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MICROFINANCE ACCOUNTING TRAINING
READING & REFERENCE MATERIALS
OVERVIEW
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
9. Internal Controls
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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
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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 (“doubleentry:). 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
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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 3: 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.
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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).
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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: 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.
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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)
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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.
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Operating activities: services provided (income-earning activities).
Investing activities: expenditures that have been made for resources intended
to generate future income and cash flows.
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.
Example of a cash flow statement.
XYZ Development Corporation Limited
Cash Flow Statement
For the year ended 31 December 2007
(need to update this with the format used for an MFI)
Cash flows from operating activities.
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Interest paid
Income tax paid
Cash flow before extraordinary item
Net cash flow from extraordinary items
xx
(x)
xx
(x)
(x)
xx
xx
Net cash from operations
Cash flow from investing activities
Acquisition of subsidiary
Purchase of property, plant and equipment
Proceeds from sale of equipment
Interest received
Dividends received
Net cash used in investing activities
xxx
(x)
(x)
xx
xx
xx
(xx)
Cash flows from financing activities
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Proceeds from issuance of share capital
Proceeds from long term borrowings
Payment of finance lease liabilities
Dividends paid (can also be operating cash flow)
xx
xx
(x)
(x)
Net cash used in financing activities
(xx)
Net increase in cash and cash equivalents
xx
Cash and cash equivalents at beginning of period (note)
Cash and cash equivalents at end of period (note)
xx
xxx
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.
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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
(A)
Number
of Loans
in Arrears
(B)
Amount of
Arrears
(C)
Value of Portfolio
at Risk
(Outstanding
Balance)
(D)
Portfolio at
Risk
%
1-30 days past
due
31-90 days past
due
91-180 days past
due
>180 days past
due
Session 4: Chart of Accounts
Note: the sections highlighted in blue below should already exist in Lao
language – check with John and BoL
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
Account description
123-44-55
USD Account in ABC Bank
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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
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
labor 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
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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, followed by three zeros:
1000
2000
3000
4000
5000
6000 & 7000
Revenue
Operating Expenses
Non-Operating Expenses
Assets
Liabilities
Equity
There is also a section 8000 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.
The full SCU chart of accounts, together with the International Accounting Standards
applicable to MFIs in Laos is shown in appendix 1.
SUMMARY SCU CHART OF ACCOUNTS
The Bank of Lao has prescribed a uniform chart of accounts to be used by Savings
and Credit Unions (SCUs) operating in the Lao PDR. This has also been adopted by
other MFIs, or is in the process of adoption. A summary is shown below.
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1000
REVENUE
1000 Loan Based
Revenue
1100 Non-Loan-BasedRevenue
1200 SCU-related fees
and charges
4000
ASSETS
4000 Cash on hand
4100 Balances with BOL
4200 Accounts with
other banks
4300 Investments &
long-term receivables
4400 Loan portfolio
4500 Loan Loss Reserve
4600 Interest & fees
receivable
4700 Fixed Assets
4800 Prepayments &
other receivables
4900 Other assets
2000 OPERATING
EXPENSES
2010 Interest to
depositors
2020-2090 Bank and other
interest
2200 Loan Loss
Provision Expense
2300 General &
Administrative Expenses
2400 Taxes and
Licenses
2500 Loan Servicing
Expenses
2600 Promotional
expenses
2700 Cashier Shortage
2800
Taxes on Profit
3000 NON OPERATING
INCOME (EXPENSES)
3100 Grant Income/
Amortisation of Grant
Income
3200 Other income
3300 Extraordinary
Income
3400 Other charges
3500 Extraordinary
charges
5000
EQUITY
LIABILITIES
5000 Customer/ member
deposits
5100 External credits/
borrowings
5200 Interest payable
5300 Accounts payable
5400 Accrued expenses/
provisions
5500 Taxes payable
5600 Deferred revenue
5700 Suspense &
clearing accounts
5900 Other Liabilities
6000 Members Share
Accounts
7000 Institutional Capital
Accounts
7000 Prior Year
Profit/Loss
7100 Reserves &
appropriations
7200 Donated capital
7300 Current Year
Profit/Loss
7400 Dividends declared
8000 OFF-BALANCE SHEET ITEMS
8000 Financing commitments
8100 Guarantees
8200 Foreign Currency Transactions
8300 Other Commitments
Session 5: 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.
