Deposit account

Example

For example, a depositor opening a checking account at a bank in the United States with $100 in currency surrenders legal title to the $100 in cash, which becomes an asset of the bank. On the bank's books, the bank debits its "currency and coin on hand" account for the $100 in cash, and credits a liability account (called a "demand deposit" account, "checking" account, etc.) for an equal amount. (See Double-entry bookkeeping system.)

In the audited financial statements of the bank, on the balance sheet, the $100 in currency would be shown as an asset of the bank on the left side of the balance sheet, and the deposit account would be shown as a liability owed by the bank to its customer, on the right side of the balance sheet.

The bank's financial statement

The bank's financial statement reflects the economic substance of the transaction -- which is that the bank has actually borrowed $100 from its depositor and has contractually obliged itself to repay the customer according to the terms of the demand deposit account agreement. To offset this deposit liability, the bank now owns the actual, physical funds deposited, and shows those funds as an asset of the bank.

Typically, an account provider will not hold the entire sum in reserve, but will loan the money out at interest to other clients, in a process known as fractional-reserve banking. It is this process which allows providers to pay out interest on deposits.

By transferring the ownership of deposits from one party to another, they can replace physical cash as a method of payment. In fact, deposits account for most of the "money supply" in use today.

For example, if a bank in the United States makes a loan to a customer by "depositing" the loan proceeds in the customer's checking account, the bank typically accounts for this event by debiting an asset account on the bank's books (called loans receivable or some similar name) and credits the deposit liability or checking account of the customer) on the bank's books. From an economic standpoint, the bank has essentially created "economic money" (although obviously not legal tender). The customer's checking account balance has no "dollar bills" in it, as a demand deposit account is simply a liability owed by the bank to its customer. In this way, commercial banks are allowed to increase the money supply (without printing currency, or legal tender).

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