Cash and Cash Equivalents
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Cash and Cash Equivalents

The objective of this article is to help you understand the components of the line item “cash and cash equivalents” in the balance sheet. After reading this article, you should have a thorough understanding of what cash is, what cash equivalents are, what their components are and what disclosures are required.

Definition of Terms

Cash - Coins and currency on hand and balances in checking accounts acceptable by the bank and available for immediate withdrawal or encashment; In layman’s terms, money in the form of bills or coins.

Cash Equivalents - These are short-term, highly liquid investments that are readily convertible to cash and are so near their maturity that they present insignificant risk of changes in value due to fluctuations in interest rates; a highly liquid debt instrument with maturities of less than three months.

Cash Fund – cash set aside for a specific purpose.

Cash in Bank – This includes demand deposit or checking account and savings deposit which are unrestricted as to withdrawal.

Cash on Hand – This includes undeposited cash collections and other items awaiting deposit such as checks, bank drafts and money orders.

Compensating Balance – a minimum credit balance that a bank or a financial institution may require a borrower to keep on deposit as a condition for granting a loan; it is a common requirement for establishing a line of credit in a bank.

Overdraft/Bank Overdraft – a draft in excess of the cash balance in a bank. This happens when the issuance of checks is in excess of the deposits made in the bank.

Sinking Fund – a fund accumulated regularly in a separate account and used to redeem debt securities.

Common Questions About Cash and Cash equivalents

When would you classify an item as cash in the statement of financial position? In order to be included as cash in the statement of financial position, funds must be represented by coins, bills, undeposited checks, drafts, money orders, and funds on deposit with a bank that are immediately available without any restriction.

What are the three main items to be included in “cash”? The three main items to be included in cash are 1) cash on hand, 2) cash in bank, and 3) Cash fund for current purposes like payroll fund, change fund, petty cash fund and dividend fund.

What are items that are commonly INCORRECTLY included in the cash balance? Postdated checks, certificates of deposit, stamps, IOUs, sinking fund, and travel advances are sometimes erroneously included in the cash balance of an entity. Take note, these items should NOT be included as cash.

Why are postdated checks not considered as cash? These are checks that have a future date written on its face. If an entity is a recipient of an outstanding check, it is not considered as cash because postdated checks are not acceptable by the bank for deposit or immediate credit. Postdated checks are considered as accounts receivable.

How should cash be valued or measured in the balance sheet? Cash should be valued at its face amount, meaning we follow what is written in the coin or the bill. A 100 dollar bill is valued at $100 and not at $50. However, cash in foreign currency should be valued at the current exchange rate.

Where is cash and cash equivalents situated in the statement of financial position? Cash and cash equivalents is presented as the first line item in the statement of financial position. An example of a snapshot of a balance sheet is presented below:

JL143 Company

Statement of Financial Position

December 31, 2012

Current Assets

     Cash                                               P 150,000

     Accounts Receivable                         100,000

     Total Current Assets                          250,000

How would restricted cash be classified in the balance sheet? Cash whose use is restricted would NOT be included with the line item cash unless the restrictions on it expire within one year or within the normal operating cycle whichever is longer. Accordingly, cash that is contractually required to be held in a sinking fund is classified as a current asset if it will be used to retire the current portion of long-term debt. However, if material, it is to be reported on a separate line rather than with cash.

How should cash deposited in a bank or a financial institution that has turned bankrupt, is in bankruptcy or in financial difficulty be valued? If this is the case, cash should be written down to its estimated realizable value if the amount recoverable is estimated to be lower than its fair value.

How should bank overdrafts be treated? Bank overdrafts are classified as current liabilities in the statement of financial position and should not be offset (deducted) against other bank accounts with debit balances. However, if an entity has two or more accounts in one bank and one account results in an overdraft, that overdraft could be offset against the other bank accounts in the same bank with debit balances.

What are the necessary disclosures to be made regarding cash and cash equivalents? The details of items comprising “cash and cash equivalents” should be disclosed to the notes to financial statements.

How compensating balances should be treated? Compensating balances that are not restricted according to use is still reported as part of cash. However, if the compensating balance could not be withdrawn anytime or is restricted according to use, the amount should be disclosed. If the amount is material, the restricted compensating balance should be reported separate from cash with the account title “cash held as compensating balance” and should be reported under the non-concurrent assets section if the related borrowings are non-concurrent liabilities. If the borrowings are current liabilities or if the compensating balance reduces fees that would have been incurred in the next year, the compensating balance should be shown as a separate line item in the current asset section of the balance sheet.

What are common examples of cash equivalents? Examples include treasury bills, commercial papers, time deposits and money market funds. Remember that these investments should have been acquired 3months or less before maturity.

Can equity securities be classified as cash equivalents? No, equity securities cannot be classified as cash equivalents because shares of stock do not have maturity dates.

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Comments (6)

Thank you Lindberg. Appreciating your support.

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The first line item in the statement of financial position. An example of a snapshot of a balance sheet is presented below: free resume builder

How about employees' pension fund?
oooohhh myyy gooood you really explain it sooo clearly, when I read my book its like I'm just reading it without comprehension because the terms are so complicated and I have/need to use merriam dictionary. But when I read this, to be honest i was shocked about myself because I understand it quickly in fact I read it once.. sorry if its too long, I'm just thankful for sharing this :)