INTRODUCTION
These reading and reference materials are provided as supplementary materials to the
Microfinance Accounting Training course. Course participants should read and refer to these materials for preparation and review of course activities.
OBJECTIVES
The objectives of the course are:
• To understand basic accounting principles and their application to microfinance
• To gain knowledge of accounting records relevant to microfinance
• To review the purpose and components of financial statements relevant to microfinance
• To practice the accounting cycle
OUTCOMES
At the end of the course participants will be able to:
• Understand and apply basic accounting practices
• Record transactions and prepare financial reports
• Understand adjustments and their impact on financial reports
TOPICS
The following topics are presented in these materials:
1. Introduction to Accounting and its Principles
2. Cash vs. Accrual Based Accounting
3. Cash Flow Management and Portfolio Reporting
4. Chart of Accounts
5. Making Accounting Entries
6. Trial Balance and Adjustments
7. Closing Entries and Preparing Financial Statements
8. Accounting for Grants Received

Session 1: Introduction to Accounting and its Principles
Definition of Accounting
Accounting is the process of identifying, measuring, recording, summarizing and communicating the economic activity of an organization.
It is often referred to as the language of business and like any other language; it has its own unique vocabulary and rules. Some people think of accounting as a highly technical field understood only by professional accountants. However, technical terms such as assets, liabilities, equity, revenue, expenses, income and cash flow are widely used throughout the microfinance field. Thus it is important that anyone involved in making business decisions understands the basic accounting concepts which form the bases of financial management.
Accounting is a service activity. It provides financial information about an organization’s economic activities and is intended to be used as a basis for decision making. It provides the information required to answer questions such as: What are the resources of the organization? What debts does it owe? Are its operating expenses too high relative to revenue? Are the organization’s current lending activities generating enough income for it to be sustainable?
Not everyone needs to understand the intricate details of an organization’s accounting system; however, it is helpful for staff to understand the framework within which accounting operates. Managers, in particular, need to know how to interpret the information it provides. Based on this information, managers can analyze the financial status of their organization and manage the organization’s finance to ensure future financial stability.
Role of Accounting
Accounting falls into two general categories, financial accounting and management accounting.
Financial accounting presents a summary of the financial results of past operations.
Financial accounting reports are aimed at external audiences although they are used internally as well.
Management accounting information is tracked and presented at a much more detailed level, such as by program or branch. Projected financial information is also part of management and is aimed primarily at internal audiences. Management reports are prepared frequently and report on an ongoing basis the differences between planned and actual results.
Financial Statements
The preparation of financial statements is virtually the last step in the accounting process but it is an appropriate point to begin studying accounting in order to understand what

will be produced. Financial statements are the primary means through which an organization communicates information about its economic activities. The purpose of these statements is to provide useful financial information to parties such as banks, investors, suppliers, government agencies, etc, who may make decisions affecting the organizations’ operations or otherwise influence the direction of its activities.
Financial statements are a means of conveying a concise picture of the financial position of the organization. An individual who has a clear understanding of these statements will be better able to understand the purpose of earlier steps in the process.
The three most widely used financial statements are the Balance Sheet, the Income
Statement and the Cash Flow Statement.
The Balance sheet is a summary of the economic resources of an organization and the claims against those resources at a specific point in time.
The Income Statement reports the organization’s economic performance over a specific period of time. It is also known as a Statement of Profit and Loss.
The Cash Flow Statement reports the organization’s sources and use of funds (also referred to as the Statement of Changes in Sources and Uses of Funds). It explains how an organization obtains cash (sources of funds) and how it spends cash (use of funds) including the borrowing and repayment of debt, capital transactions and other factors that may affect the cash position.
Together, these statements summarize all the information contained in the organization’s accounts.
In addition, and especially in the microfinance industry, a fourth statement is widely used: The Portfolio Report provides detailed information about the lending and/or savings operations of an MFI. It is prepared more frequently than the other statements and gives an indication of the portfolio quality.
ACCOUNTING PRINCIPLES
Double-entry Accounting – is based on the concept that every transaction affects and is recorded in two or more accounts on a business’ books (referred to as the Dual
Aspect Concept) and thus requires entries in two or more places (“double-entry:).
The accounting equation states that: ASSETS = LIABILITIES + EQUITY because all the assets of the business are financed either by creditors (liabilities) or owners
(equity). Each transaction affects Assets, Liabilities and/or Equity (sometimes through Revenue or Expenses). And, for every account affected by a transaction there is an equal effect on other accounts that keeps the accounting equation balanced. Thus, an increase in a business’ assets must be offset by either a decrease in another asset, or an increase in liabilities or equity.
The Conservatism/Prudence Principle – accountants must choose the method of presenting information on financial statement which ensures that: assets, revenues and gains are not overstated (so revenues are recognized only when reasonably certain) and; conversely, that liabilities, expenses and losses are not understated

(so expenses are recognized as soon as possible). Conservatism cannot be used to intentionally understate assets, revenues and gains or overstate liabilities, expenses and losses. It is intended to result in fair presentation of information from period to period.
The Materiality Principle – each material item should be presented separately in the financial statements. Immaterial information should be aggregated with similar accounts; it need not be presented separately. Information is material if its nondisclosure could influence the economic decisions of users. Materiality relates to both the nature and size of an item.
The Consistency Principle - an organization must consistently apply the same accounting principles from period to period unless it has a sound reason to change.
This ensures that reports from various periods may meaningfully be compared.
The Realization Principle – in effect it requires that revenue be recognized in the accounting period it is earned rather than to the period it is collected in cash.
The Going Concern Concept – the Balance Sheet of a business is developed with the assumption that the business will continue to operate indefinitely and thus the assets used in carrying out operations will not be sold.
The Business Entity Concept – every business is a separate entity, distinct from its owner and from every other business. Therefore, the records and reports of a business should not include the transactions or assets of either its owner(s) or those of another business.
The Matching Principle – requires that revenues and expenses be matched in the same accounting period. An organization incurs expenses in order to earn revenues. Therefore expenses should be reported on the Income Statement during the same period as the revenues they generated.
The Cost Principle – all assets must be recorded on the books of a business at their actual cost. This amount may be different from what it would cost today to replace them or the amount for which the assets could be sold.
The Money Measurement Principle – a record is made only of information that can be expressed in monetary terms.
Session 2: Cash vs. Accrual Based Accounting
Cash Based Accounting
This is a system of recording the financial activities and performance of an institution in cash terms. Cash based accounting systems record only cash receipts and cash payments, i.e. when the cash is actually received or it has actually been paid out.

