FUNDAMENTALS OF ACCOUNTING FOR MICROFINANCE
INSTITUTIONS 1
COURSE NOTES
FRIENDS’ Consult,
3rd Floor NIC Building,
P. O Box 24366,
Kampala,
Tel: 041 – 349381
1.0
INTRODUCTION
1.1
Meaning and importance of accounting in MFIs
On a daily basis, MFIs engage in transactions, which result in money changing
hands. All these transactions need to be recorded accurately otherwise an MFI
will lose track of its operations. The process of recording these financial
transactions and summarizing the results is referred to as Book Keeping. The
bookkeeper will typically be responsible for recording all financial transactions in
a transactions journal (Book of prime entry) on a day-to-day basis.
Once the transactions have been summarized, they need to be interpreted and
communicated to the end users. Accounting is therefore concerned with the
interpretation and communication of the financial information to its users through
the use of financial reports. These financial reports include amongst others the
Balance Sheet, Income Statement. For MFIs, they also need to include a Portfolio
Performance report
Generally accounting is concerned with:
•
•
•
Identifying and selecting the information which intended users will need
Evaluating the information in the manner which is most useful to the
intended users
Communicating the selected information and processing it in the form
most appropriate to the requirements of its users
It should be noted that the focus of accounting information is on its users.
Accounting is therefore simply a way of recording, analyzing and summarizing
transactions of a business and communicating the financial information to the end
users.
Below are end users of accounting information and their respective uses of such
information;
•
Board members: The board members would like to interpret
financial statements and operational statistics to better perform
duty of monitoring management performance and steering
towards attaining its institutional objectives, which usually
financial sustainability.
•
Management: They measure their performance with a view to improving
it. They would also like to study, identify and address areas of good,
average and poor performance.
•
Shareholders: These assess the prospects of receiving dividends and
capital growth and the overall safety of their assets in the institution. In the
case of non-shareholding MFIs, the members/founders are more
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/ analyse
their key
the MFI
includes
concerned about management/board prudence in running the institution’s
affairs, asset safety and ensuring that the institution continues to run in
line with their vision and mission.
•
Creditors: The creditors would like to be assured that the institution will
be able to pay both interest and principal. They are concerned with short
term liquidity (ability to meet current financial obligations as they become
due) as well as long term solvency (ability to generate enough cash to
repay long term debts as they mature) as well as the levels of debt in
relation to equity.
•
Donors: The donors would like know whether the institution will be able
to provide the service on a sustainable basis and create impact while
meeting grant or loan requirements and conditions.
•
Regulatory bodies: These would like to be convinced that the institution
is run professionally. They would also like to know whether the institution
is financially and operationally sound and that is run in such away as to
maintain the soundness.
As earlier stated, various MFI stakeholders require information to assess the
extent to which the MFI objectives have been attained. Accounting through
financial statements provides most of this information. Best practice in
microfinance suggests that good financial analysis is the basis for successful and
sustainable microfinance operations. The quality of financial analysis depends on
the quality of the information that has been recorded for analysis and this
information is derived largely from the accounting system.
Therefore, the purpose of accounting for every MFI should be:
¾ To provide records that are the starting point for measuring performance,
revising budgets, and reporting progress
¾ To provide information to facilitate high quality financial analysis by
various stake holders
¾ To provide factual information to aid clear-sighted management rather
than guesswork.
¾ To reassure and inspire confidence from donors and other sources of loan
capital of the institutions soundness and performance
¾ To help microfinance institutions to achieve their basic existence
objectives: expanding outreach to the poor and achieving sustainability
and self-sufficiency.
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This is done through:
1.2
•
Data collection on projects that allows prospective donors and
commercial lenders to evaluate performance
•
Reporting information that includes data on the loan portfolio and
outreach; interest rate policy; income and expenses; balance sheet
information, and analytical performance indicators
•
Further processing the financial and portfolio information so
assembled into conventional ratios and other performance indicators.
Meaning and Importance of Financial Management
Like all other business organisations, the managers and directors of Micro
Finance Institutions are required to prepare and present financial statements that
show the financial performance and position of the MFI over a specified period.
The information extracted from the financial statements is useful to stakeholders
in assessing the stewardship of management and to what extent the financial
objectives have been achieved. An MFI may have financial objectives that might
include amongst others;
•
•
•
•
•
•
Profit maximization
Maximizing of capital growth
Gaining or retaining market control
Financial Sustainability
Prudent asset-and – liability management
Strict application of funds to defined causes
Financial Management refers to the prudent utilisation of the MFI’s resources to
attain its stated financial objectives. Financial statements by themselves tell only a
flat story. To extract from them a meaningful story that relates to the
organisation’s vision, mission, objectives and plans, and the extent to which these
have been achieved, finance professionals have developed several tools and
methods collectively referred to as Financial Analysis. It is through thorough
financial analysis that Stakeholders will ascertain to what extent the financial
objectives have been achieved. Such analysis aids financial management, which
in turn ensures the institution achieves and continually improves financial health.
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2.0
ACCOUNTING PRINCIPLES / CONCEPTS
Accounting information, in order to be reliable, must be prepared according to
generally agreed precepts also referred to as accounting concepts or principles.
Accounting principles are the broad basic assumptions or precepts which underlie
the periodic financial accounts of business enterprises.
Accounting concepts act as filters of accounting data/facts collected from the
environment in which the accounting information system operates, govern the
processing stage and also what is output as information to the users.
2.1
Fundamental principles / Concepts:
The Accounting profession identifies the following four fundamental principles.
a) Going concern principle:
The institution is viewed as continuing in operation for the foreseeable future
and the accounts should be prepared on the assumption that the organization
has neither the intention nor the necessity of liquidating or of curtailing
significantly the scale of its operations.
b) Accruals’ principle (sometimes called the matching concept).
This requires that costs should be matched against revenues which are
produced as a result of those costs. The CA 1985 states that ‘all income and
charges relating to the financial year to which the accounts relate shall be
taken into account, without regard to the date of receipt or payment’. In other
words, if an expense has been paid in one financial period but the related
revenue does not arise until a later one the cost should be carried forward, and
if an expense is incurred in one financial period it should be charged against
the profit of that period, whether or not it has been paid for by the accounting
date. However, the prudence concept (see below) must prevail over the
accruals concept if any inconsistency between the two arises. For example,
where it is doubtful that any revenue will be earned from an expense, then the
expense should be written off in the period in which it is paid with out the
revenue being recognized.
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c) The Principle of Prudence:
A person is said to be prudent when he gives the most cautious presentation of
the situation. In accounting a knowledgeable user assumes that the preparer
has been cautious to the extent that he has not anticipated any gains (all gains
reported have been realized) and any expenses or losses foreseen with
reasonable certainty have been recognized in the financial statements.
Uncertainties inevitably surround many transactions and revenue and profits
should not be anticipated but recognized only when they are realized in the
form of cash or other assets which monetary value. The amount of any item
must be determined on a prudent basis, and in particular:
(i)
Only profits realized by the balance sheet date should be included
in the profit and loss account; and
(ii)
All liabilities and losses which have arisen or are likely to arise in
respect of the financial year to which the accounts relate (or a
previous financial year) must be taken into account. This includes
those liabilities which only become apparent between the balance
sheet date and the date on which it is signed on behalf of the board
of directors.
d) Consistency Principle
The accounting treatment of like items should be consistent over successive
accounting periods. When policies are consistently applied, it helps facilitate
comparison of performance over a range of periods. In case the accounting
treatment of any item has changed from one period to another, details of such
a change should be disclosed in the notes to the accounts. The impact of the
change should be quantified and stated.