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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.
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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
Income
Increase = credit
Expenses
Increase = debit
Balance Sheet Accounts
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.
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For example:
Bank Balance, December 31, 2007
- less outstanding cheques:
- plus outstanding deposits:
Kip
30,000,000
#1
255,000
#2
89,000
(344,000)
#1
100,000
Adjusted Bank Balance
Cash Account Balance (prior to
reconciliation)
- record bank charges
Adjusted Cash Account
244,000
30,244,000
30,344,000
(100,000)
30,244,000
Session 6: 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
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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:
a) Net income
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
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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.
Accounting within the MFIs
Accounting Treatment of grants received - the Deferred Revenue Approach
The 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 IAS 20.
At the end of the accounting period, the funds spent (e.g. on training or staff wages)
or depreciated (in the case of assets purchased) are recognized as income (Cr) and
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the same amount is drawn down from the Deferred Revenue liability (Dr). The net
effect on the income statement for the period is zero.
The detailed accounting treatment for grants to cover both expense items and fixed
assets are shown in the following worked example.
Deferred Revenue example: Let us suppose that an MFI receives a grant for 1,000,
50% to be used for increasing capacity of its staff through training over three years
and 50% for purchasing new computers, which are written-off over four years.
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. 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 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 fixed assets and debiting Deferred Revenue.
5. For years 1 to 4 grant income, equivalent to this depreciation charge, is
credited to the income account and debited to Deferred Revenue.
These movements are shown in the table below.
Example of Accounting Treatment of Grants Received and Used
Dr (Cr)
Grant Cash
Opening balance
Movement
Closing balance
Fixed Assets
Opening balance
Purchase computers
(depreciation)
Closing balance
Income & Expenditure
Spent on training
Depreciation expense
Corresponding
release of income
Net income
Receipt
of grant
1,000
During Year 1:
Purchase of
Staff
Computers
training
(500)
(100)
500
100
End of Year:
Year 1
Year 2
Year 3
Year 4
0
400
400
400
(200)
200
200
(200)
0
0
0
0
0
500
(125)
375
375
250
125
(125)
250
(125)
125
(125)
0
100
125
200
125
200
125
125
(225)
0
(325)
0
(325)
0
(125)
0
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Deferred Revenue
Opening balance
Grant received
Release of
expenditure
Closing balance
(775)
(450)
(125)
225
(775)
325
(450)
325
(125)
125
0
400
200
0
0
375
250
125
0
(1,000)
(1,000)
(1,000)
Balance comprises:
Unspent training
funds
Depreciated value of
computer
As we can see, under this approach, at the end of each year the balance on the
Deferred Revenue account is equal to the unspent training costs plus the depreciated
value of assets purchased.
Session 7: 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
Portfolio Outstanding
Bank Borrowing
Debit
Credit
7,300,000
19,000,000
17,000,000
15,800,000
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Financial Revenue
(Interest)
Personnel Expenses
Rental Expenses
5,500,000
1,000,000
32,800,000
Totals
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
Current loans
Overdue 31-90 days
Overdue 91-180 days
Overdue >180 days
Provision Required by BoL
(% of outstanding loan balance)
1%
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.