Unlike accrual accounting, this system does not record for accruals, prepayments, debtors and creditors (accounts receivable and payables) and stocks (inventories) and thus avoids the arbitrary allocations and subjectivities of accrual accounting.
Cash based accounting has been criticized for over emphasizing liquidity and for inadequately measuring performance.
Accrual Based Accounting
Unlike cash based accounting systems which recognize revenues and expenses as and when cash changes hands, accrual based accounting recognizes revenues and expenses as they are earned or incurred – even though cash is not received yet or has not been paid out yet. So far as possible, expenses are matched against the revenues for the generation of which they have been incurred. The matching process by time of occurrence results in income and expense accruals, prepayments, debtors and creditors.
Accrued income – income earned but not yet received at balance date. In microfinance this will be mainly interest due on loans which has been earned at a specific date but has not been paid by the client.
Accrued expenses – expenses which have already been incurred but remain unpaid at balance date (e.g. salary/wages, or interest payable on savings accounts).
Prepayments – expenses which have been paid for but the benefits of which have not been received at balance date (e.g. insurance).
Debtors – customers with balances or due to pay the institution but have not yet paid.
Creditors – accounts or suppliers of goods and services with balances remaining to be paid by the institution on balance sheet date (e.g. supply from a stationery shop which is only paid at month end).
While we have distinguished cash based accounting from accrual based accounting, it is possible to implement a mixture of the two systems. In microfinance accounting the two systems are used at varying levels.
To follow the conservatism principle CGAP (Consultative Group to Assist the Poorest) has recommended the following:
1. Cash-based accounting principles for interest to be received on loans.
It is recommended to record interest income only when the cash has actually been received. This provides a more accurate picture of the financial position of the institution since it cannot be certain that interest will be received from the clients. This follows the conservatism principle in order to ensure that assets (cash) are not overstated. This gives managers a more realistic view of the trend towards sustainability (emphasis on actual repayment capacity of clients, important for monitoring due to lack of collateral or enforcement possibilities).

However, for interest income which is certain to be received (e.g. from investments in governments treasury bills), interest can be accrued.
2. Accrual-based accounting principles for interest received up-front.
When interest is collected up-front then record it as cash and as deferred revenue (a liability in the balance sheet). Only once the period comes up where the portion of the interest is in fact due transfer the interest earned for that period from the deferred revenue to the interest revenue account.
This follows the conservatism principle again in order to not overstate the income earned.
3. Accrual-based accounting principles for expenses to be paid
Expenses should be recorded as and when they are due to be paid even though they will only be paid at a later stage. This follows the conservatism principle to show a correct picture of the actual cash needs of the institution and to make sure that liabilities are not understated.
Whichever principles the MFI adopts (even with a mixture of both) it is necessary to have a clear policy regarding how and when to record revenue and expense.
Session 3: Chart of Accounts
A Chart of Accounts, also known as the List of Accounts for General Ledger, provides a structure for classifying and recording transactions, and is the foundation of an MFI’s accounting system. It provides a system for classifying, recording, and reporting the transactions of the institutions by establishing the structure for accountants to post transactions to different accounts and ledgers. It also determines what can be tracked for managerial purposes and the preparation of financial statements. The Chart is a vital component of an MFI’s Management Information System (MIS).
It describes each account by:
Account number 123-44-55
Account description USD Account in ABC Bank
Account type Asset Account
Remember: The level of Detail of the Chart of Accounts determines the level of detail of the information available for decision-making!
Categories of Accounts:
Balance Sheet Accounts
Asset Accounts = Liability Accounts + Equity Accounts
Income Statement Accounts

Income Accounts - Expense Accounts = Profit Account
Revised Charts of Accounts (CoA) for both SCUs and MFIs have recently been issued by BoL. The CoA for MFIs is more detailed than the one for SCUs, but for our purposes we shall use the SCU version as it is simpler, and the purpose of this session is to understand the principles of a chart of accounts. A summary of the SCU chart of accounts is shown below. The micro-finance industry in Laos will greatly benefit from the existence of standardized and transparent financial reporting provided by a Uniform
Chart of Accounts.
For Lao microfinance institutions (MFIs), it is preferable that the accounting system adopted be computerized wholly or partly. It is very difficult for any MFI without a computerized accounting system to achieve a very significant client outreach while keeping both loan delinquencies and overhead costs under control. Much manual labour would be reduced when an MFI can afford the investment in computerization of their accounting system, since transaction entries would then be posted directly to the general ledger, replacing the various manual journals with a simple query function, and producing the reports as needed with greatly reduced effort. However, at present it may not be feasible for all MFIs to install sophisticated computerized Management
Information Systems and train the staff to use them. Meanwhile, Excel spreadsheets produced with a personal computer can be an acceptable alternative to completely manual systems.
The SCU Chart of Accounts is adaptable at all levels of accounting practice. The Chart is simple, and allows for keeping of (a) the general journal where all transactions are recorded chronologically as debits and credits: (b) the general ledger where the activity from the general journal is summarized by account number; (c) and other subsidiary ledger required to manage the business. It is important to strike a balance between extremes of too much data in the accounting system and not enough. Tracking too much unnecessary detail can overwhelm the accountant and the manager, while too few accounts will not provide the information precise enough to generate the needed indicators for tracking performance.
Nearly all financial information indicators used in management reports generated by the
MIS system of the institution will be extracted at least in part from the Chart of Accounts.
The Chart is forward-looking in that it will allow for MFIs that become registered financial institutions in the future, to implement the service of collecting savings. Also, the Chart is intended to be generally compatible with standard bank accounting.
The SCU Chart of Accounts is structured with a logical numbering system, beginning with the general sub-divisions of accounts and descending to increasingly more specific and detailed subsidiary accounts. Each account number is followed by the title of account, and in some cases by a brief explanation. Should it be necessary in the future, additional sub-accounts can be added following the general scheme of the structure.
The five major accounting segments that make up the Balance Sheet and the Income
Statement are assigned the numbers 1 through 7:
1 Revenue
2 Operating Expenses

4 Assets
5 Liabilities
6 & 7 Equity
There is also a section 8 for off-balance sheet items. These refer to what are known as contingent items, which will only be realized if a certain event occurs. An example would be a guarantee issued by a bank that should a customer default on payments to a third party then that bank would pay on his behalf. That is a contingent liability, but would only materialize if a default occurs. In practice SCUs and Other MFIs rarely issue nor receive such guarantees, so such off-balance sheet items rarely, if ever, occur.
The accounting system that should be used by MFIs is a hybrid accrual system. All accounts are on an accrual basis except for Interest Receivable, which will be accounted for as it is received. This is the recommended conservative way for MFIs to handle interest. Provided that all MFIs use the same treatment of interest they will all be judged by the same rules, and none will be penalized by this conservatism.
For any assets, liabilities, and income statement items that are in foreign currencies, separate sub-accounts are necessary, with the items stated in the Lao currency equivalent.
The Chart of Accounts segregates the loan portfolio into short-term and long-term loans.
It does not count as an asset the interest receivable from loans because interest earned is handled on a cash basis… recorded only as it is actually received. However, the
Chart does not classify the loan portfolio into the wide variety of categories that will be needed for detailed analyses of an MFI’s most important assets, its loan portfolio. More detailed information will be obtained from the Portfolio Management Information System of an MFI, where a large amount of data on each individual borrower is maintained, and that can be retrieved for the production of several Loan Reports that will needed by MFI management and lenders and/or regulators who need to evaluate the MFI’s performance.
A more detailed version of the SCU chart of accounts, is contained in handout 3.1.
SUMMARY SCU CHART OF ACCOUNTS
A summary of the SCU chart of accounts is shown below.
1 INCOME
10 Loan Interest Income
11 Non-Loan Interest
Income
12 SCU-related fees and charges
2 OPERATING
EXPENSES
20 Interest payable to depositors, bank and others
21 Fees & Commissions
Payable
22 Loan & Interest Loss
Provision Expense
23 General &
Administrative Expenses
3 NON OPERATING
INCOME & EXPENSES
31 Grant Income/
32 Other income
33 Extraordinary Income
34 Other charges
35 Extraordinary charges

