooperative sectors. C ll section-Advances outside India is classified as follows: (i) Due from Banks (ii) Due from Others :

(a) Bills purchased and discounted

(b) Syndicate loans

(c) Others Cash Credits, Overdrafts and Loans : These three items form one part of advances. They are explained below:

Banking Companies Study Material

Cash Credits: A cash credit is an arrangement by which a bank allows its customers credit facility upto a certain limit usually on hypothecation or pledge of stock. Interest on a cash credit account is charged only on the amounts actually drawn and not on the full amount of cash credit allowed. Therefore, the rate of interest on cash credit is higher than that charged on loans. To safeguard the bank against the loss that may ensue owing to the customer not drawing any amount under the cash credit, although it has to keep the entire amount ready, frequently a protection clause is inserted in the agreement by which the customer is required to pay interest on a certain proportion of the amount of credit allowed, say one-third or one-fourth, as minimum interest, although this amount may not have been withdrawn by the customer. Most of the business houses prefer this mode of advance as it gives them the facility to draw as and when required. This credit facility is provided for a short period.

Overdraft refers to a temporary arrangement by which a customer operating current account with the Bank is allowed by the latter to overdraw money upto a certain limit. Like cash credit, in case of overdraft too, interest is charged by the bank on the actual amount overdrawn by the customer and the rate of interest charged by bank is also higher as compared to loans.

Loans : A loan is a kind of advance of a fixed sum made with or with out security, for a fixed period to be withdrawn in lump sum. Interest on such loan is charged on the total amount from the date of sanction of the loan but the rate of interest is usually lower as compared to cash credits and overdrafts. If the customer repays loan and wishes to have subsequent accommodation, the latter will be treated as separate transaction.

Bills Purchased and Discounted : The bank may purchase clean or documentary bills at the current rates of interest. The bank may also discount the bills. Discounting of bills implies making payment to the holder of the bill before its maturity date after deducting discount for its unexpired period. Whether the bill is purchased or discounted, the bank holds the bill till its maturity date and gets its payment from the payee on the due date.

4. Non-Banking Assets: Non-banking assets refer to such movable and immovable assets of a banking company which are not required for the purpose of its banking business. Section 8 of Banking Regulation Act, 1949 imposes restriction on a banking company to deal in the buying or selling or bartering of goods except in connection with its legitimate banking business. However, a banking company can take possession of such assets belonging to its defaulting loanees in satisfaction of its claims. Such assets are termed as non-banking assets. These assets are shown on assets side under a separate heading in Schedule 11″Other Assets”. Profit or loss on sale of such assets must be shown separately in the Profit and Loss Account of the bank.

Section 9 of Banking Regulation Act provides that such assets must be disposed of within seven years. However, the Reserve Bank of India can extend this period by a period not exceeding five years, if it is satisfied that such extension would be in the interest of the depositors of the banking company.

5. Contingent Liabilities: Liabilities which may or may not become actual liability of the bank are known as contingent liabilities. Such liabilities depend on happening of certain contingency.

Contingent liabilities are shown in bank balance sheet after the totals of assets and liabilities, the details of which are given in Schedule 12. The following items are included in this schedule :

(i) Claims against the bank not acknowledged as debts.

(ii) Liability for partly paid investments

(iii) Liability on account of outstanding forward exchange contracts.

(iv) Guarantees given on behalf of constituents showing separately guarantees given in India and outside India.

(V) Acceptances, endorsements and other obligations.

(vi) Other items for which the Bank is contingently liable, e.g. arrears of cumulative dividends, bills rediscounted under underwriting contracts, estimated amounts of contracts remaining to be executed on capital account and not provided for etc.

Acceptances, Endorsements and Other Obligations : When a person wants to purchase goods on credit, the seller may insist upon him to produce a reputed surety. Then the purchaser may approach his Bank to stand as surety for him. In such a case a Bank can accommodate him in any of the following ways:

(i) by accepting on his behalf a bill drawn by the seller,

(ii) by endorsing his promissory note or bill in favor of the seller, and

(iii) by issuing letter of credit or giving his guarantee to the seller.

