Chapter 8 - Cash and Cash Equivalents

Topic Overview

This chapter discusses the concept of cash and cash equivalents, their characteristics, and components, along with the preparation of bank reconciliation and proof of cash.

Learning Objectives

After studying this chapter, students should be able to:

1. Identify what items are included as cash and cash equivalents.

2. Calculate the correct balance of petty cash funds.

3. Identify bank and book reconciling items.

4. Prepare bank reconciliations and proofs of cash.

Summary of Generally Accepted Accounting Principles for Cash

Cash Items

Cash items are usually unrestricted and immediately available for use in the current operations such as:

• Payment of operating expenses.

• Payment of current liabilities.

• Acquisition of current assets.

Definition of Cash

Cash comprises money and other negotiable instruments that are payable in money and accepted by the bank for deposit and immediate credit. Cash includes:

• Cash on hand.

• Demand deposits.

• Other items that are unrestricted for use in current operations.

Types of Cash

1. Cash on Hand (CUTCMoBa)

   • Customer's checks awaiting deposit.

   • Undeposited cash collections (coins and bills).

   • Traveler's checks.

   • Cashier's official checks, treasurer's checks, or manager's checks.

   • Postal money orders and bank drafts.

2. Cash in Bank a. Current Account/Checking Account/Demand Deposit/Commercial Account

   • Non-interest bearing and withdrawable by checks.
     b. Savings Deposit (Savings Account)

   • Generally non-interest bearing; depositor is issued an ATM card or passbook, withdrawable in ATMs or within the bank.

3. Cash Fund for Current Operations (CP^{2}RIntPeDiT^{2})

   • Change fund.

   • Payroll fund.

   • Revolving fund (for specific purposes).

   • Interest fund.

   • Petty cash fund (for small expenditures).

   • Dividend fund.

   • Tax fund.

   • Insurance fund.

   • Sinking fund.

Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible to cash. These include:

1. Time deposits (maturity of three months or less).

2. Money market instruments or commercial paper.

3. Treasury bills, notes, and bonds.

4. Redeemable preference shares with a mandatory redemption period.

Classification of Cash Funds

• Cash fund classification as current or noncurrent should relate to related liabilities.

• Noncurrent assets such as pension funds and sinking funds are generally not classified as cash unless the related liabilities are current.

Measurement Issues in Cash and Cash Equivalents Computation

1. Cash in Foreign Currency: Measured at face value and translated to local currency (e.g. Philippine Peso).

2. Deposit in Foreign Bank: Classified as unrestricted cash unless restricted.

3. Cash in Closed Banks: Measured at estimated realizable value, lower than face value, classified as noncurrent assets.

4. Bank Overdraft: Considered a liability; can be netted against other accounts if immaterial.

5. Stale Checks/Outstanding Checks: Defined as checks not encashed within a certain period (typically 6 months).

6. Postdated Checks: Not classified as cash equivalents as they are receivables until their maturity date.

7. Miscellaneous Income: Earnings from checks not yet presented or received.

Cash Management Techniques

• Imprest System: All cash receipts should be deposited intact, all disbursements should use checks, except for small expenditures covered by petty cash.

• Petty Cash Fund Management: Cash irregularities may be attributed to poor controls; tracking employee disbursements through petty cash need to be controlled.

Bank Reconciliation

Bank reconciliation is essential, conducted monthly, and accounts for differences between the company’s cash books and the bank statement. Key items include:

1. Deposits in Transit: Cash already recorded but not yet available for withdrawal by the bank.

2. Outstanding Checks: Checks written and recorded in the cash book but not yet presented for payment.

3. Errors in Records: Adjustments must be made for any discrepancies due to errors identified in either the company’s records or the bank's.

Proof of Cash

Proof of cash involves reconciling the cash receipts and disbursements over a period. It provides verification for the sub-ledgers against actual bank statements.

Examples and Illustrations

Example 1: Petty Cash Fund Replenishment

Problem:
A company maintains a petty cash fund (PCF) of P5,000. At the end of the period, the fund contains:

• Currencies and coins: P1,200

• Vouchers for office supplies: P2,500

• Vouchers for postage: P1,000

Solution:

1. Total Accounted for: P1,200 \text{ (Cash)} + P2,500 \text{ (Supplies)} + P1,000 \text{ (Postage)} = P4,700

2. Cash Shortage/Overage: P5,000 \text{ (Imprest Balance)} - P4,700 \text{ (Total accounted)} = P300 \text{ (Shortage)}

3. Replenishment Amount: The check to replenish the fund should be for the total of the expenses and the shortage: P2,500 + P1,000 + P300 = P3,800.

Example 2: Bank Reconciliation (Adjusted Balance Method)

Problem:
As of December 31, the following data is available:

• Balance per Bank Statement: P224,500

• Balance per Ledger (Book): P199,000

• Deposits in Transit: P40,000

• Outstanding Checks: P60,000

• Bank Service Charge: P2,000

• Collection of Note by Bank (not yet in books): P12,000

• Error: A check for P5,000 for supplies was recorded by the company as P500.

Solution:

1. Adjusted Bank Balance:

   • Unadjusted Bank Balance: P224,500

   • Add: Deposit in Transit: P40,000

   • Less: Outstanding Checks: (P60,000)

   • Adjusted Balance: P204,500

2. Adjusted Book Balance:

   • Unadjusted Book Balance: P199,000

   • Add: Note Collection: P12,000

   • Less: Bank Service Charge: (P2,000)

   • Less: Error in recording check (P5,000 - P500): (P4,500)

   • Adjusted Balance: P204,500

Conclusion

Understanding cash and cash equivalents, their classifications, and the reconciliation process is critical for financial accuracy and compliance with accounting standards.

Key Concepts of Cash and Cash Equivalents

• Cash: Money or negotiable instruments payable in money, accepted by banks for immediate credit. Must be unrestricted and available for current operations.
• Cash Equivalents: Short-term, highly liquid investments convertible to cash with a maturity of 3 months or less (e.g., Treasury bills, money market instruments).

Components of Cash

1. Cash on Hand: Undeposited collections, customer checks, traveler's checks, and manager's checks.
2. Cash in Bank:
   • Current Account: Non-interest bearing, withdrawable by check.
   • Savings Account: Withdrawable via ATM or passbook.
3. Cash Funds: Change fund, payroll fund, petty cash fund (PCF), interest fund, and tax fund.

Measurement and Classification Issues

• Foreign Currency: Measured at face value and translated to local currency.
• Closed Banks: Measured at estimated realizable value; classified as noncurrent.
• Bank Overdrafts: Generally a current liability unless offset is permitted.
• Postdated Checks: Classified as receivables, not cash.
• Stale Checks: Checks not cashed within 6 months; require adjustment back to cash.

Internal Control and Reconciliation

• Imprest System: Deposits receipts intact; disbursements via check (small items via petty cash).
• Petty Cash Fund (PCF): Managed by replenishment based on actual expenses plus any shortage (Expense + Shortage = Replenishment).
• Bank Reconciliation:
  • Book Adjustments: Add credit memos (notes collected), deduct debit memos (service charges), and correct book errors.
  • Bank Adjustments: Add deposits in transit, deduct outstanding checks, and correct bank errors.
  • Adjusted Balance Method: Ensures the book and bank balances equal each other after adjustments (Adjusted Book Balance = Adjusted Bank Balance).
• Proof of Cash: A four-column reconciliation (Beginning Balance, Receipts, Disbursements, Ending Balance) used to verify transaction accuracy over a period.