The document summarizes key aspects of bank accounting and financial statements. It discusses the principal accounts that appear on a bank's balance sheet and income statement, including assets like loans and investments, liabilities like deposits, and revenue and expense items. It also covers topics like reserves, provisions for loan losses, and off-balance sheet items. Banking's main competitors are thrift institutions like credit unions and savings associations that have similar financial statements, while statements of other financial firms differ due to their unique functions.
The document summarizes key aspects of bank accounting and financial statements. It discusses the principal accounts that appear on a bank's balance sheet and income statement, including assets like loans and investments, liabilities like deposits, and revenue and expense items. It also covers topics like reserves, provisions for loan losses, and off-balance sheet items. Banking's main competitors are thrift institutions like credit unions and savings associations that have similar financial statements, while statements of other financial firms differ due to their unique functions.
The document summarizes key aspects of bank accounting and financial statements. It discusses the principal accounts that appear on a bank's balance sheet and income statement, including assets like loans and investments, liabilities like deposits, and revenue and expense items. It also covers topics like reserves, provisions for loan losses, and off-balance sheet items. Banking's main competitors are thrift institutions like credit unions and savings associations that have similar financial statements, while statements of other financial firms differ due to their unique functions.
The document summarizes key aspects of bank accounting and financial statements. It discusses the principal accounts that appear on a bank's balance sheet and income statement, including assets like loans and investments, liabilities like deposits, and revenue and expense items. It also covers topics like reserves, provisions for loan losses, and off-balance sheet items. Banking's main competitors are thrift institutions like credit unions and savings associations that have similar financial statements, while statements of other financial firms differ due to their unique functions.
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1. What are the principal accounts that appear on a bank's balance sheet (Report of Condition)?: The principal asset items on a bank's Report of Condition are loans, investments in marketable securities, cash, and miscellaneous assets. The principal liability items are deposits and nondeposit borrowings in the money market. Equity capital supplied by the stockholders rounds out the total sources of funds for a bank. 2. Which accounts are most important and which are least important on the asset side of a bank's balance sheet?: The principal bank asset items from most important to least important are: 1Cash 2Investment Securities 3Loans 4 Miscellaneous Assets 3. What accounts are most important on the liability side of a balance sheet?- : 1 Deposits 2 Non-deposit Borrowings 3 Equity Capital 4 Miscellaneous Liabilities 4. What are the essential differences among demand deposits, savings de- posits, and time deposits?: Demand deposits are regular checking accounts against which a customer can write checks or make any number of personal withdrawals. Regular checking accounts do not bear interest under current U.S. law and regulation. Savings deposits bear interest (normally, they carry the lowest rate paid on bank deposits) but may be withdrawn at will (though a bank usually will reserve the right to require advance notice of a planned withdrawal). Time deposits carry a fixed maturity and the bank may impose a penalty if the customer withdraws funds before the maturity date is reached. The interest rate posted on time deposits is negotiated between the bank and its deposit customer and may be either fixed or floating. A NOW account combines features of a savings account and a checking account, while a money market deposit account encompasses transactional powers similar to a regular checking account (though usually with limitations on the number of checks or drafts that may be written against the account) but also resembles a time deposit with an interest rate fixed for a brief period (such as weekly) but then becomes changeable over longer periods to reflect current market conditions. 5. What are primary reserves, and secondary reserves and what are they supposed to do?: Primary reserves consist of cash, including a bank's vault cash and checkable deposits held with other banks or any other funds such as reserves 1/6 Chapter 5 Study online at https://quizlet.com/_69vkk8 with the Federal Reserve that are accessible immediately to meet demands for liquidity made against the bank.
Secondary reserves consist of assets that pay some interest (though usually pay returns that are much lower than earned on other assets, such as loans) but their principal feature is ready marketability. Most Secondary reserves are marketable securities such as short term government securities and private securities such as commercial paper.
Both primary and secondary reserves are held to keep the bank in readiness to meet demands for cash (liquidity) from whatever source those demands may arise. 6. Suppose that a bank holds cash in its vault of $1.4 million, short-term government securities of $12.4 million, privately issued money market in- struments of $5.2 million, deposits at the Federal Reserve banks of $20.1 million, cash items in the process of collection of $0.6 million, and deposits placed with other banks of $16.4 million. How much in primary reserves does this bank hold? In secondary reserves?: The bank holds primary reserves of:
Vault Cash + Deposits at the Fed + Cash Items in Collection + Deposits With Other Banks
Short-term Government Securities + Private Money-Market Instruments
= $12.4 mill. + $5.2 mill.
= $17.6 million 7. What are off-balance-sheet items and why are they important to some financial firms?: Off-balance-sheet items are usually transactions that generate fee income for a bank (such as standby credit guarantees) or help hedge against risk (such as financial futures contracts). They are important as a supplement to income from loans and to help a bank reduce its exposure to interest-rate and other types of risk.
2/6 Chapter 5 Study online at https://quizlet.com/_69vkk8 8. Why are bank accounting practices under attack right now? In what ways could financial institutions improve their accounting methods?: The tradition- al practice of banks has been to record the value of assets and liabilities at their value on the day the accounts were originally created and not change those values over the life of the account. The SEC and FASB started questioning this practice in the 1980's because they were concerned that investors in bank securities would be misled about the true value of the bank. Using this historical value accounting method may in fact conceal a bank that insolvent in a current market value sense.