Banking Companies Study Material

In all the above cases, the Bank is liable towards the party to whom the bill or guarantee is given i.e. the seller) in case of any default by its customer (i.e. the purchaser). Of course, the bank can recover the claim from its customer. This is usually done in the case of foreign bills, inland letters of credit, credit guarantee claims etc. If there is any such item outstanding at the close of the year, it is not included in total of either assets or liabilities in the Balance Sheet but the same has to be shown as contingent liabilities in Schedule 12 of Balance Sheet

6. Bills for Collection : These are drafts and hundies drawn by the sellers of goods on their customers and lodged with the Bank for collection against delivery documents (e.g. railway receipt, lorry receipt, bill of lading etc.) attached thereto, such bills are recorded by the Bank in a separate register called ‘Bills for Collection Register’. Since the number of such bills received each day in a Bank is usually very large, separate registers are maintained for outstation and imward bills. Outstation bills are sent to the outstation branches of the bank for collection as per instruction of the customer. On collection of the bills, the amount is credited to customer’s account after deducting bank charges, if any. The bills which are left uncollected at the end of the year are shown separately in the summary balance sheet of the bank as ‘bills for collection after Schedule 12 simply as a note. There is no separate schedule for this item. The amount of this item is not included in total of either assets or liabilities.

Banking Companies Study Material

Income from Non-performing Assets

For the purpose of income recognition, assets of the banks are classified as performing assets and non-performing assets. This distinction is important as income from performing assets is recognized on accrual basis whereas income from non-performing assets is recognized on cash basis.

Non-performing assets are those loans given by a bank where the borrower defaults or delays interest or principal payments. An asset becomes non-performing when it ceases to generate income for banks. The Reserve Bank of India has issued guidelines to banks for treating a credit facility as NPA which have been revised from time to time. The guidelines effective from 31st March 2001 are as follows:

(1) Term Loans : A term loan is treated as a non-performing asset, if interest and/or instalment of principal remains overdue for a period of more than 180 days. From 31st March 2005, this period has been reduced to 90 days.

Overdue: Amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank.

(2) Cash Credits and Overdrafts: A cash credit or overdraft account will be treated as NPA if the account remains out of order for a period of more than 180 days. From 31st March 2005, this period has been reduced to 90 days. An account is treated out of order if any of the following conditions is satisfied:

(a) The outstanding balance remains continuously in excess of the sanctioned limit/ drawing power.

(b) Where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power but (i) there are no credits continuously for more than 180 (90 days from 31st March 2005) days on the date of Balance Sheet or (ii) credits are not enough to cover the interest debited during the same period.

(3) Bills Purchased and Discounted : The bills purchased/discounted account should be treated as NPA if the bill remains overdue and unpaid for a period of more than 180 days. From 31st March 2005, this period has been reduced to 90 days.

(4) Other Accounts : Any other credit facility should be treated as NPA if any amount to be received in respect of that facility remains overdue for a period of more than 180 days. From 31st March 2005, this period has been reduced to 90 days.

(5) Agricultural Advances : Advances granted for agriculture purchases becomes NPA if interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half-year. From 31st March 2005 a loan granted for ‘short duration crops’ will be treated as NPA, if the instalment of principal or interest thereon remains overdue for two crop seasons. A loan granted for ‘long duration crops will be treated as NPA if the instalment of principal or interest thereon remains overdue for one crop season. Long duration crops are the crops whose crop season is longer than one year, and the crops which are not long duration crops will be treated as short duration crops.

Banking Companies Study Material

Accounting for Interest on NPA

R.B.I. has directed the banks that interest on non-performing assets is not recognised as revenue and taken to the profit and loss account. Income on such non-performing assets is recognised on cash basis, i.e., interest accrued on NPA shall not will treated income until it is actually realised. Interest accrued and credited to income statement in a prior accounting period with respect to NPA should be reversed or provided for in the current accounting period, if uncollected.

Which of the above mentioned credit facilities will be treated as NPA on 31st March 2004 ? Give reasons in support of your answer.

Solution : (i) As per guidelines issued by R. B. l.. a term loan will be treated as NPA if interest remains over due for more than 180 days. In the given case, interest is overdue for 200 days, hence this loan is to be treated as NPA.

(ii) As per guidelines issued by R. B. 1., an overdraft is treated as NPA if the account remains out of order for more than 180 days. In the given case, the overdraft account is out of order for 173 days, i.e., less than 180 days and hence it is not to be treated as NPA.

(iii) As per R. B. I. guidelines, a bill should be treated as NPA if the bill remains overdue and unpaid for more than 180 days. In the given case the bill is overdue for 31 days only and hence it is not to be treated as NPA

Note: From 31st March 2005, the period for treating an asset as NPA has been reduced to 90 days.

Illustration 4. On 31st March 2006, City Bank Ltd. finds that:

(i) on a term loan of Rs. 5 lakhs, interest for the last 100 days is overdue.