2.2
Other principles / Concepts:
Besides the above four universally agreed fundamental principles or concepts,
there are other principles. These are:
a) Entity concept
This is the assumption that the affairs of an entity are treated as separate from
the other business activities of its owner. The only time that the personal
resources of the proprietor affects the accounting records of the business is
when the proprietor introduces capital into the business, makes a drawing
origin any other transactions with the business.
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b) Duality concept
This is the assumption that the preparer of the financial statements recorded
the two aspects of each transaction in the business. Any given transaction will
affect a minimum of two accounts within assets, liabilities, or equity. If the
accounting equation (ASSETS = CAPITAL + LIABILITIES) is to remain in
balance, any change in the assets must be accompanied by an equal change in
the liabilities or equity, or by an equal but opposite change (increase or
decrease) in another asset account.
c) Materiality concept
This is the assumption that only material items appear in financial statements.
Items are material if their omission or misstatement would affect the impact of
the financial statements. Materiality as a concept is relative but some items
disclosed in accounts are particularly sensitive and even a very small
misstatement of such an item would be seen as a material error. For example,
where the disclosure of the absolute amount is a statutory requirement. In
assessing the materiality, the context of the item is important. Consider the
class of the transactions, the account balances and from the financial
statements as whole.
d) Realization concept
This requires that revenue be recognized in the accounting period it is earned,
rather than when it is collected in cash. It defines the point at which revenue is
recognized
e) “Substance over form” Concept
It stipulates that items in the financial statements need to be treated more in
line with their economic reality than just their legal form, as long as this does
not result in violation of materiality. Accordingly, assets, liabilities, income
and expenditure items can be grouped in some cases and reported as a single
item.
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3.0
ACCOUNTING TREATMENT OF KEY TRANSACTIONS
3.1
Double Entry Book Keeping:
The method used to transfer our cumulative totals from books of prime entry into
the general ledger is called Double Entry book keeping.
The Double entry principle is based on the fact that each transaction has two
effects which are equal but opposite. This is the dual effect of transactions.
Usually, this will affect two different accounts.
3.1.1
Double Entry Rules
It is necessary to always observe one important rule: every financial transaction
gives rise to two accounting entries, one a debit and the other a credit. An
account is a record of transactions between the institution/ organisation and the
third party.
The total value of debit entries for all transactions must always equal to the total
value of the credit entries at any given time. The arithmetic check of this is
usually done by way of constructing a trial balance (systematic list of all debit and
credit balances) periodically.
Each account has two sides, the left-hand side of which is called the debit side
(DR) and the right hand side of which is called the credit side (CR).
When we talk of debiting an account we mean that the transactions details should
be recorded on the left hand side and crediting means recording on the right hand
side.
Below is an example and format of an account.
Table 1: Format of a ‘T’ account
Title of account.
---------------DEBIT SIDE--------------Date
Narrative Amount
The date of
the
transaction is
recorded here
Stating
where the
double
entry
is
posted
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--------CREDIT SIDE----------Date Narrative Amount
Which account receives the credit entry and which receives the debit depends on
the nature of the transaction. Before we consider the dual effect on the main
categories of accounts lets first define the following:
Assets are items in which an MFI has invested its funds for the purpose of
generating revenue and represent what is owned by the MFI or owed to it by
others.
Liabilities represent what is owed by the MFI to others
Equity represents the capital or net worth of the MFI.
A more detailed discussion of assets, liabilities and equity is presented in section
4.1
Table 2 below shows you the dual effect on the main categories of accounts
Table 2: A summary of debit and credit impact on different account types
Main
Account
Category
Revenue (Income)
Expenses
Assets
Liabilities
Capital
A debit to an A credit to an Normal
account will:
account will:
will be:
- Decrease
+ Increase
Credit
+ Increase
- Decrease
Debit
+ Increase
- Decrease
Debit
- Decrease
+ Increase
Credit
- Decrease
+ Increase
Credit
Balance
Explanation:
We can notice the following from the above table:
An increase in Revenue (Income) e.g. donor funding received or interest on
fixed deposit accounts with the bank is a credit and a decrease is a debit. Also, a
normal balance for revenue (income) is a credit.
An increase in an expense e.g. purchase of stationery is a debit and the decrease
is a credit. The normal balance of an expense account is a debit.
An increase in assets e.g. purchase of computers or furniture is a debit and a
decrease is a credit. The normal balance of an asset is a debit.
An increase in a liability e.g. obtaining an overdraft from the bank is a credit and
a decrease is a debit. The normal balance for a liability is a credit.
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An increase in capital e.g. owners’ contributions is a credit and a decrease is a
debit. The normal capital account balance is a credit.
From the above paragraphs, it can be generalized that if the effect of an increase
on the account is a debit, the normal balance will be a debit and if it is a credit
also the normal balance will be a credit.
In line with the foregoing explanations, the following guidelines for double entry
transaction posting apply:
Table 3: Guidelines on posting transactions to different account types
Account Type
Debit
Incomes, Gains, Liabilities, Reductions in value
Capital
Expenses, Losses, Assets
Increases in value
3.2
Credit
Increases
value
Reductions
value
in
in
Recording transactions of a Typical MFI
You should be able to apply the knowledge so far acquired to record business
transactions of a MFI accurately under double entry principles. Let us see what
transpires in a MFI that is of our accounting interest and we see how to record it.
Chart of Accounts
To assist a book keeper of typical MFI record transactions in a more consistent
and easy understand manner, a chart of accounts is important. A chart of
accounts is a list of accounts classified according to their nature (that is; assets,
liabilities, capital or equity, revenue or income, expenditure) with peculiar
account numbers. There is no standard chart of accounts for microfinance
institutions. It varies from institution to institution.
A typical MFI’s business involves the following account types:
•
•
•
•
•
•
•
•
•
Cash and bank balances
Customer deposits
Customer withdrawals
Loans to customers
Short term deposits into banks
Prepayments and other current assets
Fixed assets – acquisition, disposal and depreciation
Short term and Long term loans
Interest Income
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•
•
•
Provisions for bad and doubtful debts / Loan losses
Expenditure (Interest expense, Office expenses, Staff expenses, other
expenses)
Other payables, accruals & short term provisions
3.2.1 Cash and Bank Related Transactions
a) Cash and Bank Balances
This is an amount of money at hand / bank at the end of an accounting period. It is
a balance sheet item (see section 4.1). Cash can either be a current asset or a
liability.
If it is a credit balance, it is a current asset and a DR entry
If it is an overdraft it is a liability and a CR entry
b) Customer Deposits
Some microfinance institutions accept savings deposits from their clients. These
may be demand deposits (voluntary savings) or collateralised forced savings, and
therefore, constitute a significant liability of a microfinance institution.
