Cash And Cash Equivalents

Intermediate Accounting 1, Valix Peralta Valix 2020 edition

Chapter 1 Cash and Cash Equivalents Definition of Cash From the point of view of a layman,“cash” simply means money Money is the standard medium of exchange in business transactions. Money refers to the currency and coins which are in circulation and legal tender However, in the accounting parlance, the term “cash” has a special and broader meaning. It connotes more than money. As contemplated in accounting, cash includes money and any other negotiable instruments that is payable in money and acceptable by the bank for deposit and immediate credit. Accordingly, cash includes checks, bank drafts and money orders because these are acceptable by the bank for deposit or immediate encashment. For example, when checks are received in full settlement of an account receivable, cash is immediately debited. But postdated checks received cannot be considered as cash yet because these checks are unacceptable by the bank for deposit and immediate credit or outright encashment.

Unrestricted Cash There is no specific standard dealing with “cash” The only guidance is found in PAS 1, paragraph 66 which provides that an entity shall classify an asset as current when the asset is cash or cash equivalent unless it is restricted to settle a liability for more than twelve months after the end of the reporting period. Accordingly, to be reported as “cash” an item must be unrestricted in use. This means that the cash must be readily available in the payment of current obligations and not be subject to any restrictions, contractual or otherwise. Unrestricted cash refers to monetary reserves that are not tied to a particular use. Unrestricted cash can be used for any purpose since it is not earmarked for a specific use and is extremely liquid. Often, in order to satisfy debt covenants, firms will have to maintain a certain level of cash on their balance sheets — the amount that exceeds the requirements is referred to as unrestricted cash.

Cash items included in cash

Intermediate Accounting 1, Valix Peralta Valix 2020 edition a.

Cash on hand ― This includes undeposited cash collections and other cash items awaiting deposit such as custumers’ checks, cashier’s or manager’s checks, traveler’s checks, bank drafts and money orders.

b. Cash in bank ― This includes demand deposit or checking account and saving deposit which are unrestricted as to withdrawal. c.

Cash fund set aside for current purposes such as petty cash fund, payroll fund and dividend fund.

Cash Equivalents PAS 7, paragraph 6 defines cash equivalents as short-term and highly liquid investments that are readily convertible into cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. The standard further states that only highly liquid investments that are acquired three months before maturity can qualify as cash equivalents. Examples of cash equivalents are: a.

Three-month BSP treasury bill

b.

Three-year BSP treasury bill purchased three months before maturity

c.

Three month time deposit

d.

Three-month money market instrument or commercial paper

Equity securities cannot qualify as cash equivalents because shares do not have a maturity date. However, preference shares with specified redemption date and acquired three months before redemption date can qualify as cash equivalents. Note that what is important is the date of purchase which should be three months or less before maturity. Thus, a BSP treasury bill was purchased one year ago cannot qualify as cash equivalent even if the remaining maturity is three months or less.

Investment of excess cash The control and proper use of cash is an important aspect of cash management. Basically, the entity must maintain sufficient cash for use in current operations. Any cash accumulated in excess of that needed for current operations should be invested even temporarily in some type of revenue earning investment.

Intermediate Accounting 1, Valix Peralta Valix 2020 edition Accordingly, excess cash may be invested in time deposits, money market instruments and treasury bills for the purpose of earning interest income.

Classifications of investment of excess cash Investments in time deposit, money market instruments and treasury bills should be classified as follows: a.

If the term is three months or less, such instruments are classified as cash equivalents and therefore included in the caption “cash and cash equivalents”.

b.

If the term is more than three months but within one year, such investments are classified as short-term financial assets or temporary investments and presented separately as current assets.

c.

If the term is more than one year, such investments are classified as noncurrent or long-term investments.

However, if such investments become due within one year from the end of the reporting period, they are reclassified as current or temporary investments.

Measurement of Cash Cash is measured at face value. Cash in foreign currency is measured at the current exchange rate. If a bank or financial institution holding the funds of an entity is in bankruptcy of financial difficulty, cash should be written down to estimated realizable value if the amount recoverable is estimated to be lower than the face value.

Financial Statement Presentation The caption cash and cash equivalents should be shown as the first line item under current assets. This caption includes all cash items, such as cash on hand, cash in bank, petty cash fund and cash equivalents which are unrestricted in use for current operations. However, the details comprising the cash and cash equivalents should be disclosed in the notes to financial statements.