24 Loan Servicing
Expenses
25 Promotional Expenses
26 BOL supervision &
Licensing Fees
27 Taxes & Licenses
28 Cashier Shortage
29 Taxes on Profit

5 LIABILITIES 4 ASSETS
40 Cash on hand
41 Balances with BOL
42 Accounts with Banks & other FIs
43 Investments
44 Loan portfolio
45 Loan Loss Reserve
46 Interest & fees receivable
47 Fixed Assets
48 Prepayments & other receivables
49 Other assets
50 Customer/ member deposits
51 External credits/ borrowings
52 Interest payable
53 Accounts payable
54 Accrued expenses & provisions
55 Taxes payable
56 Deferred revenue
57 Suspense & clearing accounts
59 Other Liabilities
EQUITY
6 Members Share
Accounts
60 Member Shares
61 Other Member Shares
7 Capital Accounts
70 Retained Earnings
71 Reserves & appropriations
72 Donated capital
73 Current Year
Income/Loss
74 Dividends declared
8 OFF-BALANCE SHEET ITEMS
80 Written-off Loans and Interest
89 Control Account
Session 4: Making Accounting Entries
Voucher
Each time transactions take place there must be some sort of documentation to be able to later on verify where the money went or from what income was generated. Therefore, vouchers are used. Usually these are accompanied by supporting documents (invoice, ticket buts, cheque stubs etc.) There is not really a standard for a voucher system and every organization has its own way of doing it.
Vouchers are important for internal control. Through the paper trail, transactions can be verified later on and assets can be safeguarded.
Journal Entries
All economic transactions are entering the accounting system through a journal entry.
They are recorded in the General Journal, a two-column book (one sheet each day) which lists all economic transactions in chronological order. This is to record how each transaction affects either an asset, liability, equity, revenue and/or expense account.
The left-hand column is called “Debit” and the right-hand column is called “Credit”. This accounting language might seem a bit unusual since commonly debit is often related with decrease and credit with increase.
Ledger Account

From the general journal, transactions are posted into respective ledger accounts which record increase or decrease in the Balance Sheet or Income Statement.
Examples are: cash, loan outstanding, savings and salary.
A ledger account is the accumulation of all transactions reflecting changes in an account. (e.g. all transactions concerning incoming and outgoing cash during one month will be recorded in the cash ledger account).
Each ledger account is identified by its account name and its account number. The accounts are numbered based on whether they are an Asset, Liability, Equity, Revenue or Expense account.
Double Entry Accounting
First of all, if an economic event occurs it needs to be recorded. The rule in accounting is that each time a transaction takes place a minimum of two accounts in the balance sheet are affected. It is either an equal or opposite reaction to each event resulting in either increasing or decreasing of asset, liability and equity. Referring back to the accounting equation it is a method of ensuring that all transactions are balanced out.
Any change in the left side (asset) must be accompanied by equal but opposite change in the left side (asset) or an equal change in the right side (liability or equity). Income and expense accounts are usually affected, too, which ultimately results in a net surplus or deficit recorded in the balance sheet.
In accounting language, recording takes place through debit and credit entries. An amount recorded on the right side of the ledger account is a credit entry. Often there is a wrong impression about debit and credit entries. Many people assume that debit means decrease and credit means increase. It is important to learn that in accounting debit only means the left side and credit means the right side.
This results in the following:
Income/Revenue accounts
Debit – decrease ; Credit – increase
Asset accounts
Debit – increase; Credit – decrease
Liability and equity accounts
Debit – decrease; Credit – increase
Expense accounts
Debit – increase; Credit – decrease
The following table may help you to remember whether a transaction is a debit or a credit:
Income Statement Accounts Balance Sheet Accounts

Income
Increase = credit
Expenses
Increase = debit
Bank Balance, December 31, 2007
- less outstanding cheques: #1
Assets
Increase = debit
Liabilities & Equity
Increase = credit
Cash Accounting and Bank Account Reconciliation
One of the most important ledger accounts the Cash Account. The Cash account (or bank account) is used to record all cash and bank transactions.
It is important to keep a close eye on the cash account because:
•
The number of cash transactions is large in most MFIs. Examples are loan disbursement, loan repayment, payment of salaries and other expenses, etc.
•
The chances of fraud being committed with cash are higher compared to other assets, so strict control is required. A properly maintained cashbook helps to achieve control.
•
MFIs need to have cash on hand all the time. It is therefore important to have timely information on the balance at hand.
Usually on a monthly basis (after receipt of the bank statement) the bank statement should be reconciled with the accounting records. This is done by taking the closing cash balance reported on the bank statement and subtracting any outstanding checks and adding any outstanding deposits.
In addition, all bank charges and credits not previously recorded in the accounting records must be recorded (in the example below, 100 was incurred in bank charges which must be recorded into the General Journal when the bank statement is received, and then the General Ledger). The new balance of the Cash account must then equal the adjusted bank balance. All figures quoted below are shown in thousands.
For example:
Kip
255,000
30,000,000
- plus outstanding deposits:
Adjusted Bank Balance
Cash Account Balance (prior to reconciliation)
- record bank charges
Adjusted Cash Account
#1
(344,000)
100,000
244,000
30,244,000
30,344,000
(100,000)
30,244,000

Session 5: Trial Balance & Adjustments
Trial Balance
At the end of an accounting period (usually monthly), once all journal entries have been made and posted in the General Ledger, it is necessary to verify that the debits and credits are in balance. This procedure is referred to as preparing the Trial Balance.
The Trial Balance is prepared by taking the Accounting Balances from the General
Ledger and listing the accounts having debit balances in one column and those having credit balances in the other column. Next, the debit balances are totaled and the credit balances are totaled. Finally, the sum of the debit balances is compared with the sum of the credit balances. The sums should be equal in order for the ledger accounts to be in balance.
If the trial balance does not balance, the General Ledger should be checked to ensure that every Account Balance is correct and has been transferred properly.
Trial Balance
August 1, 2007
Ledger Accounts
Cash and Due to Banks
Debit Credit
7,300,000
Portfolio Outstanding
Bank Borrowing
Financial Revenue
(Interest)
Personnel Expenses
Rental Expenses
Totals
19,000,000
5,500,000
1,000,000
32,800,000
17,000,000
15,800,000
32,800,000
Adjustments
Once the trial balance is completed (and balanced) adjustments are made to record transactions that have previously not been recorded. Accounting transactions which are not yet included in the trial balance relate to non-cash items.
Accounting adjustments are used to reflect income and expense items which are not cash based and therefore have not yet been recorded, such as:

