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Bulletin HASKINS & SELLS 37 Interest Collected But Not Earned A VERY interesting question grows out of that which is the subject of pamphlets issued recently by a number of national banks. The Comptroller of the Currency in his call for a statement of condition, as of November 1, 1918, reminded national banks that beginning January 1, 1919, provision would have to be made for interest earned but not collected, as well as interest collected but not earned. In a previous call there appeared the following notice: "As it has been the custom of many national banks to credit discounts as collected directly to profits and to credit profits with accruing interest only after actual collection, it has been thought proper to give the banks a reasonable time to make the adjustments which will be required in order to report accurately items 21 (interest earned but not collected) and 27 (interest and discount collected or credited in advance of maturity and not earned)." The treatment of the first item is simple and follows what accountants have been advocating for years in spite of the contention made by some banks that the procedure is unnecessary because one period will offset the other. The second item raises the question, academic perhaps, as to whether a bank in discounting a note for a customer really collects the interest or discount in advance. The practice of banks, as is generally known, is to compute the interest on the principal at the rate agreed and for the time involved, and deduct the interest from the amount for which the customer has applied, actually loaning him the net amount. Take, for example, a case where the loan requested is $1,000.00; the rate 6%; the time three months. By a process of bookkeeping, the transaction is made to appear as if the bank had loaned $1,000.00 and collected in advance the interest in the amount of $15.00. In other words— "Loans and Discounts" is debited in the amount of $1,000.00; "Unearned Discount" is credited with $15.00. The same effect upon the assets of the bank would be shown if "Loans and Discounts" had been charged and "Cash" credited in the amount of $985.00. The matter is treated as first mentioned because a note of this character may circulate somewhat and shows on its face the amount which it will bring at maturity. If, however, it changes hands during its life the unearned discount must be adjusted. It would seem therefore, offhand, that the same result might be accomplished by making the note for $985.00 and having it bear interest at 6%. It would then be a matter of adjusting the accrued interest at the time of the transfer instead of adjusting the unearned discount. Careful consideration discloses the fallacy of this argument as long as the discount is calculated as at present. The proceeds of a note for $1,000.00 at 6% for three months with discount calculated by what is known as true discount would amount to $985.22. This sum at 6% for three months would amount at maturity to $1,000.00. The proceeds of the same note with the discount calculated by what is known as bank discount would amount to $985.00. This amount at 6% for three months would amount to $999.78. While the difference involved is for practical purposes too small to have any real effect upon the situation, it shows the principle involved. It also brings out clearly the fact that the second mentioned method of computing the discount is more advantageous to the lender. This perhaps explains why the bookkeeping entries are made to show the transaction broad instead of net. Regardless of the method used in computing the discount or the bookkeeping entries which are made to record the transaction, the fact remains that the bank making the loan parts with a certain amount of
Object Description
Title |
Interest collected but not earned |
Author |
Anonymous |
Subject |
Interest -- Accounting |
Citation |
Haskins & Sells Bulletin, Vol. 02, no. 05 (1919 May 15), p. 37-38 |
Date-Issued | 1919 |
Source | Originally published by: Haskins & Sells |
Type | Text |
Collection | Deloitte Digital Collection |
Digital Publisher | University of Mississippi Libraries. Accounting Collection |
Date-Digitally Created | 2009 |
Identifier | HS Bulletin 2-p37 |