(ii) the outstanding balance of an overdraft account has been continuously in excess of the sanctioned limit of Rs. 20 lakhs since 10th October 2005.

(iii) the amount, Rs. 2 lakhs, of a discounted bill was due on 28th February 2006 but the same has not been received Which of the above mentioned credit facilities will be treated as NPA on 31st March 2006 ? Give reasons in support of your answer.

Solution : (i) As per revised guidelines issued by R. B. I. effective from 31st March 2005, a term loan will be treated as NPA if interest remains over due for more than 90 days. In the given case, interest is overdue for 100 days, hence this loan is to be treated as NPA.

(ii) As per guidelines issued by R. B. I. effective from 31st March 2005, an overdraft is treated as NPA if the account remains out of order for more than 90 days. In the given case, the overdraft account is out of order for 173 days, i.e., more than 90 days and hence it is to be treated as NPA.

Banking Companies Study Material

(iii) As per guidelines issued by R. B. I. effective from 31st March 2005, a bill should be treated as NPA if the bill remains overdue and unpaid for more than 90 days. In the given case the bill is overdue for 31 days only and hence it is not to be treated as NPA.

Banking Companies Study Material

Old Approach to Accrued Income from NPA

Interest on Doubtful Debts : In the case of banking companies, interest accrued on doubtful debts at the end of the accounting year is not treated income, as there is element of uncertainty attached to it. Hence, the amount of such accrued interest is debited to the loan account concerned but it is not credited to Interest Account; instead, it is credited to a newly opened Interest Suspense Account. The balaance of Interest Suspense Account is included in ‘Other Liabilities and Provisions’ in Schedule 5 on the liabilities side of Balance Sheet. As and when this loan is settled, a transfer is made to the extent of interest received by debiting Interest Suspense Account and crediting Interest Account; the remaining amount of interest is transferred back to the Loan Account by debiting Interest Suspense Account and crediting Loan Account. The irrecoverable principal value of loan is transferred from Loan Account to Bad Debts Account.

Illustration 5. While closing the books of a bank on 31st March 2003, you find in the ‘Loan Ledger’ an unsecured balance of Rs. 2,00,000 in the accounts of a merchant whose financial condition is reported to you as bad and doubtful. Interest on the same account amounting to Rs.20,000 remains to be recorded. How would you deal with this item of interest in the accounts of the year 2002-03.

During the year 2003-04, the bank accepts 75 paise in the rupee on account of the total payment of debt due from the merchant as on 31st March, 2003. Pass journal entries for two years and prepare necessary accounts to show the ultimate effect of the transactions in two years’ books of accounts.

Banking Companies Study Material

Classification of Bank Advances and Provision for Loss on Advances

For calculating the amount of provision for loss on advances, the banks have to classify their advances into four broad groups as follows:

(i) Standard Assets : Loans on which interest and principal amounts are received regularly are called standard or performing assets. These assets also include loans where arrears of interest and /or of principal amount do not exceed 180 days and 365 days respectively at the end of a financial year. Thus, a standard asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such assets are not NPA as discussed earlier. A general provision of a minimum of 0.25% of total standard assets should be made. The provision should be made on global loan portfolio basis and not on domestic advances alone.

(ii) Sub-standard Assets : Sub-standard asset is one which has been classified as NPA for a period not exceeding 18 months. With effect from 31st March 2005, a sub-standard asset is one which has remained as NPA for a period less than or equal to 12 months. There is no possibility of recovering the debt in full in view of the net worth of the borrower, guarantor or current value of security charged to the bank. Hence, there is clear possibility to incur some loss, if the deficiencies are not corrected. Term loans in respect of which instalments of principal are overdue exceeding one year out not exceeding 18 months are treated as sub-standard assets. A general provision of 107015 required of such total outstandings. The unsecured exposures which are identified as sub-standard would attract additional provision of 10% with effect from 31st March 2005. Unsecured exposure is defined as an exposure where the realisable value of the security (tangible) is not more than 10% of the outstanding exposure.

(iii) Doubtful Assets : A doubtful asset is one which has remained NPA for a period exceeding 18 months. Term loans in respect of which instalments of principal remained overdue for more than 18 months should be treated as doubtful assets. With effect from 31st March 2005, an asset would be classified as doubtful if it remained in sub-standard category for more than 12 months. For determining the amount of provision, secured portion and unsecured portion of such assets need to be ascertained. 100% provision is required for the unsecured portion of such advances while for the secured portion, provision is required as follows:

Banking Companies Study Material