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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
Kip
Credit
Loan Loss Provision (expense in the profit and loss statement) 50,000
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)
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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
Cash account (asset account)
Credit
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
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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 8: 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 9: Internal Controls
DEFINITION AND OBJECTIVES
Internal controls are mechanisms, policies, and procedures used to minimize and monitor
operational risks. In order to deter employees and/or members from committing a
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dishonest or fraudulent act the controls must be thorough and comprehensive. However,
internal controls by themselves are not enough. They will be effective only if they are
reinforced by the MFI’s culture, policies and procedures, information systems, training,
and supervision of staff.
The primary objectives of internal controls are to:
• Safeguard assets and member savings;
• Verify the efficiency and effectiveness of the operations;
• Assure the reliability and completeness of financial and management information;
• Prevent fraud and mistakes; and
• Ensure compliance with applicable laws and regulations.
TWO CATEGORIES OF INTERNAL CONTROL
Internal controls can be broken down into two categories – accounting and administrative
controls. These two categories are not mutually exclusive; some of the procedures and
records involved in accounting control also apply to administrative control.
ACCOUNTING CONTROLS
Accounting controls should provide:
• Reasonable assurance that staff perform transactions according to management’s
direction and their authorization level.
• Transactions should be recorded and financial statements prepared according to
accepted accounting principles.
• Records must reflect actual financial condition, structure, and results of operation.
Accounting controls may differ with the size and complexity of a MFI.
1. Daily Posting
• Daily posting records will maintain each day’s activities separate and distinct from
another day’s work. This makes it much easier to locate errors and make corrections.
2. Subsidiary Records
• Accounting staff should balance subsidiary records such as share and loan ledgers,
bank and investment statements and individual cashier records with the respective
general ledger control accounts.
• Accounting staff should review the periodic reconciliations and document their
reviews
3. Internal Reports
• MFIs should design their accounting systems to facilitate the preparation of internal
reports.
• A staff member who is not involved in the transactions should regularly review all of the
reports. The review of the reports should be documented and any irregularities
discussed immediately with a supervisory or general manager.
4. Recording of Transactions
• The recording of transactions should be consistent from one accounting period to the
next.
• MFIs may not defer expenses or accelerate income for the purpose of manipulating
earnings.
5. Sequential Numbering
• Sequentially numbered instruments used for items such as cheques, cash receipt
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vouchers, journal vouchers, and share certificates assists in reconciling and
controlling used and unused items.
• MFIs should retain unissued, pre-numbered items under dual control.
6. Audit Trail
• Records and systems should provide an audit trail (i.e. paper documentation) that
allows for the tracing of each transaction from its inception to completion.
• The documentation should include the name of the individual making the transaction,
the date of the transaction, how much it is for, and what general ledger accounts it
effects. Some of the more common record keeping deficiencies include:
o General ledger entries that fail to contain an adequate description of the
transaction;
o Lack of permanent and satisfactory records pertaining to cash items and
overdrafts;
o Teller cash sheets that do not contain adequate details;
o Bank account reconciliations that are not current or fail to reflect the
description and disposition of outstanding items;
o Inadequate details concerning debits and credits to the cash account;
o Correcting record keeping errors by erasing instead of crossing through the
error;
o Numerous corrections each month;
o Failure to make daily postings to the accounts and records;
o Failure to promptly close the books each month; and
o Failure to review exception and other internal control reports
7. Audit Program
• Every MFI should have an adequate audit program.
• The scope of the internal audit depends on the size of the MFI and the number and
complexity of the services offered.
• An active supervisory committee may be adequate for small, limited service MFIs,
while medium-sized institutions offering more than basic services should employ the
expertise of an external auditor to perform the annual audit.
ADMINISTRATIVE CONTROLS
Administrative control is a managerial responsibility that directly affects the success or
failure of the MFIs. These controls establish lines of authority and responsibility, segregate
the operating and recording functions, and provide for the hiring of qualified employees.
1. Accounting System
•
The board should adopt an accounting system that is flexible in its capacity and rigid in
its controls and standards.
• The system should provide timely, accurate, and useful data to all employees.
• All staff should be adequately trained on the system prior to performing transactions
that affect general ledger and member accounts.
