Financial Institutions

Chapter 3: Reporting Banks’ Cash and Investment Securities

Transactions

3.1. Introduction
In this chapter, we will focus on how to report the main transactions in the bank’s
journal entries; mainly, cash & deposits due from banks and government investment
securities.
3.2. Cash & deposits due from banks
As mentioned in the previous chapter, cash is the primary reserve of the bank and a
nonearning asset. In effect, cash is intended to be the first item of assets that
normally is listed in a bank’s balance sheet under the heading “Cash and Deposits
Due from Banks”. Usually, the cash pool of a bank includes:
(1) Cash on Hand: This item is considered the ultimate liquidity because it is
held in the form of currency and coins. This item of cash is essential and
necessary to facilitate the fluctuant or uneven cash flows on a daily or weekly
basis. Practically, cash is a nonearning or an unprofitable asset. As a result,
it must be invested in some form to provide a source of income for paying
bank charges such as salaries, debit interest, and other expenses.
Accordingly, any excess in cash (currency and coins) are usually invested in
earning assets to produce income.
(2) Balance at the Central Bank: Cash balance at the central bank consists of
two types:
(a) Legal Reserve which is (b) Amounts in excess of required
required by regulating laws and reserves that are available to the bank
may not be invested or converted as a liquid optional reserve and are
into currency and coins. subject to be loaned overnight or over
the weekend to other banks or financial
institutions.
The rate of interest on optional reserve funds transactions is determined by
the contracting parties. Like any other short-term interest rate, the interest
rate is highly fluctuant (volatile) and changes frequently.

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(3) Balances at other Banks: In addition to deposits at the Central Bank, there
are deposits placed by bank with other banks to facilitate check clearings or
as compensation for services rendered or for many other reasons. These
deposits may take the form of demand or time deposits and thus provide
different degrees of liquidity. Amounts due from banks provide a source of
cash inflows, while amounts due to banks may require cash outflows at some
time in the future.
(4) Cash Items in the process of collections: These items of cash include mainly
uncollected checks in the process of being presented for payment, such as
maturing interest coupons, checks, redeemed government saving bonds, etc.
these items are reimbursed or deposited to the bank within a very short
period.
In effect, the above cash assets are considered the bank’s first line of defense
against changes in the volume of deposit withdrawals and the first source of funds
to look to when a customer comes in with an unexpected loan request that the bank
feels obliged or compelled to meet. Usually, banks strive to keep the size of cash as
low as possible, since cash balances earn little or no interest income for the bank.
Recording Cash Transactions:
There are many daily transactions that affect the components of bank’s cash pool.
But there are two types of changes that affect the cash pool.
1- Changes between components of the cash pool.
These changes affect the relative size of the various components but none of
these types of transactions change the size of the total cash pool. For instance,
collection of specific balances at other banks will result in an increase in liquid
cash and a decrease in balances at other banks. Transferring of liquid cash to the
Central Bank will result in increase in the balance at the Central Bank and a
decrease in the liquid cash. The journal entry needed to record the above changes
in the cash pool will be as follows:

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Currency and Coins (or Cash) xxx

Due from Banks-Bank A xxx
To record a collection of cash from other banks.
Due from Banks-C.B xxx
Currency and Coins (or Cash) xxx
To record a transfer of cash to the Central Bank.

Notice from the above case, that the cash pool is not changed. The final effect
of these transactions is a reclassification of components within the cash pool. As a
result of the first transaction, one item of the cash pool was increased (Currency and
Coins) and another item was decreased (Due from Banks). Similarly, because of the
second transaction, one item of the cash pool was increased (Due from Banks-C.B)
and another item was decreased (Currency and Coins). However, no change in the
total of assets and the total of liabilities.
2- Changes in component of the cash pool:
Logically, these changes will affect the size of the cash pool. The amount in
the cash pool will change if there is a transaction which affects a liability
account, or an asset account not considered as a component of the cash pool.
For example, if a customer deposit L.E.10,000 in currency to his/her current
account the cash pool will increase, as shown from the following journal
entry:
Currency and Coins (Cash) 10,000
Current Account-Customer A 10,000
To record a deposit of cash by a customer in
the current account.

As a result of this transaction, the cash pool increased by L.E.10,000, thus; the
total assets increased by the same amount. On the liability side, the demand deposit
account (customer’s current account) increased by L.E.10,000; hence, it will
increase the total liabilities by the same amount.

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Example (1)
XYZ bank performed the following transactions, prepare the journal entries for
these transactions.
1. A customer opens a demand deposit account for L.E 4,000 in cash and a
check drawn on another bank (A) amounted of L.E 5,000.
2. L.E 10,000 of cash is withdrawn from another bank (B) in which this bank
has a demand deposit account to increase the bank’s vault cash.
3. A customer gives the bank a check “on us” in the amount of L.E 8,000 for
repayment of a loan.
4. A customer transfers funds of L.E 9,000 from a saving account to checking
account.
5. A customer cashes a certificate check drawn on another bank in the amount
of L.E 7,480.
6. A customer deposits a check drawn on another bank in the amount of L.E
9,550 to a checking account.
7. The bank sells reserve funds overnight from its excess reserve funds at the
Central Bank to another bank for L.E 2,000,000.
8. Checks for L.E 3,400,000 are received from the Central Bank for in-clearing
belonging to check accounts.
9. Vault cash in the amount of L.E 1,500,000 is transferred from the main office
to a branch office.
10. Checks for L.E 4,000,000 are sent to the Central bank for out-clearing
belonging to check accounts.
Solution.
1. Cash 4,000
Due from banks – bank A 5,000
Demand deposit (checking a/c -customer) 9,000
2. Cash 10,000
Due from banks – bank B 10,000

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3. Checking a/c (DD) – customer 8,000

Loans 8,000
4. Savings account-customer 9,000
Checking a/c (DD) – customer 9,000
5. Due form banks-bank 7,480
Cash 7,480
6. Due from banks 9,550
Checking a/c (DD)– customer 9,550
7. Reserve funds sold 2,000,000
Due from banks- CB (or due to banks) 2,000,000
8. Checking a/c (DD) 3,400,000
Due from banks 3,400,000
9. No entry will be recorded, since nothing changed in
the cash account, except the location. The entry will
be recorded in the subsidiary records of the main
office & the branch office
10. Due from banks 4,000,000
Checking a/c (DD) 4,000,000

3.3. How Bank Controls Over its Cash?

To safeguard cash, it is necessary for the bank to have a strong system of control
over cash. In practice, there are a variety of procedures to control cash, the most
important of which are:
A Surprise Audit Daily Separation of Duties Daily Reports
Reconciliation of
Cash Pool
In a surprise Each teller Individuals Daily B/S and
audit, the reconciles and responsible for cash reports
internal auditor verifies the cash handling cash should provide
takes charge or inflows and not have any access information to
responsibility of outflows with to the recording management
a particular beginning and process. for the control
teller’s station ending balances of Accordingly, cash of liquidity and
without any cash. As a result, receipts and exposure to
advance errors are disbursements risk.
notification and discovered and should be assigned to
then reconcile necessary actions individuals without
the activities and are taken, if any access to the
balances of that possible, to correct accounting records.
teller. Indeed,
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these surprise and rectify these

audits serve as a errors.
valuable tool in
achieving
control over
cash and
activities
involving cash.

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