To ensure strong controls over customer deposits, the following records are
usually maintained;
¾ Savings deposit form
¾ Savings Account Ledger card
¾ Customer Passbook
¾ Treasury book
¾ Scroll book
¾ General ledger vouchers
A customer wishing to deposit cash at an MFI branch completes the savings
deposit form (SDF), in duplicate. Both completed forms are handed to the
receiving cashier other officer/ credit officer with the correct amount of cash to be
deposited.
The receiving cashier verifies the cash received from the customer and ensures
that the SDF is properly completed and signed by the customer. Once satisfied as
to the proper completion of the SDF and the accuracy of the cash amount, the
cashier stamps both copies of the SDF “Received”, initials and dates the form,
and then returns the duplicate SDF to the customer.
The original SDF is retained by the cashier and submitted, periodically during the
day, to the back office staff, for posting and safe custody.
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The following entries are raised, on MFIs General Ledger Vouchers, to record the
savings deposit:
DEBIT
Cash (With the amount of the deposit)
CREDIT
Customer’s account (With the amount of the deposit)
(On Savings Ledger Cards)
The debits to the cash account are summarized at the end of the day, broken down
by cashier, and posted to the Treasury Book and the Scroll Book.
The customer’s Passbook is updated (Credited) whenever a customer makes a
deposit to match the entries on the Savings Ledger Card.
At each end of day, the Treasury Book is reconciled with the Scroll Book. It is
usual practice for Back-office staffs to maintain the Treasury Book and Scroll
Book, while the cashiers maintain the Till Sheets.
c) Customer Withdrawals
Customer withdrawals constitute a significant cash movement at MFIs.
In
addition to ensuring physical custody of cash, the MFI needs to ensure that cash
withdrawals are properly documented.
To ensure strong controls over customer cash withdrawals the following records
need to be maintained;
¾
¾
¾
¾
¾
¾
Withdrawals Form
Savings Account Ledger Card
Customer Passbook
Treasury Book
Scroll Book
General Ledger Vouchers
A customer wishing to withdraw cash from MFIs completes the Withdrawal Form
(WF), in duplicate. Both completed forms are handed to the MFIs Paying
Cashier.
The Paying Cashier verifies the customer’s signature and the customer’s physical
appearance against the specimen signature/passport photograph in MFIs records.
In addition, the Paying Cashier checks to ensure that the customer’s cleared
balance with MFIs is sufficient to cover the customer’s withdrawal, any
outstanding debits and the required minimum balance on the savings account.
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Once satisfied that the customer is the genuine owner of the account and that
he/she has a sufficient balance, the cashier stamps both copies of the WF “Paid”,
initials and dates the form, and then passes both copies to the customer, to
acknowledge receipt of the money requested for on the WF. Once the customer
has acknowledged receipt of the money, the Paying Cashier hands the cash to the
customer, together with the duplicated WF.
The original WF is retained by the cashier and submitted, periodically during the
day, to the back office staff, for posting and safe custody.
The following entries are raised, on MFIs General Ledger Vouchers, to record the
cash withdrawal:
DEBIT
CREDIT
Customer’s account (With the amount withdrawn)
(On savings ledger card)
Cash (With the amount withdrawn)
The credits to the cash account are summarized at the end of the day, broken
down by cashier, and posted to the Treasury Book and the Scroll Book.
The customer’s Passbook is updated (debited) whenever a customer withdraws
cash – to match the entries on the Savings Ledger Card.
d) Loans to Customers
The purpose of keeping records on credit is to ensure an MFI accounts for loans,
overdrafts and accrued interest thereon in accordance with generally accepted
standards. The following records should be maintained as a control measure;
¾
¾
¾
¾
Pass book
Loan cards
Loan application forms
General ledger vouchers
A customer wishing to obtain a loan from the microfinance institution completes
an
application form. The credit / loan officer receives and signs the form to
certify that:
¾ The loan application form has been accurately completed
¾ The customer meets the respective MFIs standard credit requirements
¾ A microfinance institution is willing to proceed with the credit evaluation
process.
The MFI officers then carry out the standard credit assessment procedures. The
loan will be accepted or rejected.
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If the loan is granted, the following entries are passed on the MFIs General
Ledger.
DEBIT
Customer Loan Account
CREDIT
Customers’ Savings Account or Cash depending on the method of
disbursement
e) Short Term Deposits into Banks
These refer customer deposits into the bank
DEBIT
Common Deposit Account (Bank Deposit Account)
CREDIT
Customers Account
3.2.2 Prepayments and other Current Assets
Prepayments
A Prepayment can either be an asset or a liability. It is an asset when it’s an
expense paid in a financial period but when it relates to another financial period, it
is a liability.
Accounting treatment for a prepayment (asset) is;
DEBIT
Prepayment (Balance Sheet item)
CREDIT
Particular Expense Account (P&L)
Accounting treatment for a prepayment (liability)
DEBIT
Income Account
CREDIT
Pre paid Income Account
Therefore it is an asset to the person paying out and a liability to the one receiving
Other Current Assets
The Accounting treatment for other assets is as follows;
DEBIT
CREDIT
Other Current assets (Balance Sheet item)
P& L the individual accounts
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3.2.3 Fixed Assets/ Non Current Assets
The purpose of keeping accounting records is to safeguard MFI’s fixed assets
from theft, damage and forms of wastage, and to ensure fair valuation of the fixed
assets from MFI records is reported in the balance sheet.
Any asset, tangible or intangible, acquired for retention by an MFI for the purpose
of providing a service to its business, and not held for resale in the normal course
of MFI’s business is a fixed asset.
The following entries are passed, on MFI’s General Ledger Vouchers, once a
fixed asset is required:
DEBIT
Respective Fixed Asset Account (With the cost of the fixed asset)
CREDIT
Bank or cashier account
Fixed assets depreciation
Different methods of charging depreciation are used by different microfinance
institutions. The following methods are normally used when calculating
depreciation;
¾ Straight line basis – Where a uniform depreciation charge is put on the
asset yearly till the whole purchase value is depreciated to zero. In some
cases, a residual value remains on the asset.
¾ Declining balance / reducing balance – Where the depreciation is charged
on the assets book/ written down value of the previous year.
Example: X Microfinance Ltd acquired a motor vehicle on 1st January 2004 at a
cost of UGX 15 million. Depreciation charge per annum is 25%.
The depreciation charge will be 25% × 15 million = 3,750,000
To record the depreciation charge, the following entries are made;
DEBIT
CREDIT
Depreciation expense – motor vehicles by UGX 3,750,000
Accumulated depreciation – motor vehicles by UGX 3,750,000
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Disposal of fixed assets
To record the sale or disposal of a fixed asset, the cost and accumulated
depreciation of the fixed asset are transferred to a Fixed Assets Disposal Account
as follows:
DEBIT
CREDIT
DEBIT
CREDIT
Accumulated Depreciation with the balance on the Accumulated
Depreciation Account
Fixed asset disposal with the balance on the Accumulated
Depreciation Account
Fixed Asset Disposal Account with Fixed Asset Cost
Fixed Asset Cost Account with Fixed Asset Cost
The proceeds received on disposal are recorded as follows:
DEBIT
CREDIT
Bank or Cash with the selling price of the asset
Fixed Asset Disposal A/C with the selling price of the asset
The balance on the fixed asset disposal account after passing the above entries is
transferred to the Profit/Loss on disposal of fixed assets in the profit and loss
account. A debit balance represents a loss on disposal, whilst a credit balance
represents a profit on disposal.