Make a loan loss provision to reflect the portfolio which is at risk and adjust the loan loss reserve in the balance sheet
Depreciation of fixed assets which is an expense in the income statement to reflect the value of fixed assets
Accrued revenue or expense
These adjustments are usually done periodically, i.e. monthly, bi-monthly or annually.
A Loan Loss Reserve equals the amount of outstanding loan balances which are not expected to be recovered by the MFI. It is set aside to cover losses on the loan portfolio.
This amount is a non-cash item and does not affect the cash flow of the MFI. Only once the loan is delinquent (i.e. past due) does it affect the cash flow. The longer a loan is past due, the lower the chance of receiving payment.
The amount of the loan loss reserve is usually based on historical information regarding loan default and the aging analysis (how long have the amounts been past due). Aging of the portfolio at risk creates the information necessary to establish the adequacy of the loan loss reserve. There are regulations from the Bank of Lao which require the MFI to provide for a certain percentage of overdue loans (classified by length of time overdue) as a loan loss reserve.
Classification Provision Required by BoL
(% of outstanding loan balance)
1% Current loans
Overdue 31-90 days
Overdue 91-180 days
Overdue >180 days
25%
50%
100%
The Loan Loss Reserve is a Balance Sheet item (a negative asset item reducing the net outstanding loan balance) and has an opening balance, unless no Reserve has ever been created. It reduces the outstanding loan portfolio.
Provision for Loan Losses is the amount expensed in a period to increase the Loan
Loss Reserve to an adequate or required level to cover expected defaults of the loan portfolio. Although the Provision for Loan Losses is a non-cash expense, it is treated as a direct expense for an MFI (does not have an opening balance). Some MFIs combine the provision for Loan Losses with the operating costs. It is helpful to separate the
Provision for Loan Losses as a separate cost.
Respective Accounting Entries:
Debit
Credit
Loan Loss Provision (expense account)
Loan Loss Reserve (negative asset account)
Provisioning Example: The MFI has given out loans to a small village near Pakse. Two of the borrowers have not paid their monthly installments and are more than one month late. The loan officer is not sure if they will start paying again or if the loan amounts are lost. In accordance with BoL policy, the MFI puts 25% of the outstanding loan amounts aside as a provision. The outstanding loan amount is 200,000 Kip, so the provision is
50,000 Kip (25% * 200,000).

Debit
Credit
Loan Loss Provision (expense in the profit and loss statement) 50,000 Kip
Loan Loss Reserve (balance sheet item) 50,000 Kip
Depreciation is the gradual expense of the cost of a capital asset item over its useful life. When a capital asset is purchased (e.g. building, car) the entire cost of the asset is not immediately recorded as an expense in the profit and loss statement. It is depreciated over time so that each year only a portion of the cost is expensed. It is done at the end of each accounting period. Normally there is a note to the annual accounts explaining the depreciation method and the percentage used each year.
Respective accounting entries:
Debit
Credit
Depreciation (Expense account)
Accumulated Depreciation (negative asset account)
Usually microfinance institutions do not have large capital assets. Therefore, the amounts are relatively small.
Depreciation Example: The MFI purchases a new motorcycle for the loan officers on 1
July 2007 for 1,500,000 Kip. It decides to depreciate the asset over 4 years.
Debit
Credit
Fixed asset account 1,500,000 Kip
Cash account 1,500,000 Kip
Year end depreciation (25% per year).
Debit
Credit
Depreciation 375,000 Kip
Accumulated Depreciation 375,000 Kip
Accrued Income or Expenses refers to income or expense which is recorded but is not yet received or has not yet been paid (refer back to session 2)
Accrued Income: For example, if an MFI has invested money in a 6-month term deposit with a bank. The MFI might record the interest (revenue) as an asset already even though it has not yet received the money.
It is acceptable to accrue interest from an investment in deposits, treasury bills etc. because it is sure to be paid at the end of the period (it is earned but not been paid yet).
Respective accounting entries:
Debit
Credit
Interest receivables (asset account)
Financial revenue (income account)
Once the money is actually/finally received the income statement is not affected
(because it has been already recognized in the income statement previous).
Respective accounting entries:

Debit
Credit
Cash account (asset account)
Interest receivables (asset account), i.e. the amount received is taken out of the interest receivables account.
Accrued Expense: If a bill is due to be paid but will only be paid at a later stage the MFI may choose to book this transaction already as an accrued expense. This means that the respective expense account in the profit and loss statement is already debited (e.g. stationery, equipment) and the respective liability account in the balance sheet is credited, even though actual cash has not yet left the MFI. Following the conservatism principle this is recommended because it will show the true financial picture of the MFI.
Respective accounting entries:
Debit
Credit
Expense account (income statement account)
Short-term accounts payable (liability account)
Once the money is actually paid out the income statement is no longer affected.
Debit
Credit
Short term accounts payable (respective amount is taken out)
Cash account (amount is being paid)
Accrual Example: The MFI has short-term liabilities at year end of 10,000,000 Kip
(assume that it had the liabilities the whole year, no changes). It must pay 5% interest p.a. on the borrowings, which have not yet been paid. It therefore needs to accrue this expense.
Debit
Credit
Interest Expense 500,000 Kip
Short term accounts payable 500,000 Kip
Microfinance institutions should, for example, make adjustments for savings collected on which no interest has been paid so far. Even though it might be difficult to determine exactly how much interest is going to be paid out, it is more conservative to estimate a possible amount (can be based on historic figures plus a percentage if the savings collected have increased in total amount).
Once the adjustments are determined, the respective journal entries have to be recorded in the general journal (all transactions have to be in the general journal to maintain proper records) and in the respective ledger accounts. Final account balances can be calculated.
The next step would be to prepare closing entries and then the financial statements.
Session 6: Closing Entries & Preparing Financial Statements
Closing Entries and Draft Financial Statements
At the end of the year, once you have completed the general journal, the general ledger, the trial balance and the adjusting entries, the next steps is to record closing entries.