2. Written Policies and Procedures
• MFI policy is established by the board to direct operations and establishes clear limits
and authority.
• Operational staff develop procedures. They are normally not approved by the board.
Procedures describe “how” to do a job.
• Policies and procedures let all employees know what is expected of them, how
they should perform their job duties, and what the consequences are if they do not
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perform them as required.
Written policies and procedures also enable the MFI and its employees to treat
each client consistently.
• These policies and procedures should be included in a regularly updated operations
manual.
• The manual should clearly define the steps required for each transaction, explain how
to handle exceptions, and delineate lines of authority.
3. Board Approval and Monitoring of Information
• The board establishes control and direction through the annual budget and the
longer-term business plan that they are a part of developing, approving, and
reviewing on a periodic basis.
• The board should request, at least quarterly, and preferably monthly, the following reports
to monitor the financial condition of the MFI:
o Balance Sheet;
o Income Statement;
o Cash Flow and Liquidity Analysis;
o Comparison of Actual Results to Budgeted Figures;
o Outstanding Investments;
o Delinquent Loans; and
o Savings and Lines of Credit Overdrafts.
4. Cash Control
• Cash is the most liquid and accessible asset to most employees.
• Adequate cash controls include:
o Surprise cash counts that are performed frequently;
o Cashiers are required to balance the contents of their cash drawer with the
general ledger total daily. Additionally, cashiers should not be allowed to
leave the MFI until the drawer balances or the difference has been recorded
as income or expense;
o Cash limits established for the total amount that can be kept on the MFI
premises, in the vault, and in each cashier’s drawer;
o Limited access to the vault and cashier drawers to those individually
responsible for the funds in the vault or drawer;
o Counting of cash under dual control if tellers buy or sell funds to the vault or
another teller;
o Documentation of all transactions made by and between cashiers with a
receipt;
o Vault and cashier drawers equipped with adequate, functioning, locking
devices; and
o Prohibiting cashiers and employees transacting business on their own
accounts or those of related persons.
5. Segregation of Duties
• The participation of two or more persons in a transaction creates a system of
checks and balances and reduces the opportunity for fraud considerably.
• The MFI should assign duties so no one person dominates any transaction from
beginning to end. For example – A person handling cash should not post to the
accounting records; a loan officer should not disburse loan proceeds for loans
they approved; and those having authority to sign checks should not reconcile
bank accounts.
• In situations where this separation of duties is not possible, because of a limited
•
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staff, the supervisory committee should perform additional procedures to offset the
lack of adequate control.
6. Dual Control
• Accessing vaults, files, or other storage devices should require at least two keys
or combinations under the control of at least two different people.
• Only collusion can bypass this important control feature. Examples of items that
should be under dual control are: vault cash, negotiable collateral, investment
securities, reserve supply of checks, unissued travelers’ checks, credit cards and
money orders, the night depository, mail receipts, ATM cash, dormant savings
accounts, and spare keys to cashier drawers.
7. Protection of Assets
• A principal method of safeguarding assets is to limit access to authorized
personnel only.
• Protection of assets can be accomplished by:
o Developing operating policies and procedures for cash control;
o Establishing dual control over cash;
o Conducting periodic physical check for assets (cash and fixed assets);
o Protecting assets by purchasing adequate insurance;
o Requiring the use of passwords to access the computer system and
changing passwords no less than quarterly; and
o Limiting physical access to cash and the computer system.
8. Zero Tolerance
• MFIs should have a culture that supports internal controls and does not tolerate
excessive errors or fraud.
• These values can be promoted by establishing:
o Severe consequences for fraud that are written, conveyed verbally, and
strictly followed. All fraudulent acts should be met with swift and permanent
action;
o Clear negative consequences for staff with excessive error rates;
o A performance based incentive system that rewards high productivity and
low error rates;
o Competitive salaries that reduce the motivation to commit fraud; and
o Training that explains the reasons behind internal controls and emphasizes
how fraud and errors hurt the institution and its members.