Permanent diminution of fixed assets
If, in the opinion of MFI management, a fixed asset suffers permanent diminution,
the asset is written off the books against the profit and loss account in the year
that the permanent diminution is first identified. The permanent diminution in
value may involve a partial or absolute loss in value. To record the permanent
diminution, the cost and accumulated depreciation of the fixed asset are
transferred to a fixed assets disposal account as follows:
DEBIT
CREDIT
DEBIT
CREDIT
Accumulated Depreciation A/C with the balance of the assets
accumulated depreciation
Fixed Assets Disposal A/C with the balance of the assets
accumulated depreciation
Fixed Asset Disposal A/C With the cost of the Fixed Asset
Fixed Assets Cost A/C With the cost of the Fixed Asset
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The net balance in the fixed assets disposal account after passing the above entries
is charged to the profit and loss account as follows:
DEBIT
CREDIT
Profit and Loss Account
Fixed Asset Disposal A/C
Revaluation of Fixed Assets.
Revaluation of fixed assets should only be booked in MFIs books if the
revaluation is performed by professional valuers. The following entries are
passed to record the revaluation:
DEBIT
Fixed Asset A/C (With the revaluation amount)
CREDIT
Revaluation Reserve
The revaluation amount is the difference between the value of the fixed asset as
determined by the valuers and its net book value. The net book value of an asset
is its cost minus its accumulated depreciation.
The revaluation surplus is a non-distributable reserve-it cannot be paid out a
profits/surplus. The balance in the revaluation reserve is transferred to the profit
and loss account when the asset is disposed off. In addition, the excess
depreciation arising on revaluation is debited to the revaluation reserve and
credited to the profit and loss account.
Example:
Suppose the MFI acquired a vehicle on 1/1/1995 for UGX 15 million and
depreciates over 4 years on a straight-line basis, with nil salvage value. On 31
December 1997 a firm of professional valuers appointed by MFI re-value the
asset at UGX 8 million.
MFI management would like to recognize the
revaluation in the accounting records.
At the time of the revaluation (31/12/97), the net book value of the vehicle was as
follows:
UGX
Cost
Less: Accumulated depreciation
3* (25%*UGX 15 million)
15,000,000
11,250,000
Net book value
3,750,000
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The new valuation of the vehicle is UGX 8 million; therefore the revaluation
surplus is UGX 4,250,000 (8,000,000 – 3,750,000)
The revaluation surplus would be credited to the Revaluation Reserve Account
and debited to the Motor Vehicle Account.
The vehicle would still be depreciated over 4 years (until 31/12/98).
Any
additional depreciation (based on the revalued amount), would be reduced by an
equivalent transfer from the revaluation surplus account.
Maintenance of Fixed Asset Register
The Fixed Assets Register (FAR) records details of all MFI’s fixed assets.
General ledger entries to record the purchase of fixed assets must be passed
simultaneously with those in the FAR.
The FAR records the following details on each Fixed Asset:
•
•
•
•
•
•
•
•
•
•
Nature of the asset (e.g. motor vehicle, building, computer etc)
Unique serial number of the asset (e.g. vehicle No 678 UCH)
Total cost
Date of acquisition
Vendor details (name and address)
Location
Estimated useful life
Depreciation rate
Estimated salvage value on disposal
Accumulated depreciation (updated)
Physical verification of fixed assets
The physical verification of fixed assets is aimed at:
•
•
•
•
Confirming the existence of MFI fixed assets as recorded in the FAR
Determining whether MFI owns any fixed assets which are not
recorded in the FAR
Determining the condition of the fixed assets (e.g. damages or
obsolescence)
Confirming other details about the fixed assets contained in the FAR.
Fixed assets unique identification.
In addition to the manufacturer’s serial numbering of fixed assets, an MFI
engrave/label its fixed assets. Each asset should bear a unique identification
mark, which is also recorded in the FAR. The unique identification should be
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bold and easily noticeable by an observer – this act as a deterrent to would be
thieves.
Accounting for fully depreciated assets
Fully depreciated assets are not depreciated any further. On a case by case basis,
MFI management decides whether or not to revalue its fixed assets. The decision
to revalue fixed assets is based on the following criteria.
•
•
Estimated (additional) useful life of the asset
Estimated value of the asset (materiality test)
• Generally Accepted Accounting Policies (GAAP)
3.2.4 Short Term & Long Term Loans
It is usually the Bank and donors which gives the loans to microfinance
institutions. A bank charges a commercial rate of interest. A donor usually
charges a subsidised rate of interest.
When an MFI receives a loan, the following entries are made;
DEBIT
Cash & Bank Account of the institution with the principal amount
CREDIT
The bank issuing the loan with the principal amount
CREDIT
CREDIT
Long Term Loan A/C
P& L (Interest as Income)
When the MFI is paying back,
DEBIT
The Bank issuing the loan with the Principal and interest
CREDIT
The Cash & Bank Account with the Principal and interest
3.2.5 Interest Income
Interest on loans should normally be calculated on reducing balance basis and
accounted for on an accruals basis. The following example illustrates a typical
MFIs interest computation procedure.
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Example
W Microfinance Ltd makes a loan to one of its customers at the following terms:
¾ Principal amount
¾ Interest rate
¾ Loan period
UGX2 million
3% per annum
6 months (182 days)
The interest payable by the customer at the end of the first month will be
computed as follows:
UGX 2million × 3% = UGX 60,000
The following entries will be passed on W Ltds’ general ledger voucher to record
the above transaction:
1)
To record the principal amount of the loan
DEBIT
CREDIT
2)
3)
4)
5)
Customer Loan Account
UGX 2,000,000
Customers’ Savings Account UGX 2,000,000
To record the total interest receivable at the end of the first month
DEBIT
Interest receivable
UGX 60,000
CREDIT
Unearned interest
UGX 60,000
To record subsequent interest earned on the loan on a monthly basis, the
process is repeated for the reducing amounts of interest. E.g. For the
second month:
DEBIT
Interest Income
UGX 50,000
CREDIT
Interest
UGX 50,000
To record receipt of repayment instalment from customer:
DEBIT
Customers’ Savings Account or Cashier
CREDIT
Customers Loan account
UGX 383,197
To record interest payment by the borrower,
DEBIT
CREDIT
Cash or Customers Savings A/C UGX 50,000
Interest Receivable A/C
UGX 50,000
20
If a loan is non – performing (based on W LTDs’ credit policy), interest income is
not recognised in the profit and loss account; It is suspended on the balance sheet.
As soon as a loan is classified non – performing, the out standing interest
receivable is reversed (reversal entries in step 2 above) as follows.
DEBIT
Interest Income (with outstanding interest receivable)
CREDIT
Interest receivable
The following entries are then passed to record the interest in suspense;
DEBIT
Interest in suspense – asset
CREDIT
Interest in suspense – liability (With the outstanding / unearned
interest income at the time that the loan is classified non – performing).