Closing entries are prepared after the final Trail Balance is completed. Closing entries clear and close revenue and expense accounts at the end of each accounting period by transferring their balances to the Current year profit/loss account. This leaves them with a zero balance.
To clear revenue accounts, which have normal credit balances, an entry debiting the account and crediting the Current Year Profit/ Loss account is required. Similarly, to clear expense accounts, which have normal debit balances, an entry to credit the
Current Year Profit/Loss account is required. The net effect on the Current Year
Profit/Loss account is equal to the Net Operating Profit/Loss for the period as recorded in the income statement. A debit balance will be a current year loss and a credit balance will be a current year profit.
The final step in summarizing an organization’s change in financial position over a period is to transfer the amounts from the Trial Balance to the financial statements. By transferring the amounts to the Balance Sheet and Income Statement the financial position to the MFI as of the respective reporting date can be determined (which includes the recording of the net operating profit or loss for the current full year in the balance sheet).
Always remember, balance sheet accounts have a balance which is continuously carried forward, whereas income statement accounts have a closing balance, i.e. they will start next year within a “0” again.
Session 7: Accounting for Grants Received
Accounting for Grants and Concessional Funds
Many microfinance institutions receive grant and/or concessional funds from donor or other external agencies.
In view of highlighting the degree of dependency on external funding (which has an impact on sustainability) it is important that MFIs do not include grants in operational income. It should be reported “below the line” in the Income Statement, i.e. after the net operational income. In addition, grants are recorded as deferred revenue (a liability) in the Balance Sheet and should be clearly separate from equity generated from operations (retained earnings).
Concessional Funds (loans that have been given to the MFI below market interest rates i.e. a subsidized interest rate) should be recorded separately from commercial borrowing in order to highlight the “subsidy”.
Accounting treatment of grants received
As the BoL will be distributing matching grants to MFIs it is important to have some understanding of how they should be accounted for. Before outlining the detailed procedures for dealing with grant funds it is necessary firstly to examine their accounting treatment as defined by international best practice and International Accounting
Standards (IAS).

Capital vs Revenue
The accounting treatment of grants has been the subject of much discussion as it is not just a technical issue; it has a fundamental effect on the financial statements of institutions and thus on measuring their performance. Historically there have been two conflicting treatments of grant funds received by MFIs and similar institutions; crediting grants to capital, where they are added to shareholders funds, or crediting them to income over the period in which the grant is utilised. In recent years the argument for adopting the income approach has won the day and a simple example demonstrates why.
Example of Capital vs. Income Approaches to treatment of grants: Let us suppose an MFI starts the year with a net worth of 1,800 and has in the year a net income of 200.
It’s return on capital employed would be: b) Shareholders funds at year-end (1800+200 income)
Return on capital employed (a/b)
200
2,000
10%
Capital Approach
Let’s assume that in that year it receives a grant of 100, and spends that on projects within that year. Using the capital approach the grant would be credited to shareholders funds, grant monies spent would be expensed and return on capital employed would be: a) Net income (200-100 spent) b) Shareholders funds at year end (1800+100 income + 100 grant)
Return on capital employed (a/b)
100
2,000
5%
Income approach
Using the income approach funds are credited to income when the monies spent. Return on capital employed would be: a) Net income (200+100 grant less 100 spent) b) Shareholders funds at year end (1800+200)
Return on capital employed (a/b)
200
2,000
10%
As can be seen the capital approach distorts reporting and offers less clarity as grant funds are merged with general shareholders funds. This makes receipt of grants and the relevant expenditure harder to track. There is also the question of who are the shareholders who own these extra funds. Both international best practice and
International Accounting Standards (IAS), in the form of IAS 20 - Accounting for
Government Grants, firmly state that grants should be credited to income over the period of time during which the grant is utilised.
The method of doing this is by initially treating grant received as deferred revenue and releasing it to income proportionately to expenditure. Indeed the adoption of IAS 20 is advocated in the SCU Chart of Accounts. CGAP also recommends that MFIs treat grants in this way.

The accounting entries under IAS 20 are explained in the section on Accounting in MFIs below. A summary of the main points of IAS 20, which is a long and complex document, is shown the box below.

Summary of International Accounting Standard 20: Accounting for
Government Grants and Disclosures of Government Assistance
Why Report Receipts of Government Grants?
The receipt of government assistance by an enterprise may be significant for the preparation of the financial statements for two reasons.
Firstly, if resources have been transferred, an appropriate method of accounting for the transfer must be found.
Secondly, it is desirable to give an indication of the extent to which the enterprise has benefited from such assistance during the reporting period. This facilitates comparison of an enterprise's financial statements with those of prior periods and with those of other enterprises.
Recognition of Government Grants
Government grants should only be recognized if the organization is reasonably sure that:
(a) the enterprise will comply with the conditions attaching to them; and
(b) the grants will be received.
Credit Capital or Credit Income?
IAS 20 paragraphs 13 - 15 discuss two potentially alternative ways of accounting for
Government Grants: the capital approach, under which a grant is credited directly to shareholders' interests, and the income approach, under which a grant is taken to income over one or more periods.
After discussion it concludes that there is no allowed alternative treatment of
Government Grants: they MUST be credited to Income
Government grants should be recognised as income over the periods necessary to match them with the related costs which they are intended to compensate, on a systematic basis. They should not be credited directly to shareholders' interests.
Accounting Treatment of Government Grants
IAS 20 goes on to say that Government grants must be recorded in accordance with the principles of IAS 1: that is, they must be recognized in accordance with the accruals principle and not on the receipts basis unless "no basis existed for allocating a grant to periods other than the one in which it was received."
Paragraphs 17 - 22 of IAS 20 expand on the provisions of paragraph 16 by discussing the periods over which the income and expenditures associated with a government grant are to be recognized, in that grants in recognition of specific expenses are recognised as income in the same period as the relevant expense.
The internationally recommended accounting treatment of grants received is to treat them initially as deferred revenue (a liability in the balance sheet) which is released to income over the period in which the grants are expensed, in accordance with
International Accounting Standard (IAS) 20.

Expenses
At the end of the accounting period, the grant funds contributed to expenses (e.g. on training) or depreciated, in the case of assets purchased, are recognized as income (Cr) and that amount is drawn down from the Deferred Revenue liability (Dr). These funds are shown in the income statement for the period as grant income.
Grants
Grants made to certain institutions under the CMP programme may include an element for seed capital. This is not “spent” as such; it is used to increase the value of the loan portfolio so the grant capital remains within the MFI. In this case the capital portion of the grant should remain in deferred revenue. Should the institution eventually wish to transfer these funds to capital it should be shown as a separate line item “Grant Capital”.
Accounting within the MFIs - Deferred Revenue example
The detailed accounting treatment for grants to cover grant capital, expense items and fixed assets are shown in the following worked example.
Let us suppose that an MFI receives a grant for 1,300, 500 to be used for increasing capacity of its staff through training over three years, 500 for purchasing new computers, which are written-off over four years and 300 for seed capital. The MFI will contribute matching funds of 500 for training and 500 for computers.
In the example below for the sake of simplicity it is assumed that all asset and expense movements are reflected by cash; i.e there is no adjustment for accruals or prepayments. Should the MFI over-spend, the amount to be taken from deferred revenue is limited to the maximum stated in the implementation plan; e.g. if 1100 is spent on training the maximum taken into grant income is 500, not 550.
The movements in the accounts over the four years can be summarised as:
1. On receipt of the grant the whole amount is credited to Deferred Revenue
(liability).
2. Any purchase of fixed assets, in our example computers, causes cash to be credited and a debit made to fixed assets (computer equipment). Note Deferred
Revenue remains unchanged.
3. At the end of years 1 to 3 grant income, equal to 50% of the amount spent on training, is credited to the income account.
4. At the end of years 1 to 4 a depreciation charge for the computers is made, crediting Accumulated Depreciation and debiting Depreciation Charge.
5. For years 1 to 4 grant income, equivalent to 50% of this depreciation charge, is credited to Grant Income and debited to Deferred Revenue.
6. During year 1 the seed capital element was used to on-lend to customers. Debit
Deferred Revenue and credit Grant Capital with the full value of that seed capital.
These movements are shown in the table below.