9. Personnel Policies
• Personnel policies should specifically state the consequences for fraudulent acts
and excessive errors so each employee understands the ramifications of such
actions.
• Employees should be familiar with the personnel policy; a review of this policy
should be part of each employee’s initial training.
• The policy at a minimum should:
o Require management to check references of prospective employees;
o Include written position descriptions that define the duties, responsibilities,
and performance standards for each position; and
o Require written performance appraisals of all employees annually.
10. Rotation of Personnel
• From time to time, employee job functions should be rotated unannounced.
• The rotation should be of sufficient duration to discover any fraud.
• Rotation of personnel is a valuable aid in the MFIs’s overall training program as
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employees learn how to perform other jobs. The cross-trained employee can
substitute when other employees take vacations, are absent, or are rotated.
11. Succession Planning
• The on-going success of MFIs will be greatly impacted by the ability to fill key
management positions in the event of resignation or retirement.
• Succession planning should address the general manager and other senior
management positions.
• The existence of a detailed succession plan that provides trained management
personnel to step in at a moment’s notice is essential to the long-term stability of a
MFI.
POTENTIAL INTERNAL CONTROL WEAKNESSES OF MFIs
Cash
• No segregation of duties
• Delays in preparing and reviewing bank reconciliations
• Lack of physical security over cash on hand
• Inadequate processes surrounding teller cash counts
• Flaws in reconciling inter-bank and clearing accounts
Investments
• No segregation of duties
• Lack of appropriate authorization of purchases and sales
• Noncompliance with board decisions on investments or investment policy
• Improper calculation of gains or losses on sales
• Lack of physical security over investments
Loans
• No segregation of duties
• Inadequate checks and balances in loan approval process
• Lack of adherence to MFI policies and procedures
• Absence of, or noncompliance with, policies for immediate follow-up on delinquent
loans
• Improper loan file documentation
• Loan tracking system fails to flag loans that are refinanced, rescheduled, or
paid off with something other than cash
• Excessive refinancing or rescheduling of loans
• Inaccuracy or untimely availability of loan tracking system information
• Material discrepancies between accounting and loan tracking systems
• Existence of related party “insider” loans
• Absence of internal audit function, including an operational audit unit
• Absence of unannounced visits to branches and clients by managers or
internal auditors
Loan loss provisions
•
•
•
•
•
Nonexistent or inaccurate aging schedules
Unreasonable aging standards
Growth is masking delinquency problems
Lack of adherence to laws and regulations
Unverifiable capital adequacy
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Payables and accruals
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•
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No segregation of duties
No proper cutoff
Incorrect management assumptions used in the determination of accruals
No pre-numbering of checks
No matching of bills of lading with invoices and purchase orders
Debt
• No segregation of duties
• No monitoring of covenants
• Improper calculation of premiums or discounts on debt
• No recording of donor loans and improper recording to capital
• No board approval
• Improper calculation of interest expenses
Savings and deposits
• No segregation of duties
• Passbook entries not verified by internal audit
• No monitoring of compulsory savings
Capital
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No segregation of restricted and unrestricted funds
No board authorization of capital transactions
Noncompliance with donor agreements
Noncompliance with capital adequacy requirements and other laws and
regulations
Revenues and expenses
• Activity recorded in the wrong period
• Interest income recorded incorrectly
• Interest charged to branches not eliminated in consolidation
• Donor grant revenue incorrectly recognized when received over time
• Improper accounting of fixed assets
• Purchases recorded to expenses
• Salary rates incorrect
• Possible existence of “phantom” employees
• Multiple family members on payroll
Management information systems
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System incapable of handling volume of transactions
Faulty programming, resulting in distorted financial reporting
Weakness in access control or other security features
No disaster recovery plan
Accounting for Microfinance Institutions – Reading & Resource Pack
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