3.2.6 Provision for bad & doubtful debts (Loan Loss Provisions)
The decision whether to provide against loans and the magnitude of any
provisions made is based on qualitative and quantitative factors.
Qualitative factors include the performance of the customer’s project, on going
discussions with the customer, nature of the security provided by the customer
and strength and performance of the rest of the group members. These factors are
largely unquantifiable, but affect the quality of the loan.
Quantitative factors are measurable, and include the age of the facility, ‘days past
due’, date of last credit / debt service.
Example:
The following provisioning guidelines for W Microfinance Ltd are based on the
“days past due”. However in deciding whether or not to provide and how much to
provide W Ltds’ management is guided by both the qualitative factors referred to
above and the ‘past due’.
Number of days Category
past due
0–7
Performing
8 - 30
Irregular
31 – 90
Sub – standard
91 – 180
Doubtful
Over 180
Loss
21
Required provision
1%
20%
50%
75%
100%
Loans under the irregular, sub-standard, doubtful and loss categories are
considered non-performing.
The general guidelines for accounting for bad and doubtful debts are:
¾ Once the decision is made to provide against a loan, the profit and loss
account is debited immediately with the amount of the provision whilst the
credit is posted to a bad debts provisions account (a balance sheet item)
¾ Provisions are made as a percentage (20%, 50%, 75% or 100%) of the
outstanding principle amount
¾ Normally no further provisions are required in respect of interest
income. Any outstanding/unearned interest is reversed and suspended as
already illustrated above.
¾ Provisions for bad and doubtful debts may only be reversed (written back)
to the extent of the reduction (repayment) of the outstanding loan. For
example, if W Ltd recovers Shs 500,000 from a customer classified
“doubtful”, then only Shs 375,000 (75% of 500,000) can be reversed from
the provision account.
¾ On a yearly or half yearly basis, the provisions are done in line with the
procedure explained above. The resulting figure of total provision is called
the Loan Loss Reserve, and is deducted from the Gross Loan Portfolio in
the balance sheet to get the Net Loan Portfolio. Incremental provisions are
taken to the P&L.
3.2.7 Other Payables, Accruals & Short Term Provisions
Payables, accruals, and short term provisions are liabilities to an institution. Their
accounting treatment is as follows:
DEBIT
CREDIT
The Expense Account to which they relate
Accruals or other payables (balance sheet items)
Provisions are estimates debited to the P & L Account during the accounting
period. Examples of provisions include bad debts, Audit fees, Depreciation and
discounts.
Accounting treatment is as follows:
DEBIT
Profit & Loss Account
CREDIT
Provisions for these Accounts (Balance sheet items)
22
4.0
Revenue and Expenditure Recognition.
A Microfinance Institution may choose to recognise revenue on cash or accruals
basis but expenditure should always be recognised on an accruals, rather than
cash basis. Under the accruals method revenue is generally recognised in
Microfinance Institution’s financial statements when the MFI acquires a right to
inflows of economic benefits from another entity/person.
Under the accruals method recognition of revenue and expenditure is not based
purely on the receipt or payment of cash. Transactions are recognised even when
there is no immediate cash flow from the transaction. Interest revenue is
recognised on a time proportion basis that takes into account the effective return
on an asset (e.g. total interest receivable from a loan), as long as the loan remains
performing.
A microfinance institution should always recognise expenses as they arise
whether or not payment has been made. For example expenditure on telephones is
recognised (accrued) on a monthly basis;
Do not await receipt of the telephone bill to recognise the expense.
4.1
Expenditure Controls
The following general controls are applied to expenditure.
¾ Competitive bids (at least two quotes) are obtained for all significant
procurements (above a certain amount).
¾ Cash expenditure is limited to urgent procurements, not exceeding a certain
amount. All other expenditure is paid for by cheque.
¾ All cash expenditure is authorised by the CEO, manager or any other person
nominated by them
¾ At least two signatories are required for each bank transaction
¾ All cash expenditure is recorded on a cash voucher, and all bank expenditure
is recorded on a bank payments voucher.
¾ All expenditure (cash or bank) is supported by third party documents, e.g.
invoices or receipts
¾ All documents supporting payment are cancelled / stamped ‘PAID’
immediately after effecting payment.
¾ A microfinance institution utilises all credit periods, prompt payment
discounts and any other facility availed by suppliers to reduce expenditure
¾ To the extent that is practicable, all expenditure incurred is in line with the
approved budget. Any expenditure incurred outside the approved budget is
reported, as an exceptional item, in monthly reports.
23
Exercise 1 Accounting treatment of various transactions (A client going
through the entire process of getting a loan & a hypothetical MFI acquiring
assets and eventually disposing them)
24
5.0
COMPONENTS OF FINANCIAL STATEMENTS
At the end of each financial year, an MFI prepares and presents its financial
statements that show its financial performance over the one-year period and the
financial position at the close of the year. These financial statements comprise
of:
(i) The Balance Sheet
(ii) The Profit and Loss Account/income statement
(iii)The Cash flow Statement
5.1
The Balance Sheet
Definition
The Balance sheet is a snap shot of a MFIs asset and liability position at a point in
time. It reflects:
• What the MFI owns and what is owed to it(assets),
• What it owes other persons or entities (liabilities)
• The difference between the above two is the equity or the net worth.
A balance sheet is likened to a snap shot since it simply captures the financial
position at that time.
Note: In a balance sheet, assets should always be equal to the sum of liabilities
plus net worth/ equity.
5.1.1 Categorisation of balance sheet items
Broadly the balance sheet has the following major items:
•
Current Assets – These are assets that are held / owned and operated by an
entity with in one financial reporting period. These vary depending on the
nature of business. They are all assets that are expected to expire, be used
up or change form with in one year.
•
Non – Current Assets / fixed assets – These are assets that are owned or
held and operated to generate profit for more than one year.
Current Liabilities – These are debts / obligations of an entity by the
balance sheet date, which the entity will settle in the next 12 months.
•
•
Non- Current Liabilities/Long term liabilities- These arise where an entity
is given credit and debt to be settled after more than one year from the
balance sheet date. They are all debts owed by the entity, expected to be
retired after 12 months or longer
25
•
Equity- This includes capital which is a special form of debt for the
business. Owners are seen as special lenders whose contribution is used in
operations for the life of the entity. This debt is only repayable on the
event of closure of the business. It also includes retained profits/reserves.
Where an entity is a trading concern, it is possible for it to expand its scale
of operations by choosing to plough back any profit made.
It also
includes other capital accounts like the share premium and revaluation
reserve. In a nutshell, equity is the total claim on the business b its owners,
EQUITY = TOTAL ASSETS – TOTAL LIABILITIES.
5.1.1.1 Current Assets
The following are the major items under current assets in a typical MFI balance
sheet.
• Cash
• Deposits in financial institutions
• Short term investments
• Gross loan portfolio
• Loan loss reserve
• Other short term assets
Cash
The amount held in cash and current accounts (non –interest bearing) by the
Microfinance Institution.
Deposit in Financial Institutions.
This is cash held in commercial banks or, if applicable, the central bank for
regulated institutions (prescribed by the law governing the institutions. These
balances are available to the organization on a demand basis but earn interest.
Short term investments;
These are investments that mature within 12 months and earn interest income for
the Microfinance Institution.
