Loans are typically one of the biggest balances on a bank's balance sheet.

So let's take a look at how the loans balance is accounted for in a bit of detail.

Typically, the majority of loans on a bank's balance sheet are recorded at amortized cost net of an allowance for expected loan losses.

We're not gonna cover the allowance for loan losses in detail here, but that is an allowance or a provision for the risk that the loan doesn't get repaid in full.

It's calculated based on expected future credit losses rather than losses which have already been incurred.

So what do we mean by accounting for loans at amortized cost? When the loan is initially issued, the bank's balance sheet will see cash go down and the loan asset is created.

However, this may not match exactly the nominal size of the loan since if any fees that need to be paid by the borrower such as arrangement fees are deducted from the cash paid to the borrower only the net amount is shown as the loan asset in the income statement.

The interest expense is calculated by taking the beginning balance sheet loan asset and multiplying this by the effective interest rate on the loan.

The effective interest rate on the loan is the IRR or internal rate of return of the cash flows on the loan.

If the initial loan amount is less than the nominal amount due to those arrangement fees, then the effective interest rate will be higher than the cash interest rate that needs to be paid by the borrower each year.

In the cashflow statement, the amount of interest paid by the borrower, which is the cash interest rate on the loan times the loan's nominal amount will be recorded in the cashflow statement.

If there is a difference between the income statement, interest income, and the cash flow statement, cash received, the difference will be an adjustment to the loan asset balance.

The effect of this is that it will move the loan asset balance from the net cash advanced at issue towards the nominal amount at maturity, which is the amount that will need to be repaid on the maturity date.

Here we have an example of how loans are shown on a real bank's balance sheet.

We're looking at Goldman Sachs here.

While the vast majority of these loans are recorded at amortized cost, a small number of these loans are shown at fair value where the bank has opted to account for these loans at their fair value in the balance sheet.

This fair value option is typically only used for loans.

The bank is looking to sell or syndicate, and you can also see that the loan balance is net of the allowance or provision for expected future credit losses.

Let's have a look at how this translates through to the income statement.

When initially looking at a bank's income statement, it Might look very different from non-financial companies income statements because interest income and interest expense are included within net revenues at the top of the income statement, when the most non-financial companies, they're shown much lower down after operating profits.

But why is this the case? Well, generating interest income is a key operating activity for most banks earned through issuing those loans.

So this is shown within the revenue section.

Also, the interest expense from the deposits and other debt financing that is needed to finance the loans is a closely associated expense, so it is deducted below interest income to give us net interest income.

Since looking at the Goldman Sachs financial statements here, they earn more substantial revenues from their non-interest investment banking activities, which is why interest income and expense are shown a little lower down.

But for most commercial banks, the interest, income and interest expense will be shown at the top of the income statement.