Example of Accounting Treatment of Grants and Matching Funds Received and
Used
During Year 1:
Dr (Cr)
Grant/Matching Funds Cash
Opening balance
Movement
Receipt of grant/ matching funds
Purchase of
Computers
2,300 (1000)
Staff training
(200)
Closing balance
Fixed Assets
Opening balance
Purchase computers
(depreciation)
Closing balance
Income & Expenditure
Spent on training
Depreciation expense
Released to Grant Income
1000
200
Net cost
Deferred Revenue
Opening balance
Grant received
Release of expenditure
Closing balance
Balance comprises:
Donated Loan Capital
Unspent training contribution
50% of depreciated value of computers
(1,300)
Donated
Loan
Capital
0
(300)
End of Year:
Year
1
Year
2
Year
3
800 400
Year
4
0
0
800 400 0 0
0
1,000
375 250 125
(250) (250) (250) (250)
750 500 250
400 400
0
200
250 250 250 250
(225) (325) (325) (125)
225 225 225 225
(775) (450) (125)
(1,300)
225 325 325 125
(1,075) (750) (425) 300
300
400
300 300 300
200 0 0
375 250 125
As we can see, under this approach, at the end of each year the balance on the
Deferred Revenue account is equal to 50% of the unspent training costs plus 50% of the depreciated value of assets purchased.
0
Reports submitted to BOL by certain MFIs in receipt of grants showed that the grant was not being accounted for correctly. In particular the full grant was being credited to Grant
Capital, while in the Income & Expenditure account no grant income was shown to offset the relevant expenses. This had the effect of reducing profitability, reflected by

depressed OSS levels. The correct method is to put the movements through Deferred
Revenue (shown in the Liabilities section of the balance sheet), releasing grant income in proportion (i.e. 50%) to expenses for which the grant was given.
The accounting entries for each stage in the process are shown below, together with the appropriate codes in the latest version of the SCU/MFI Charts of Accounts.
Transactions
Chart of Accounts
Codes
SCU MFI
1. When the grant is received in the MFI’s bank account:
Dr. Accounts with Banks and other Financial Institutions
Deferred Revenue
42 42
56.1 57.1
With the full value of the grant
2. When the funds are utilized: a) For expenses for which the grant is making a contribution (e.g. training)
Dr. Deferred Grant Revenue
Cr. Grant / Donations Income Received
With the grant proportion of those expenses (usually 50%)
56.1
31.1
57.1
31.1 b) For funds made available for on-lending
Dr. Deferred Grant Revenue 56.1 57.1
72 64
With 100% of that portion of the grant given for on lending c) For purchase of capital equipment
Dr. Property and Equipment 47
Cr. Accounts with Banks or Accounts Payable 42/53.1
47
42/54.1
(No adjustment to deferred revenue) d) When depreciation is charged on that equipment at period end
Dr. Depreciation Expense 23.6 23.62
47.9 47.9
With the full amount of that depreciation
And
Dr. Deferred Grant Revenue
Cr. Grant / Donations Income Received
With the grant proportion of that depreciation (usually 50%)
56.1
31.1
57.1
31.1
If the SCU/MFI over-spends on expense items or equipment, the amount to be taken from deferred revenue is limited to the maximum stated in the implementation plan.
When all activities have been completed the only balance remaining on deferred revenue should be the un-depreciated grant portion of fixed assets.

Session 8: Cash Flow Management & Portfolio Reporting
Without a cash flow plan or a historical cash flow statement an institution may find itself in a liquidity crisis and face an eventual winding-up of operations.
Underpinning most institutional failures is a shortage of cash. An entity ceases to operate or is put to an end when there is no cash. This may seem tragic for a business but serves to reflect the importance of cash in any entity – big or small. Microfinance institutions and small practitioners are no exception.
In short, a business will die when there is no cash or when it has run out of money.
Cash means survival and this reflects the importance of a cash flow plan. Management of cash centres around two records:
1. Cash flow plan
2. Cash flow statement
Cash Flow Plan
This predicts cash flow timing. Essentially you look into the future and estimate when cash will be received and when it will be paid. It can be done for many months into the future.
Its importance is to help avoid the trap of cash shortage. This is particularly important for
MFIs since their main business is giving out cash loans and collecting cash savings.
An accurate cash flow plan can only be done if all plans of a business are known in detail. Once clear plans have been made the cash consequences need to be identified.
In essence this means the amount of cash being received or spent as a result of each planned item/transaction and the timing of the cash receipt or payments is documented.
Cash Flow Statement
A cash flow statement is a statement based on historical or past cash flow data. Its aim is to explain where money has come from and how it was spent or distributed and how much money is available for use. It states the cash flow position of the MFI and is regarded as a third financial statement.
Cash is the organisation’s most liquid asset and efficient use of it is most important.
Cash and profit may or may not be the same. Cash will be the same as profit if a cash based accounting system is adopted by the institution. They will not be the same when accounting records are kept under the accrual accounting system or when a combination of the two systems is in use.

Under an accrual system profit is calculated with consideration for i) ii) iii) non-cash items like depreciation and loan loss provisions (reserves) time bound expenses and revenue asset acquisition (purchase) and disposal
Preparing a cash flow statement
1. To prepare a cash flow statement under a cash-based accounting system the following financial statements are required. a) Beginning and ending balance of balance sheet (i.e. ending balances of previous period and ending balances of current period in order to calculate the changes) b) a statement of receipts and payments for the period.
The statement of receipts and payments will produce the same result as a cash flow statement in terms of ending balances. They will, however, differ in their presentation.
2. To prepare a cash flow statement under an accrual accounting system the following financial statements and information will be required: a) beginning and ending balance of balance sheet (i.e. ending balances of previous period and ending balances of current period in order to calculate the changes) b) profit and loss statement for the period (including non-cash items) c) information on gains or losses incurred on the sale of assets
Under this system neither the Profit and Loss Statement or the Balance Sheet will show the cash position. A cash flow statement will, therefore, be necessary.
Cash Flow Statement
A cash flow statement shows where an institution’s cash came from and how it was used over a period of time. It classifies the cash flows into operating, investing and financing activities.
ƒ Operating activities: services provided (income-earning activities).
ƒ Investing activities: expenditures that have been made for resources intended to generate future income and cash flows.
ƒ Financing activities: resources obtained from and resources returned to the owners. Resources obtained through borrowings (short-term or long-term) as well as donor funds.
Note: The Balance Sheet and Income Statement are accounting reports. The figures can be influenced by management’s choices regarding accounting policies. A Cash
Flow Statement cannot be changed by any accounting policy.