Gross Loan Portfolio;
This includes the total of all the outstanding principal balance of the Microfinance
Institution’s loans including current, delinquent and restructured loans to its
clients, but not loans that have been written off. Some Microfinance Institutions
choose to break down the components of the gross loan portfolio into performing
or current loans, portfolio at risk and restructured loans. The gross loan portfolio
does not include interest receivable. Although some regulated Microfinance
Institutions may include accrued interest, the reporting Microfinance Institution
26
should provide a note that provides a breakdown between the principal
outstanding and interest accrued. The gross loan portfolio is frequently referred
to as the loan portfolio or loans outstanding. These terms should not be used to
refer to the Net Loan Portfolio explained below. The gross loan portfolio should
not be confused with the value of the loans disbursed.
Loan Loss Reserve:
This is a portion of the gross loan portfolio that has been expensed (provisioned
for) in anticipation of losses due to default. This item represents the cumulative
value of the loan loss provision expense (from the income statement) less
cumulative value of loans written off.
The Loan Loss reserve is recorded as a negative asset on the Balance Sheet: a
reduction from the gross loan portfolio.
It should be noted that the Loan reserve is not a cash reserve, but rather an
accounting entry to adjust for anticipated loan losses. The reserve accumulates
from provision expenses related to the portfolio at risk or in some cases general
provision expenses against the entire gross loan portfio. The value of the Loan
loss reserve should not be less than the value of loans anticipated to be written off.
Net Loan Portfolio is = Gross Loan Portfolio – Loan Loss Reserve.
Other short-term Assets
Often these are other short term assets not listed above that will be used or change
form within the next 12 months, such as prepaid expenses like rent and insurance,
accrued interest, accounts/ fees receivable, etc.
5.1.1.2 Non – Current Assets
Non – Current assets are those that are expected to continue existing in their
current form as assets of the business for more than 12 months after the balance
sheet date.
The following are the line items under non-current assets of a balance sheet;
• Long term investments
• Fixed assets
• Accumulated depreciation
• Net fixed assets
• Total assets
27
Long –term investments;
These are amounts held in long-term instruments. These are investments not
intended as a ready source of cash and include stocks, bonds and promissory notes
that will be held for more than one year. Typically they yield higher interest than
shorter term forms of investment.
Fixed Assets.
Fixed assets are tangible, long lasting assets that are acquired for use in the
business rather than for resale in ordinary course of business, with a useful life of
more than one year. These include land and buildings, company vehicles, office
equipment, etc. recorded at their initial cost at time of purchase.
Accumulated Depreciation
As earlier explained, accumulated depreciation is a “negative asset” showing
estimated cumulative reduction in the value of fixed assets.
It represents the sum of depreciation expenses recorded in the current and
previous accounting periods. It represents a decrease in the book value of fixed
assets. (See depreciation in the income statement section).
Net Fixed Assets.
Net Fixed Assets = Fixed Assets – Accumulated depreciation. This is often
referred to as book value or written down value of fixed assets.
Total Assets
Total Assets = Total Current Assets + Total non-current assets
5.1.1.3 Current liabilities
Below is a list of the line items under the current liabilities of a typical MFI
balance sheet
•
•
•
•
•
•
•
•
Restricted / Compulsory savings
Voluntary savings
Time deposits ≤ 1 year
Total short – term deposits
Short – term debt (market rate)
Short – term debt (subsidised rate)
Loans from the central bank
Other current liabilities
28
Restricted /compulsory savings
These are also referred to as compulsory savings, forced savings, Loan Insurance
Funds (LIF), collateralised saving, Loan Guarantee Funds (LGF) or compensating
balances. These represent funds that must be contributed by borrowers as a
condition to receiving a loan, sometimes as a percentage of the loan, and
sometimes an absolute amount. Compulsory savings are considered part of the
loan, and sometimes as a nominal amount. Compulsory savings are considered
part of the loan product rather than savings product since they are tied to receiving
loans and are generally not allowed to be on-lent by the Microfinance. They are
however, owed to clients and are thus a current liability.
Voluntary Savings.
Savings that are not an obligatory part of accessing credit services. Voluntary
savings services are provided to both borrowers and non-borrowers who can
deposit and withdraw according to their needs. They are customers’ demand
deposits in that usually the client can deposit cash into or withdraw from the
account any time.
Time deposit ≤ 1 year
These are deposits for which the depositor agrees not to withdraw any part of the
deposit prior to the maturity date or the expiry of a specific time in this case ≤ 1
year (unless the depositor is willing to forgo interest). Such deposits by the clients
into the MFI constitute a liability for the MFI.
Total short-term deposits
Summarises of Short-term deposit liabilities = restricted compulsory savings +
Voluntary savings + Time deposits ≤ 1 year
Short-term debt (market rate)
These are amounts outstanding on all short-term borrowings (those which mature
in less than 12 months) on which a commercial (or market) rate of interest is paid
by the MFI.
Short-term debt subsidised rate
29
The amount outstanding on all short-term borrowings (those which mature in less
than 12 months) on which a concessional rate (or below market rate) rate of
interest is paid by the MFI.
Loans from the central bank.
The amount outstanding on all short-term borrowings from the central bank (for
those MFIs that can borrow from the central bank.
Other current liabilities
Any other liabilities due within 12 months such as interest payable on savings
accounts or taxes due that are not listed above.
Total current liabilities
Total current liabilities = summation of current liabilities explained above.
5.1.1.4 Non – Current liabilities
Below is a list of the line items under the Non-current liabilities of a balance sheet
•
•
•
•
•
Time deposits > 1 year
Long – term debt (market rate)
Long – term debt (subsidised rate)
Deferred income or restricted income
Other long – term liabilities
Time deposits > 1 year
These are the deposits for which the depositor agrees not to withdraw any part of
the deposit prior to the maturity date or the expiry of a specific time in this case >
1 year (unless the depositor is willing to forego the interest).
The client makes a lump sum deposit into the MFI, with the understanding that it
would not be drawn down before the maturity period which is more than 12
months.
Long – term debt (market rate):
This is the total outstanding on all long – term borrowings (those which mature in
12 months or more) on which a commercial rate (or market rate) of interest is paid
to the microfinance institution.
Long – term debt (subsidised rate)
30
The amount outstanding on all long-term borrowings (those which mature in 12
months or more) on which a concessional (or below market) rate of interest is
paid by the Microfinance Institution.
Deferred income or restricted funds
Donations or grants provided to the Microfinance Institutions that are restricted in
some way to a particular purpose or time frame. Theoretically if the Microfinance
Institution failed in its performance of the specific condition(s), the donor could
recall these funds. As the Microfinance Institution provides the services agreed
on and incurs expenses, the deferred revenue is reflected as grant revenue on the
Income Statement and used to cover these expenses.
Other Long-term Liabilities
Other non-current liabilities that do not meet any of the above criteria.
Total non-current liabilities
Summation of Non-current liabilities
Total liabilities
Summation of Total current liabilities and Total non-current liabilities
4.1.1.5 Equity
As earlier stated, equity is the shareholders/ owners’ claim on the business.
Below is a list of the line items under the equity of a typical balance sheet
•
•
•
•
•
•
•
Capital from shareholders (paid up share capital).
