Once a derivative transaction is executed, the back office enters it in the ledger as account bookkeeping and updates it at each settlement and revaluation. Ledger records support reconciliation to the front office's positions and profit and loss, and the preparation of the closing figures.

Why transactions are recorded in the books

Transactions are recorded in the books to confirm positions and profit and loss and to provide the basis for the closing figures. According to the examination manual of the US Federal Reserve Board (the "examination manual" below), recording outstanding transactions lets a dealer verify its positions, manage risk, and keep a record of profit and loss1. The back office (operations and settlement) confirms and settles trades and handles account bookkeeping, and in doing so fixes positions and profit and loss2.

If records are inadequate, the audit trail used to trace a transaction later may become unusable. Poor recordkeeping can also lead to a qualified or adverse opinion by the public accountant (the examination manual's term)3.

Processing transactions, recording contracts in the accounting system, and reconciliation to prevent errors are work done outside the trading unit4.

From a transaction to the general ledger

The general ledger is the book that sorts all transactions by type of account and tallies them. Recording a transaction as debits and credits is called journalizing, and the book in which journal entries are recorded is called a journal. The Corporate Tax Act Enforcement Regulations require a corporation filing a blue return to keep these two books5.

Front officeBack officeEnter thetrade recordPost to theledger, backedby the copyUpdate the ledgeron the settlement date
Figure 1From entry of a transaction in the ledger to its update
Figure description

Once the trade record is entered, the entry in the ledger is made, backed by a copy of the trade agreement. On the settlement date, the ledger is updated.

  1. Trade capture records the terms of the executed trade in the system. Entry and checking are covered in Trade Capture and Approval.
  2. The trade is posted to the ledger. Entries in the contingent liabilities, general ledger, and subsidiary ledgers are all backed by a copy of the trade agreement. The copy is marked to show where it has been posted6. Examiners check whether postings follow the institution's chart of accounts and procedures7.
  3. The ledger is updated on the settlement date. On that date cash or securities are received and paid, and the ledger entries are updated at the same time8.
  4. The trade is revalued regularly. Independent revaluation is done by a control unit independent of the traders9. The back office independently verifies the price estimates used in the valuation. Revaluation whose prices the back office verifies helps maintain the subsidiary and general ledgers10. Valuation methods and the fixing of profit and loss are covered in Daily Valuation and P&L Sign-Off.
  5. When a trade ends, it is taken off the books. A trade leaves the books when it matures, is sold, is terminated, is exercised, or expires worthless. Related deferral accounts go on to later accounting procedures11.

Reconciling positions and profit and loss

The section of the examination manual dated February 1998 lists the following as the typical reconciliations for the ledger12.

Record to reconcile Compared with What is checked
Trader position sheet General ledger Whether the front office (sales and trading) position agrees with the ledger
General ledger Report to authorities Whether the report agrees with the ledger
Broker statement General ledger Whether the external statement agrees with the ledger

The profit-and-loss statement is also subject to reconciliation.

The frequency of reconciliation is set according to the volume and complexity of trading. The staff who reconcile are kept independent of those who entered the trade data12. Examiners check whether the procedures for reconciling outstanding trades, positions, and profit and loss to both the front office records and the ledger are adequate and timely13.

Traders also cross-check from their side. After handing the trade ticket to the back office, a trader takes no part in processing, except to compare daily positions with a record the back office prepares separately and to review the periodic reports the back office produces14.

Investigating differences

When reconciling positions to the ledger, examiners check whether unusual items and items outstanding for a long time are investigated. They also check whether the reconciliation records show that balances and accounts were reconciled correctly15.

The examination manual lists the following responses to differences in revaluation values.

  • A difference between the trader's input and an independent market value is resolved and recorded. A record of differences is kept with the reason for each difference and its impact on profit and loss, and large differences are reported to management16.
  • When the result of an independent revaluation differs significantly from the book value, the threshold amount that triggers an investigation is set in a written policy. Once the cause is known, the institution decides whether its financial reporting needs to be corrected9.
  • When a valuation estimate is changed and the ledger is corrected, the adjustment is clearly recorded and reported to management16.