There are two types of cash flow statements: direct and indirect. A direct cash flow statement can only be prepared from within the organization as it requires details of cash receipts and cash payments that can only be generated from within the MFI’s accounting system. An indirect cash flow statement is largely compiled by comparing the current and previous period-end balance sheets and calculating the increase or decrease in cash and current assets and current liabilities, together with certain line items from the
Income and Expenditure account. As such it can be compiled by an external person. By far the most useful to an MFI’s management is the direct cash flow statement and that is the one we shall be concentrating on in this session.
EXAMPLE DIRECT CASH FLOW STATEMENT
XYZ Development Corporation Limited
Cash Flow Statement
For the year ended 31 December 2008
1
2
3
4
5
6
7
8
9
Cash Flows from Operating Activities
Cash Received from Interest, Fees and
Commissions on Loan Portfolio
Cash Received from Interest on Investments
Cash Received as Other Operating Revenue
Value of Loans Repaid by Customers
LAK xx xx xx xx
LAK
(Cash Paid for Financial Expenses on Funding
Liabilities) (xx)
(Cash Paid for Other Financial Expenses)
(Cash Paid for Operating Expenses)
(Cash Paid for Taxes)
(Value of Loans Disbursed)
10 Net (Purchase)/Sale of Trade Investments
11 Deposits/(Withdrawals) from Clients
12
Cash Received/(Paid) for Other Operating Assets and Liabilities
(xx)
(xx)
(xx)
(xx) xx xx xx
A Net Cash from Operating Activities xxx
Sum
1-12
Cash Flows from Investing Activities
13 Net (Purchase)/Sale of Other Investments xx
14 Net (Purchase)/Sale of Fixed Assets xx
B
Sum
13-14
Cash Flows from Financing Activities
15 Net Cash Received /(Repaid) for Short and Long-
16 term Borrowings
Issuance/(Repurchase) of Paid-In Capital xx xx
17 (Dividends Paid) (xx) xx
C
Sum
15-18
D
Net Cash Received/(Paid) for Non-Operating
Activities xxx B + C

E Net Change in Cash and Cash equivalents
19 Cash and Cash equivalents at the Beginning of the Period
20 Exchange Rate Gains/(Losses) on Cash and
Cash equivalents
Cash and Cash equivalents at the end of the
Period xx xxx
A + D
xxx E+19+20

Portfolio Report
A portfolio report provides information about the lending and savings operations of an
MFI. It provides timely and accurate data about the quality of the portfolio. It usually also includes other key portfolio performance indicators (e.g. outreach).
Information usually includes:
•
Number and value of loans outstanding end of period
•
Number and value of loans disbursed during the period
•
Average outstanding balance of loans
•
Value of outstanding loan balances with one or more payments in arrears, value of payments in arrears
•
Value of loans written off during period
•
Aged arrears analysis
•
Number of new and total savings accounts
•
Value of savings mobilized, and total savings balance.
•
Breakdown of portfolio by product, branch or loan officer
Portfolio quality ratios can be calculated from portfolio information. This information together with the aged arrears analysis can give a picture of the health of the portfolio and can also give valuable insight into an MFI’s sustainability.
The Portfolio Report relates to the income statement in that it is the loan portfolio that generates the income for the MFI.
It relates to the balance sheet in that it provides information on the value of the outstanding loan portfolio and value of loans written off during the period.
It relates to the balance sheet and income statement in that the portfolio data is used as an input to calculate the loan loss reserve on the balance sheet, from which the amount of loan loss provision on the income statement is calculated.
Different MFIs will generate different portfolio reports, based on their own needs and the capabilities of their Management Information System. The following example presents the basic information usually contained in a portfolio report. The layout of the report will differ from one MFI to another.
Example Portfolio Report
Name of MFI
Portfolio Report for period: ________
Loans (repeat for each loan product)
Loans disbursed this period
Total loans outstanding (end of period)
Loans written off during period
Average loan size
Loan term (months)
Total number of credit officers
Savings (repeat for each savings product)
Savings collected this period
Total savings balance (end of period)
Average savings balance
No. Amount

Aged Arrears Analysis and PAR Provision
(A)
Number of Loans in
Arrears
(B)
Amount of
Arrears
(C)
Value of Portfolio at Risk
(Outstanding
Balance)
(D)
Portfolio at Risk
%
(E)
Portfolio at
Risk
Provision
(C X D)
1-30 days past due
31-90 days past due
91-180 days past due
>180 days past due
Total
Accounting for loan loss provisions and write-offs
At the end of the period, once the portfolio at risk provision has been calculated then the entry must be made to record that in the GL, and therefore in the balance sheet and income statement. The important point to remember is that the full value of the provision is reflected in the Balance Sheet, and the charge to Income Statement is the difference between that and the value of the provision in the Balance Sheet at the end of the previous period . When the institution decides that the loan is not recoverable it should be written-off against that reserve. This is done by debiting the loan loss reserve in the balance sheet and crediting the loan in the customer ledger.
The following example shows the accounting entries.
Loan loss provision at end of period 1: 1,000
Portfolio at risk end of period 2:
INCOME STATEMENT
1,200
Dr provision for loan Loss
BALANCE SHEET
Cr. Loan Loss Reserve
Being adjustment to reserve for the period
200
200
In the next period it is decided that unrecoverable loans amount to 100
BALANCE SHEET
Dr Loan Loss Reserve 100

Session 9: The Accounting Cycle
The primary objectives of the accounting function in an organization are to process financial information and to prepare financial statements at the end of the accounting period. Companies must systematically process financial information and must have staff who prepare financial statements on a monthly, quarterly, and/or annual basis. To meet these primary objectives, a series of steps is required. Collectively these steps are known as the accounting cycle and are illustrated by the following diagram and described below.
Diagram: The Accounting Cycle: a Circular Process
(1)
Analyse Business
Transactions
(2)
Journalise the
Transactions
(9) (3)
Prepare a
Post to
Post-closing
Ledger Accounts
Trial Balance
(8) (4)
Journalise and Post
Closing Entries
Prepare a
Trial Balance
(7) (5)
Prepare Financial Journalise and Post
Statements:
Income Statement
Balance Sheet
Adjusting Entries:
Prepayments/
Accruals/ Depreciation
(6)
Prepare an Adjusted
Trial Balance