Donated equity
Reserves
Retained surplus / (deficit) Current year
Retained surplus / (deficit) Prior period
Retained surplus ( deficit)
Other capital accounts
Capital from shareholders:
31
This is the amount of paid up share capital from share holders.
Donated equity:
Accumulated donations over time including current period donations. These are
the total grants received. Microfinance institutions use different methods for
reporting donated equity. For some, donated equity includes all donations,
regardless of their purpose. For others, donated equity includes only donations for
financing the loan portfolio or fixed assets. Donated equity in the balance sheet
should not include deferred grant income as this is for the time being “unearned”
and should be reported as a liability.
Reserves:
Other forms of equity other than paid up share capital or retained earnings. They
may arise from a surplus on asset revaluation or capital contributions not
registered as paid up capital. They could also be created out of net retained profits
for special purposes.
If inflation adjustments are incorporated within the MFIs financial statements and
carried forward from year to year, then in addition to creating an expense on the
income statement, this will also generate a reserve in the balance sheets’ equity
account. This reserve will reflect the amount of the MFIs cumulative retained
earnings that have been consumed by the effects of inflation.
Retained surplus / (deficit) Current year
This is the surplus or deficit from MFI operations that has been retained by the
institution in the current financial year.
Retained surplus / (deficit) Prior years
This is the cumulative surplus or deficit from MFI operations that has been
retained by the institution in prior years, since the formation of the MFI.
Retained surplus / deficit
Summation of prior period and current retained surpluses, representing the total of
all the surpluses/ profits and/or deficits/ losses made ever since the MFI started
operations.
Other Capital accounts
32
They may be other equity accounts other than paid up share capital, retained
surplus / (deficit) or retained earnings examples are share premium, revaluation
reserve.
Total Assets
Total assets = Total liabilities + Total equity
Exercise 2: Preparation of a balance sheet from data of a hypothetical MFI
5.2
Income Statement
5.2.1 Definition of the Income Statement
The Income Statement is a summary of incomes earned and expenses incurred
during a period, with the bottom line being the profit or loss realised.
The Income Statement is also known as Profit and Loss Statement, summarizes
all financial activity during a specific period of time, usually a month, quarter or
year. It records the income that was received and expenses incurred during the
period, showing the profit earned or loss incurred (difference between income &
expenses). The bottom line of an income statement is the net income (net profit or
surplus) or net loss (or deficit) for the period. MFIs should record grant income
below this line on the Income Statement. The income statement measures
performance of the microfinance institution over the reporting period.
5.2.2 Categorisation of income statement items
The following are the major items of an income statement;
• Income
• Financing expenses
• Operating expenses
• Net income from operations
• Net income from operations after tax
• Net income from non – financial services
• Grant income
5.2.2.1 Income
33
Below is a list of the line items under Income;
•
•
•
•
•
Interest Income from loans
Fee income from loans
Income from investments
Other operating income
Total operating income
Interest income from loans
This is interest received on loans. Some MFIs record interest income on an
accrual basis while others record interest income only when received (cash basis).
The method of recording interest received should be described in the notes to the
financial statements, and should remain consistent across accounting periods.
If an MFI records interest on an accrual basis, this should generally stop if the
loan becomes non- performing. Some MFIs capitalise (record on the balance
sheet) interest income once a loan becomes non performing resulting in a larger
outstanding loan balance. This too should be described in the notes to the
financial statements.
Fee income from loans
These are fees and commissions, including penalty fees (if applicable) received on
loans.
Income from investments
This is revenue from interest, dividends or other payments generated by financial
assets other than the loan portfolio, such as interest bearing deposits, certificates
of deposits, Treasury Bills and Government Bonds. This includes not only interest
received in cash but also interest accrued but not yet received.
Other operating income
Revenue generated from other financial services, such as fees and commissions
for non - credit financial services. This item may include revenues linked with
lending such as membership fees. If the MFI views training as an integral element
of the financial service it provides, then training fees would be included in other
operating income. This figure should not include revenue earned on activities not
related to the provision of financial services.
Total operating income
34
It is the summation of all operating income during the period or year-to-date.
5.2.2.2 Financing Expenses
These arise where an institution acquires debt in form of a loan or overdraft and
uses the money in its operations. Finance expenses are costs the MFI pays to
access and use such debt. Examples of financing cost are interest on loan and
bank overdraft, loan processing fees and commitment fees paid on loans. Below is
a list of the line items under financing expenses of an income statement;
•
•
•
•
•
Interest and fees paid on market debt
Interest and fees paid on subsidised debt
Interest paid on unrestricted savings
Interest paid on restricted savings
Total financing expenses
Interest and fees paid on market date
This is the total amount of interest and fees to access and use loans borrowed at a
commercial interest rate.
Interest and fees paid on subsidised debt
This is the total amount of interest paid during the period on funds borrowed at a
concessionary (or subsidized) interest rate.
Interest paid on unrestricted savings
This is the total amount of interest paid during the period on voluntary savings
Interest paid on restricted savings
This is the total amount of interest paid during the period on compulsory savings
Total financing expenses
This is the summation of all financing expenses during the period. It embraces all
interest, fees and other expenses incurred in accessing and using funds by the MFI
Gross Financial Margin
It reflects the difference between what is earned by the Microfinance Institutions
by providing financial services and its financing costs associated with its financial
activities.
It therefore, reflects how well the Microfinance Institutions is
performing in terms of generating a sufficient ‘spread’. It is the difference
between Total operating revenue and Total financing expenses.
Gross Financial Margin = Total Operating Revenue – Total Financing Expenses
Provision for Loan Losses.
35
This is a non-cash expense that creates or increases the Loan loss reserve on the
Balance Sheet.
This expense may be comprised of general and specific
provisions. The general provision is calculated as a percentage of the value of
the Gross Loan portfolio that is at risk of default based on aging analysis.
Specific provisions are made for specific loans. It is common to use the term
provision for loan losses and loan loss reserve interchangeably.
To avoid
confusion between this expense and the loan loss reserve, analysts prefer to use
the term reserve for the balance sheet account, and the term provision for the
expense account. It is also helpful to include the word expense when referring to
this latter account.
The provision for loan loss expense should always be separated from other
operating costs.
Net Financial Margin (NFM);
The NFM represents the difference between the income generated from the
portfolio and other investments, and the costs directly associated with those
investments during the period (Financing expenses and provision for loan losses).
This represents the amount of income available to cover operating expenses for
the period or year-to-date.
5.2.2.3 Operating expenses
Operating expenses include the following items ;( costs incurred by the MFI in its
operations, other than financing or capital costs.
• Personnel expenses
• Rent and utilities
• Travel and transport
• Depreciation
• Stationary and office supplies
• Other operating expenses
Personnel expenses
These include staff salaries, bonuses, and benefits, as well as employment taxes
paid by the Microfinance Institution. It is also referred to as salaries and benefits
or staff expenses. It may also include costs of recruitment and initial orientation.
It does not include on-going or specialized training costs, which normally fall
under other operating expenses.
Rent and utilities
Expenses incurred for the lease or rent of land and/or buildings during the period
and utilities such as electricity, water and telephone bills.