The biggest controversy centered on the banks' investment portfolio which would appear to be easy to value at its current market price. At a minimum, banks could help themselves by marking their investment portfolio to market. This would give investors an indication of the true value of the bank's investment portfolio. Banks could also consider using the lower of historical or market value for other accounts on the balance sheet. 9. What accounts make up the Report of Income (income statement of a bank)?: The Report of Income includes all sources of bank revenue (loan income, investment security income, revenue from deposit service fees, trust fees, and miscellaneous service income) and all bank expenses (including interest on all borrowed funds, salaries, wages, and employee benefits, overhead costs, loan loss expense, taxes, and miscellaneous operating costs.) The difference between operating revenues and expenses (including tax obligations) is referred to as net income. 10. In rank order, what are the most important revenue and expense items on a Report of Income?: By dollar volume in most recent years the rank order of the revenue and expense items on a bank's Report of Income is:
Revenue Items / Expense items
1 Loan Income / Deposit Interest 2 Security Income / Interest on Non-deposit Borrowings 3 Service Charges on Deposits Salaries, Wages, and and Other Deposit Fees / Employee Benefits 4 Other Operating Revenues / Miscellaneous Expenses 11. What is the relationship between the provision for loan losses on a bank's Report of Income and the allowance for loan losses on its Report of Condition?: Gross loans equal the total of all loans currently outstanding that are recorded on the bank's books. Net loans are equal to gross loans less any interest income on loans already collected by the bank but not yet earned and also less 3/6 Chapter 5 Study online at https://quizlet.com/_69vkk8 the allowance for loan-loss account (or bad-debt reserve).
The allowance for loan losses is built up gradually over time by an annual noncash expense item that is charged against the bank's current income, known as the Provision for Loan Losses. The dollar amount of the annual loan-loss provision plus the amount of recovered funds from any loans previously declared worthless (charged off) less any loans charged off as worthless in the current period is added to the allowance-for-loan-losses account.
If current charge-offs of worthless loans exceed the annual loan-loss provision
plus any recoveries on previously charged-off loans the annual net figure becomes negative and is subtracted from the allowance-for-loan-losses account. 12. Suppose a bank has an allowance for loan losses of $1.25 million at the beginning of the year, charges current income for a $250,000 provision for loan losses, charges off worthless loans of $150,000, and recovers $50,000 on loans previously charged off. What will be the balance in the allowance for loan losses at year-end?: The balance in the allowance for loan loss (ALL) account at year end will be:
Beginning ALL= $1.25 million
Plus: Annual Provision for Loan Losses= +0.25 Recoveries on Loans Previously= +0.05 Charged Off Minus: Charge Offs of Worthless= -0.15 Loans
Ending ALL= $1.40 million
13. Who are banking's chief competitors in the financial services: The closest competitors of banks in recent years (at least in terms of the similarity of their financial statements) are the thrift institutions. These include credit unions and savings associations. If we move a little further away from banks both in terms of what they do and the way their financial statements look, banks also compete with finance companies, life and property casualty insurance companies and security brokers and dealers.
4/6 Chapter 5 Study online at https://quizlet.com/_69vkk8 14. How do the financial statements of major nonbank financial firms resem- ble or differ from bank financial statements? Why do these differences or similarities exist?: Banks have very similar financial statements to credit union and savings associations. The only difference may be in the structure of their loan portfolio. Credit unions probably have more loans to individuals and savings associations may have more real estate loans as well as loans to individuals.
More differences exist between banks and other major competitors. These dif- ferences exist because of each company's unique function. Finance companies have loans but on their balance sheet they are called accounts receivables. In addition, they show heavy reliance on money market borrowings instead of deposits. Insurance companies are different in that loans they make to businesses show up on the balance sheet as bonds, stocks, mortgages and other securities. On the liability side, insurance companies receive the majority of their funds from insurance premiums paid by customers for insurance protection.
Mutual funds hold primarily corporate stocks, bonds, asset-backed securities and money market instruments and their liabilities consist primarily of units of the mutual fund sold to the public. Security brokers and dealers tend to hold a similar range of securities funded by borrowings in the money and capital markets. 15. What major trends are changing the content of the financial statements prepared by financial firms?: The content of the financial statements of financial firms is changing for several reasons. One trend that has affected the financial statements of financial firms is the call for those statements to reflect the true market value of the assets held by the financial firm. More accounts are being listed at the lower of historical or market value so that investors can get a better understanding of the true value of the firm.
Another trend that is affecting financial firms is the increased use of off-balance sheet items. The notional amount of these items is sometimes surpassing the value of the items on the balance sheet, especially for larger financial institutions. This has led regulators to change their reporting requirements for financial firms and there are likely to be additional requirements in the future.
Another trend that is affecting financial firms is the convergence of the various types of financial firms. In addition, financial firms are becoming larger and more complex and more financial holding companies are formed. These are also leading to changes in the content and structure of the financial statements of financial firms. 5/6 Chapter 5 Study online at https://quizlet.com/_69vkk8 16. What are the key features or characteristics of the financial statements of banks and similar financial firms? What are the consequences of these statement features for managers of financial-service providers and for the public?: The financial statements of financial-service firms exhibit three main characteristics that have important consequences for managers of these firms and the public.
The first characteristic of these firms is that they have lower operating leverage. They have small amounts of buildings, equipment and other fixed assets. Operating leverage adds risk to the firm and firms with large amount of operating leverage can face large fluctuations in net income and earnings per share for small changes in revenues.
Financial-service firms do not have this problem. However, financial service firms have large amounts of financial leverage. Financial leverage comes from how the firm finances their assets. If a firm borrows a lot, they face have larger financial leverage and have a larger amount of risk as a result. Financial service firms finance approximately 90% of their assets with debt and therefore face significant financial leverage.
Small changes in revenues can lead to large changes in net income and earnings per share as a result. In addition, changes in interest rates can have significant effects on the net income and capital position of financial firms. Finally, most of the liabilities of financial firms are short term. This means that financial firms can face significant liquidity problems. A sudden demand by depositors for funds can lead to large problems for financial firms.