Foreign Currency Cash in foreign currency should be translated to Philippine Pesos using the current exchange rate.

Intermediate Accounting 1, Valix Peralta Valix 2020 edition Deposits in foreign countries which are not subject to any foreign exchange restriction are included in “cash”. Deposits in foreign bank which are subject to foreign exchange restrictions should be classified separately among noncurrent assets and the restriction clearly indicated.

Cash fund for a certain purpose If the cash fund is set aside for use in current operations or for the payment of current obligation, it is a current asset. The cash fund is included as part of cash and cash equivalents. Examples of this fund are petty cash fund, payroll fund, travel fund, interest fund, dividend fund, and tax fund. On the other hand, if the cash is set aside for noncurrent purpose or payment of noncurrent obligation, it is shown as long-term investment. Examples of this fund are sinking fund, preference share, redemption fund, contingent fund, insurance fund and fund for acquisition or construction of property, plant and equipment.

Classification of cash fund The classification of a cash fund as current or noncurrent should parallel the classification of the related liability. For example, a sinking fund that is set aside to pay a bond payable shall be classified as current asset when the bond payable is already due within one year after the end of reporting period. However, a cash fund set aside for acquisition of a noncurrent asset should be classified as noncurrent regardless of te year of disbursement.

Bank overdraft When the cash in bank account has a credit balance, it is said to be an overdraft. The credit balance in the cash in bank account results from the issuance of checks in excess of the deposits. A bank overdraft is classified as a current liability and should not be offset against other bank accounts with debit balances. For example, an entity maintains two bank accounts: a. Cash in bank ─ First Bank, which is overdrawn by P10,000. b. Cash in bank ─ Second Bank, with a debit balance of P100,000. The net cash balance is P90,000.

Intermediate Accounting 1, Valix Peralta Valix 2020 edition The proper statement classification of he two accounts is as follows: Current asset: Cash in bank - Second Bank

100,000

Current liability: Cash in bank - First Bank 10,000 Note that it is not necessary to adjust and open a bank overdraft account in the ledger. In other words, the Cash in bank ─ First Bank account is maintained in the ledger with a credit balance. It is to be stated that generally overdrafts are no permitted in the Philippines.    

Cash in bank has “credit balance” Issuance of checks in excess of deposits Generally, overdrafts are not permitted in the Philippines Classified as current liability and should not be offset against other bank accounts with debit balances  When an entity maintains two or more accounts in one bank and one account results in an overdraft, such overdraft can be offset against the other bank account with debit balance in order to show “cash, ne of bank overdraft” or “bank overdraft, net of other bank account”.  Overdraft can also be offset against the other bank account if the amount is not material.  Identifying material account is relative. It based on personal and proffesional judgement.

Exception to the rule on overdraft When an entity maintains two or more accounts in one book and one account results in an overdraft, such overdraft can be offset against the other bank account with a debit balance in order to show cash, net of bank overdraft or bank overdraft, net of the other bank account. An overdraft can also be offset against the other bank account if the amount is not material. Under IFRS, bank overdraft can be offset against other bank account when payable on demand and often fluctuates from positive to negative as an integral part of cash management.

Compensating balance A compensating balance generally takes the form of minimum checking or demand deposit account balance that must be maintained in connection with a borrowing arrangement with a bank. A compensating balance is a minimum bank account balance that a borrower agrees to maintain with a lender. The purpose of this balance is to reduce the lending cost for the lender, since the

Intermediate Accounting 1, Valix Peralta Valix 2020 edition lender can invest the cash located in the compensating bank account and keep some or all of the proceeds

For example, an entity borrows P5,000,000 from a bank and agrees to maintain a 10% or P500,000 minimum compensating balance in a demand deposit account. In effect, this arrangement results in thee reduction of the amount borrowed because the compensating balance provides a source of fund to the bank as partial compensation for the loan extended.  Minimum checking or demand deposit account balance that must be mainain in connection with a borrowing arrangement with a bank.  Example: Company X borrowed P5Million from a bank and agrees to maintain a 10% or P500,000 minimum compensating balance in demand deposit account  Not legally restricted (informal) - “cash”  Legally restricted (formal agreement) - “cash held as compensating balance” under current assets if related to short-term and noncurrent investment if the related loan is long term

Classification of Compensating balance If the deposit is not legally restricted as to withdrawal by the borrower because of an informal compensating balance agreement, the compensating balance is part of cash. If the deposit is legally restricted because of a formal compensating balance agreement, the compensating balance is classified separately as “cash held as compensating balance” under current assets if the related loan is short-term. If the related load is long-term, the compensating balance is classified as noncurrent investment.