The examination manual gives no format for recording differences between positions and the ledger. Consider a hypothetical example in which a desk's interest rate swap positions are reconciled between the trader's position sheet and the ledger. The example follows the manual's record of differences. The total notional amount is 50 billion yen on the position sheet and 49 billion yen in the ledger, a difference of 1 billion yen. Checking trade by trade shows that one trade with a notional amount of 1 billion yen was not posted to the ledger. The record of the difference (example) looks like this.

Item Content
Records reconciled Position sheet (notional amount 50 billion yen) and ledger (49 billion yen)
Reason for the difference One trade with a notional amount of 1 billion yen was not posted to the ledger
Impact on profit and loss If the mark-to-market value of this trade is a gain of 20 million yen, the ledger profit is 20 million yen lower. If it is a loss, the ledger loss looks 20 million yen smaller
Response Post the trade to the ledger and record why it was missed. If the difference exceeds the threshold in the policy, report it to management

Revaluation frequency and the record for closing

The US examination manual's section dated February 1998 says revaluation for recording profit and loss should be done at least monthly at every financial institution, and daily in active trading units. It also says accounting revaluation should use prices from a source independent of the traders' input18.

The results of the independent month-end revaluation are documented in enough detail to trace how they were reached, and a summary is passed to management and control units (examination manual, April 2003)19.

Financial closing is based on the transactions recorded in the books. The Corporate Tax Act Enforcement Regulations require a corporation filing a blue return to record all transactions affecting assets, liabilities, and capital according to the principles of double-entry bookkeeping, and to close its accounts on the basis of those records20.

Documents and data used

Accounting operations handle transaction documents, books, and reconciliation records. The names in the following table differ from one financial institution to another.

Document or data Content Use
Copy of the trade agreement The document stating the terms of the trade Backs entries in the ledger and subsidiary ledgers, and is the basis for payment instructions at maturity
General ledger and subsidiary ledgers The book that sorts transactions by type of account (the general ledger) and its subsidiary ledgers Reconciled to the traders' position sheets, reports to authorities, and broker statements
Trader position sheet The record of positions kept by the front office Reconciled to the ledger
Record of differences The reason for a revaluation difference and its impact on profit and loss Used to investigate and report revaluation differences
Chart of accounts and bookkeeping policy The list of accounts and the bookkeeping policy for items such as internal trades Examiners check whether postings follow the chart of accounts and procedures

The table is based on the examination manual's descriptions612167. The description of the general ledger (the book that sorts transactions by type of account), however, is based on the Corporate Tax Act Enforcement Regulations5.

In Japan, a financial instruments business operator that conducts Type I Financial Instruments Business (a securities firm, for example) must prepare and retain books and documents on its business21. These include a trade journal and a trading products account ledger. The trading products account ledger records the course of each trade separately for each instrument, covering option transactions, futures transactions, forward transactions, and others, and is kept for 10 years from the date it is prepared22.

Departments and roles

The back office may be a single unit or may be divided into units such as financial control, risk control, accounting, and securities custody, depending on the institution's organization. Some institutions have moved part of the back office's responsibilities to the middle office (risk management and similar functions)24.

Department Role in accounting operations
Front office (sales and trading) Enters the trade record and compares daily positions with a separate back office record (does not approve accounting methods or ledger entries)
Back office (operations and settlement) Fixes positions and profit and loss by confirming terms, settling, and bookkeeping (entries and payments are handled by different staff; segregation of duties)

The division of roles in the table is based on the examination manual and the Bank of Japan document2526214. Internal audit checks that the front office is not involved in the work of confirming trade terms27.

What this page does not cover

This page does not cover the substance of accounting standards (classification for fair-value measurement, hedge accounting requirements, disclosure).