Data flows in a logical sequence in the accounting cycle. Completion of the accounting cycle steps enables the accountant to combine and summarise all of the MFI/SCU transactions in two concise statements that all MFI/SCUs produce no less than monthly.
These are the Balance Sheet and the Income Statement. The cycle is as follows.
Step 1 Transactions
The majority of entries originate with the receipt or disbursement of cash. Members complete a deposit voucher if funds are being deposited or a withdrawal voucher to receive funds. The cashier updates their passbook and notes the new balance.
Other cash transactions include payment of salaries and employee taxes and other deductions and sundry items purchased by petty cash or cheque. Items purchased from regular suppliers, such as water, electricity, telecoms, stationery etc. usually do not immediately result in a cash transaction; they are processed via the Accounts
Payable ledger.
The accountant completes the necessary documentation or voucher for a cash disbursement or a non-cash item. The accountant ensures that the correct accounts are being debited and credited and that the entry is in balance (the debits equal the credits).
Each time step 1 transactions occur, documentation must be maintained. Voucher preparation refers to the recording of economic transactions in a way relevant to their accounting treatment. Vouchers are supported by invoices and cheque stubs or cash requests and generally include the following:
•
Number and nature of voucher;
•
Name of department;
• prepared;
•
Account name and number and amount of money;
•
Source and description of transaction;
•
Authorised
•
Attachment of original bills and cash receipts.
Every organisation has specific means of preparing vouchers. The important aspect to remember is that vouchers result in a paper trail for each transaction, enabling an organisation to have adequate internal control over its recordkeeping and ensure that its assets are safeguarded.
MFI/SCU accountant ensures that all entries at the end of the day balance and that the amount of the cash received is equal to the bank deposit.
Step 2 Journals
The accountant records all the deposits, withdrawals, and disbursements after the day’s work on the appropriate summary form or General Journal and verifies that the total debits equal the total credits. This is always done on a daily basis to reduce the possibility of making an error and to reduce the time it takes to find and correct the error. Each daily transaction is known as a journal entry. All transactions are entered into the accounting system by means of a journal entry. A journal entry records how each transaction affects (debit or credit) an asset, liability, capital, income, and/or expense account. Journal entries are made to the General Journal, which is a listing of all economic transactions, in chronological order.
Step 3 Postings

The journal entries described above are posted to the ledgers. Cash entries are posted to the general Ledger via the Cashbook, Purchases via the Accounts Payable
Ledger and Salaries and deductions via the a Salaries control journal in the General
Ledger.
Step 4 Prepare a Trial Balance
After all the journal entries for have been made for all routine transactions during the month, the accountant performs a Trial Balance first to ensure that total debits and credits for assets, liabilities, capital, income and expenses are equal. The Trial
Balance is prepared by taking the account balances from the General Ledger and listing the accounts having debit balances in one column and those having credit balances in the other column. Next, the debit balances are totalled and the credit balances are totalled. Finally, the sum of the debit balances is compared with the sum of the credit balances. The sum should be equal in order for the ledger accounts to be in balance. If debits equal credits then the accountant prepares the final financial statements. If the Trial Balance does not balance, the General Ledger should be checked to ensure that every account balance is correct and has been transferred properly. If the debits and credits are equal the MFI/SCU accountant then transfers the outstanding balances from the general ledger for assets, liabilities, and capital to the Balance Sheet and the outstanding balances from the General Ledger for the income and expense accounts to the Income Statement.
Step 5 Journalise and post Adjusting Entries
At the end of the month, after ensuring that all accounts are in balance the General
Ledger balance for each MFI/SCU account is updated with adjusting journal entries.
The General Ledger records the final entries for the month. The monthly financial statement balances for each account flow from the General Ledger. Other entries consist of adjustments or transfers between accounts, accounting corrections, establishment and maintenance of a provision for loan losses, write offs of bad loans, accruals for income, payment of interest and operating expenses, and recording depreciation of fixed assets.
No less than monthly, the accountant ensures that all Subsidiary Ledgers (ledgers that are independent of the SCU accounting system such as bank reconcilements, individual member share, savings and loan records, investment statement balances, etc.) balance with the MFI/SCU’s General Ledger balances. When a General Ledger account summarises a number of transactions, it is necessary to provide detailed information about this account with a record known as an Accounting Schedule. In this situation the accounts in the general ledger are considered control accounts, with detail supporting these control accounts carried in the supporting schedules.
The schedules are imperative for all accounts in which more than one item is being accounted for.
For example, in the general ledger account for furniture depreciation all of the depreciation amounts are summarised as one end of month amount. A fixed asset schedule is necessary for each piece of office furniture because the MFI/SCU is depreciating all the office furniture for various lengths of time and for different amounts. An account schedule is not necessary for a General Ledger account in which only one item is being accounted for, such as a MFI/SCU Certificate of Deposit
Investment in XXX Bank. The subsidiary for this account would be the statement received from the institution in which the investment was made stating the current

investment balance and value. The member share, savings, and loan ledgers are also examples of Subsidiary Ledgers, which show the detailed savings and loan transactions of each member. The savings and loan accounts in the General Ledger reflect the total transactions with all members. These General Ledger accounts are the control accounts since they act as a control or check over the numerous postings to the Subsidiary Ledgers. Subsidiary Ledgers are balanced with related control accounts on a monthly basis and any reconcilement, or other proof of balancing should be retained.
Step 6 Prepare an Adjusted Trial Balance
After all period-end adjustments have been made the accountant then prepares the
Post- adjustment Trial Balance.
Step 7 Prepare Financial Statements
From the post-adjustment TB the Financial Statements are prepared; the chief of these being the Income statement and Balance Sheet. These are submitted to
MFFMU together with the supporting monthly reports showing, amongst others, breakdowns of Deposits and Loans and Analalysis of Overdue Loans and Provisions thereon. Although not required by BoL there are many benefits to be derived from producing a cash-flow statement. In addition a number of internal management reports are usually produced; such as geographical analysis of savings and loans, loan collections per credit officer etc. It is recommended that variances from plan for
Income Statement and Balance Sheet and detailed analysis of staff costs and overheads are shown on those reports.
Step 8 Journalise and Post Closing Entries
At the end of the accounting period, the accountant closes the income and expense accounts. The closing entries are prepared after the Trial Balance and financial statements are completed. Closing entries clear and close income and expense accounts at the end of each accounting period by transferring their balances to the
Retained Earnings account. This leaves them with a zero balance. These entries are necessary in order to transfer the net effect of increases and decreases out of the income and expense accounts and into the Retained Earnings account. In addition, closing entries cause the income and expense accounts to begin each new accounting period with zero balances. To clear income accounts, which normally have credit balances, an entry debiting the account and crediting the Retained
Earnings account is required. Similarly, to clear expense accounts, which normally have debit balances, an entry crediting the account and debiting Retained Earnings is required. The net effect on the Retained Earnings account is equal to the Net
Income or Loss for the period. The balance sheet accounts are not closed as the
Income Statement accounts; they continue to accumulate information as long as the
SCU/MFI remains a going concern.
Step 9 Prepare the Post-closing Trial Balance
Finally the accountant prepares the final or “after closing” Trial Balance (in which the net income has been “closed” into the Retained Earnings). MFI/SCUs shall close their books annually after share dividends have been paid. This post-closing trial balance is the opening position for the new period; after which the cycle begins again.