Undelivered or unreleased check An undelivered or unreleased check is one that is merely drawn and recorded but not given to the payee before the end of reporting period There is no payment when the check is pending deliver to that payee at the end of reporting period. The reason is that undelivered check is still subject to the entity’s control and may thus be canceled anytime before delivery at the discretion of the entity. Accordingly, an adjusting entry is required to restore the cash balance and set up the liability. Cash Accounts payable or appropriate account

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Intermediate Accounting 1, Valix Peralta Valix 2020 edition In practice, the foregoing adjustment is sometimes ignored because the amount is not very substantial and there is no evidence of actual cancellation of the check in the subsequent period.  Drawn and recorded but not given to the payee before the end of reporting period  There is no payment.  The undelivered check is still subject to the company’c control and may be cancelled anytime before delivery at its discretion.  Example: Company A drew a check with the amount of P10,000 and recorded as payment to supplier on November 15, 2020. However, as of the end of the year (December 31, 2020) the check is not yet delivered to the supplier and still possession of the Company A.  Adjusting Entries Cash P10,000 `` Accounts payable P10,000 

Postdated check delivered A postdated check delivered is a check drawn , recorded and already given to the payee but it bears a date subsequent to the end of reporting period. The original entry recording a delivered postdated check shall also be reversed and therefore restored to the cash balance. Cash Accounts payable or appropriate account

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The reason is that there is no payment until the check can be presented to the bank for encashment or deposit.

Stale check or check long outstanding A stale check is a check not encashed by the payee within a relatively long period of time. The question is how long a time must the check remain outstanding? The negotiable instruments Law provides that where the instrument is payable on demand, presentment must be made within a reasonable time after issue. In determining what a reasonable time, consideration shuld be made regarding the nature of the instrument, the usage of trade or business, if any with respect to such instrument and the facts of the particular case. Clearly, the law does not specify a definite period within which checks must be presented for encashment. Reference is made to usage of trade or business practice. In banking practice, a check becomes stale if not encashed within six months from the time of issuance. Of course, this is a matter of entity policy.

Intermediate Accounting 1, Valix Peralta Valix 2020 edition Thus, even after three months only, the entity may issue a stop payment order to the bank for cancellation of a previously issued check. If the amount of stale check is immaterial, it is simply accounted for as miscellaneous income. Cash Miscellaneous income

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However, if the amount is material and liability is expected to continue, the cash is restored and the liability is again set up. Cash Accounts payable or appropriateaccount

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 Walang standard na nagsasabi na stale check ito  Stale check - not encashed by the payee within a relatively long period of time. 

Accounting for cash shortage Where the cash count shows cash which is less than the balance per book, a cash shortage is to be recorded. Cash short or over Cash

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The cash short or over account is only a temporary or suspense account. When financial statements are prepared the same should be adjusted. Hence, if he cashier or cash custodian is held responsible for the cash shortage, the adjustment should be: Due from cashier Cash short or over

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However, if reasonable efforts fail to disclose the cause of the shortage, the adjustment is Loss from cash shortage Cash short or over

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Accounting for cash overage Where he cash count shows cash which is more than the balance per book, a cash overage is to be recorded. Cash Cash short or over

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Intermediate Accounting 1, Valix Peralta Valix 2020 edition

Note that whether it is a cash shortage or cash overage, the offsetting account is cash short or over account. Such account should be adjusted when statements are made. The cash overage is treated as miscellaneous income if there is no claim on the same. Cash short or over Miscellaneous Income

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But where the cash overage is properly found to be the money of the cashier, the journal entry is: Cash short or over Payable to cashier

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Imprest System The imprest system is a system of control of cash which requires that all cash receipts should be deposited intact and all cash disbursements should be made by means of check. While internal control ideally requires that all payments should be made by means of check, this is sometimes impossible. There are occasions when the issuance of checks becomes impractical or inconvenient such as when small amounts are paid or things are hurriedly bought or customers are entertained. Consequent