36
Travel and transport
Expenses incurred for transportation, room and board, etc of staff members while
on official duties for the Microfinance Institution.
Depreciation
A non-cash expense that is determined by estimating the useful life of each asset
and expensing a portion of the useful life for the period (see methods used to
calculate depreciation in accounting for treatment for fixed assets). Depreciation
represents a decrease in the value of property/assets and accounts for the portion
of useful lifetime that is expensed during each accounting period. (See
Accumulated depreciation on the Balance Sheet.).
Stationary and office supplies
Expenses incurred for stationary, office supplies, etc
Other Operating Expenses.
Other operating expenses (non-financial) directly related to the provision of
financial services or other services not included above that from of integral part of
providing financial services. These could include advertising and consulting
fees, training expenses, legal fees, insurance etc. or direct expenses associated
with accessing donor funding. Does not include taxes on employees, revenues,
or profits, but may include taxes on transactions and purchase, such as valueadded taxes if not included above.
Total Operating Expenses.
Includes all personnel expenses and other operational expenses during the period,
but excludes all Financing expenses and Provision for loan the do not form an
integral part of providing financial services.
Total Expenses
Summation of all Financing expenses, Loan loss provision and operating
expenses for the period or year-to-date.
Net Income from Operations
Net Income from Operations =Total Operating Income less Total Expenses.
37
Income Taxes
Include all taxes paid on net income or other measure of profits as defined by
local tax authorities. Income tax for an MFI, like is the case with any other
incorporated entity is levied on net profit. It is known as corporation tax.
Net income from Operations after Tax = Profit /Loss from Operations - Tax (if
any).
Income from non-financial services
Income received from non-financial services which are not an integral part of
offering financial services.
Expenses from non-financial services
Represents expenses that an institution incurs for providing non-financial
services.
Net income from non-financial services
Represents the contribution to net income from non-financial services.
5.2.2.4 Grant income
A grant is a donation made by an organisation or person to the MFI. Major
categories are:
• Grant income for loan capital
• Grant income for fixed assets
• Grant income for operations
• Un restricted grant income
• Recorded on the Income statement for memorandum purposes only
• Not included in the retained surplus / deficit current year
Grant income for loan capital (for memorandum purposes only)
Funds donated to the Microfinance Institution to capitalize the loan fund, that is,
which are restricted to use as lending funds and cannot be used for operating
expenses. This amount may be on the Income Statement for memorandum
purposes only and is not included in the Retained surplus/deficit. It normally goes
to the balance sheet as separate item “Revolving Funds” under liabilities and
equity.
Grant income for fixed assets
38
Funds donated to the Microfinance Institution to purchase fixed assets
(depreciable), which are restricted to fixed asset purchases and cannot be used for
operating expenses. This amount is recorded on the Income Statement for
memorandum purposes only and is not included in the Retained surplus/deficit of
the current year. It should prudently, go to the equity portion of the balance sheet
as a non – distributable reserve.
Grant income for operations.
Funds donated to the Microfinance Institutions to cover operating expenses and
supplement earned income. This amount is recorded on the Income Statement
for memorandum purposes only and is not included in the Retained surplus/deficit
Current year. It goes to the balance sheet as a reserve.
Unrestricted grant income
Unrestricted funds donated to the Microfinance to cover any need including funds
for loan capital, purchase of fixed assets, or operating shortfalls. This amount is
recorded on the Income Statement for memorandum purposes only and is not
included in the Retained surplus/ deficit Current year
Total grants received
The summation of all grant income to support the delivery of financial services
(and non –financial services if applicable).
Net Income after Grants (for the period)
Summation of Net Income from Operations after Tax, Net income from nonfinancial services and Total grants received.
Exercise 3: Preparation of an income statement from data of a hypothetical
MFI.
5.3
Cash flow Statement
5.3.1 Definition of a Cash flow Statement
A cash flow statement is a logical statement summary of how cash flowed in and
out of the business (MFI) during the reporting period. It should always be
constructed such as to the end of the period. Information about the cash flows of
an enterprise is useful in providing users of financial statements with a basis to
assess the ability of the enterprise to generate cash and cash equivalents (see
definition below) and the needs of the enterprise to utilise those cash flows. The
economic decisions that are taken by users require an evaluation of the ability of
39
the enterprise to generate cash and cash equivalents and the timing and certainty
of their generation.
5.3.2 Benefits of Cash flow Information
A cash flow statement when used in conjunction with the rest of the financial
statements provides information that enables users to evaluate the changes in net
assets of an enterprise, its financial structure (including its liquidity and solvency)
and its ability to affect the amounts and timing of cash flows in order to adapt to
changing circumstances and opportunities.
Historical cash flow information is often used as an indicator of the amount,
timing and certainty of future cash flows. It is also useful in checking the
accuracy of past assessments of future cash flows and in examining the
relationship between profitability and net cash flow and the impact of changing
prices.
5.3.3 Major Components of a cash flow statement
The following are the major line items of a typical Cash flow Statement
•
•
•
•
•
•
Cash flows from operating activities
Cash flows from Investing activities
Cash flows from Financing activities
Net increase or decrease in cash or cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Operating Activities
These are the principal revenue producing activities of the enterprise. The amount
of the cash flows arising from operating activities is an indicator of the extent to
which the operations of the enterprise have generated sufficient cash flows to
repay loans, maintain the operating capability of the enterprise, pay dividends and
make new investments without recourse to external sources of financing.
Information about the specific components of historical operating cash flows is
useful, in conjunction with other information, in forecasting future operating cash
flows.
Cash flows from operating activities are primarily derived from the principal
revenue-producing activities of the enterprise. Therefore, they generally result
from the transactions and other events that enter into the determination of net
profit or loss.
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Investing Activities
These are cash flows that represent the extent to which expenditures have been
made for resources intended to generate future income and cash flows. Examples
include cash payments to acquire equity or debt instruments. They involve
acquisition and disposal of long term assets and other investments.
Financing Activities
These are activities that result in changes in the size and composition of equity
capital and borrowings of the enterprise. They are useful in predicting claims on
future cash flows arising from financing activities.
Cash and Cash Equivalents
Cash comprises cash on hand and demand deposits
Cash equivalents are short term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant
amount of changes in value. Cash equivalents are held for the purpose of meeting
short term cash commitments rather than for investment or other purposes.
6.0
DISCLOSURE OF ACCOUNTING PROCEDURES
It is a requirement by the international accounting standards (wholly adopted by
ICPAU) AND CGAP Disclosure guidelines for microfinance institutions that in
addition to preparing financial statements (balance sheet, income statement with
accompanying notes) disclosures be made. This ensures meaningful information
to the users. Donors, other investors, board members, and managers of
microfinance institutions (MFIs) rely on the financial statements of an MFI when
they assess its financial sustainability and loan portfolio. Many financial
statements do not however, include enough information to permit such an
assessment. The following disclosures should be made;
¾
¾
¾
¾
¾
¾
¾
Segment reporting
Donations
Micro loan portfolio accounting issues
Portfolio quality and management
Details of liabilities and equity
Other significant accounting policies
Other non – accounting disclosures
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Attached are the CGAP disclosure guidelines for financial reporting by
microfinance institutions.
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