Premature Fixed Deposit Closure and Interest Accounting
On 1 April, a customer opens a fixed deposit of ₹5,00,000 for two years at 6.80% per annum, with quarterly compounding. The bank's premature withdrawal policy says interest is paid at the card rate applicable for the actual period the deposit has run, less a penalty of 1.00%, computed on a simple-interest basis for the actual number of days. The card rate for 12 months to less than 24 months is 6.50%. The customer closes the deposit on 5 May of the following year, after 400 days. The bank has already accrued and credited interest of ₹34,900 at the original contracted rate for the first year. The customer also maintains a savings account with an average daily balance of ₹80,000 during the same period and asks why savings interest is lower than the FD rate. The branch must calculate the closure proceeds and pass the accounting entries.
1. Compute the closure proceeds payable to the customer.
Read the worked answer
Contracted rate: 6.80% for 2 years. Actual run: 400 days. Card rate for 12 to less than 24 months: 6.50%. Penalty: 1.00%. Eligible rate = 6.50% − 1.00% = 5.50% on a simple-interest basis.
Interest = 5,00,000 × 5.50% × 400/365 = 5,00,000 × 0.055 × 1.09589 = ₹30,137 (rounded).
Total payable = ₹5,00,000 + ₹30,137 = ₹5,30,137.
TDS: interest is below ₹40,000, so no TDS for a non-senior customer. The bank had already credited ₹34,900 at the original rate, so the excess interest of ₹4,763 must be reversed. The customer should be told that the premature penalty reduced the effective yield; the bank should not simply pay the originally accrued interest.
2. Pass the accounting entries for opening, accrual and closure.
Read the worked answer
Opening: Dr Cash/Party account ₹5,00,000 Cr Fixed Deposit account ₹5,00,000
Accrual/credit of first-year interest ₹34,900: Dr Interest Expense ₹34,900 Cr Fixed Deposit account ₹34,900 (The FD liability is now ₹5,34,900.)
Closure after 400 days: Dr Fixed Deposit account ₹5,34,900 Cr Customer Savings account ₹5,30,137 Cr Interest Expense (reversal) ₹4,763
This records the lower premature rate, reverses excess interest, and discharges the FD liability. If TDS had applied, a separate Cr TDS Payable entry would be needed.
3. Explain to the customer how savings interest is calculated and why it is lower than the FD rate.
Read the worked answer
Savings interest is calculated on the daily balance method: each day's closing balance is multiplied by the applicable rate and divided by 365; the daily products are added and interest is credited quarterly. For an average daily balance of ₹80,000 at, say, 3.00%, annual interest is about ₹2,400, far below the FD. The reasons are:
- Savings deposits are demand liabilities; the customer can withdraw at any time, so the bank offers a lower rate.
- The FD locks funds for a term and pays a higher rate for that commitment.
- The balance fluctuates, so interest is earned only on the actual daily balance.
The customer's comparison should use the effective annual yield, not the headline FD rate alone, and should account for the premature penalty if the FD is broken early.