Notes

  1. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 "Operations and Systems Risk (Back-Office Operations)" (February 1998), page 6, "ACCOUNTING." ↩

  2. Bank of Japan, Financial System and Bank Examination Department, Center for Advanced Financial Technology, "市場リスク管理態勢の整備" (September 2019), page 6 (the back office's "confirmation of trade terms and account bookkeeping") and page 32, "５．バック部門の役割" (5. The role of the back office) (in Japanese). ↩ ↩2

  3. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 7, "DOCUMENTATION AND RECORDKEEPING." ↩

  4. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (April 2003), page 1, opening. ↩

  5. "法人税法施行規則" (Corporate Tax Act Enforcement Regulations, in Japanese), Article 54 (books on transactions and the items to be recorded). The journal is "the book that records all transactions as debits and credits," and the general ledger is "the book that sorts all transactions by type of account and tallies them" (our translation). ↩ ↩2

  6. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 3, continuation of "TICKET FLOW." ↩ ↩2

  7. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.2 (February 1998), page 1, item 13, and Section 2060.3, page 1, item m. ↩ ↩2

  8. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 4, "Settlement Process." ↩

  9. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2100.1 "Financial Performance" (February 1998), page 2, "Independent Price Testing and Revaluation." ↩ ↩2

  10. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (April 2003), page 1 (the paragraph on the role of the back office). ↩

  11. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 3, continuation of "TICKET FLOW." ↩

  12. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 5, "Reconciliations." ↩ ↩2 ↩3

  13. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.2 (February 1998), page 1, item 8. ↩

  14. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1, "TICKET FLOW," from the end of page 2 to the start of page 3 (the boundary between the April 2003 and February 1998 sections). ↩ ↩2

  15. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.3 (February 1998), page 4, "RECONCILIATION PROCEDURES," item 1. ↩

  16. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 6, continuation of "REVALUATION." ↩ ↩2 ↩3

  17. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 3010.3 (February 1998), page 3, "3. Review the integrity of data inputs." ↩

  18. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (February 1998), page 7, the third item under "SOUND PRACTICES FOR BACK-OFFICE OPERATIONS." ↩

  19. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2100.1 (April 2003), page 3 (documentation of month-end valuation results). ↩

  20. "法人税法施行規則" (Corporate Tax Act Enforcement Regulations, in Japanese), Article 53 (closing of accounts by a corporation filing a blue return). ↩

  21. "金融商品取引法" (Financial Instruments and Exchange Act, in Japanese; English translation: Japanese Law Translation), Article 46-2, and "金融商品取引業等に関する内閣府令" (Cabinet Office Order on Financial Instruments Business, etc., in Japanese), Article 157, paragraph 1, item 4 (trade journal) and item 13 (trading products account ledger). ↩

  22. "金融商品取引業等に関する内閣府令" (Cabinet Office Order on Financial Instruments Business, etc., in Japanese), Article 167, paragraph 2, item 1 (the course of each trade recorded separately for each instrument) and Article 157, paragraph 2 (retention period). ↩

  23. "金融商品取引業等に関する内閣府令" (Cabinet Office Order on Financial Instruments Business, etc., in Japanese), Article 167, paragraph 1, item 2 (option transactions), item 3 (futures and forward transactions), and item 4 (swap transactions, meaning the transactions in Article 2, paragraph 21, item 4 and paragraph 22, item 5 of the Financial Instruments and Exchange Act, among others). ↩

  24. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (April 2003), page 1 (the paragraph beginning "Back office, for the purposes of this manual"). ↩

  25. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.1 (April 2003), page 2, "INTERNAL CONTROLS," the item on separation of duties. ↩

  26. Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual," Section 2060.3 (February 1998), page 2, "SEGREGATION OF DUTIES," item 2. ↩

  27. Bank of Japan, Financial System and Bank Examination Department, Center for Advanced Financial Technology, "市場リスク管理態勢の整備" (September 2019), page 42, "内部監査のポイント（続き）" (Points for internal audit, continued) (in Japanese). ↩