Lesson 1

Cash and Cash Equivalents

Topics
1. Definition of cash
2. Definition of cash equivalents.
3. Items considered cash
4. Items considered as cash
5. Cash and cash equivalents measurement.

Learning Objectives
After studying this lesson, you will be able to:
1. To understand the concept of cash.
2. To understand the concept of cash equivalents.
3. To identify items considered as cash.
4. To identify items considered as cash equivalents.
5. To determine the measurement of cash

Definition of Cash
Cash, the most liquid of assets, is the standard medium of exchange and the
basis for measuring and accounting for all other items. Companies generally classify
cash as a current asset. Cash consists of coin, currency, and available funds on
deposit at the bank. Negotiable instruments such as money orders, certified checks,
cashier’s checks, personal checks, and bank drafts are also viewed as cash.

PAS 1, paragraph 66, states that an entity shall classify an asset as current when
the asset is cash or a cash equivalent unless it is restricted to settle a liability for
more than twelve months after the end of the reporting period. Accordingly, an item
must be unrestricted in use to be reported as cash.

What about bank accounts? Bank saving deposits are considered. Banks do have
the legal right to demand notice before withdrawal. But, because banks rarely demand
prior notice, savings accounts nevertheless are considered cash. Some negotiable
instruments provide small investors with an opportunity to earn interest. These items,
more appropriately classified as temporary investments than as cash, include money
market funds, money market savings certificates, certificates of deposit, and similar
types of deposits and “short-term paper.” These securities usually contain restrictions
or penalties on their conversion to cash. Money market funds that provide checking
account privileges, however, are usually classified as cash. Certain items present
classification problems:

Companies treat postdated checks and I.O.U.s as receivables. They also treat
travel advances as receivables if collected from employees or deducted from their
salaries. Otherwise, companies classify the travel advance as a prepaid expense.
Postage stamps on hand are classified as part of office supplies inventory or as a
prepaid expense. Because petty cash funds and change funds are used to meet current
operating expenses and liquidate current liabilities, companies include these funds in
current assets as cash.
Definition of Cash equivalents

Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and that are subject to an insignificant risk of
changes in value. PAS 7.7 explains that cash equivalents are held for the purpose of
meeting short-term cash commitments rather than for investment or other purposes.

PAS 7 does not define 'short-term' but does state that ‘an investment normally
qualifies as a cash equivalent only when it has a short maturity of, say, three months
or less from the date of acquisition’ (PAS 7.7). Consequently, equity or other
investments that do not have a maturity date are excluded from cash equivalents
unless they are, in substance, cash equivalents. This three-month time limit is
somewhat arbitrary but is consistent with the concept of insignificant risk of changes
in value and a purpose of meeting short-term cash commitments. It is viewed that the
exceptions to this three-month time limit are rare and investments with a longer
maturity at inception may be included in cash equivalents only if there is strong
evidence to show that they are, in substance, cash equivalents.

Any investment or term deposit with an initial maturity of more than three
months does not become a cash equivalent when the remaining maturity period is less
than three months.

Demand deposits and other types of deposit account

PAS 7 does not provide a definition of demand deposit. In practice, these are
generally considered to be deposits with financial institutions that are repayable on
demand within one working day and without penalty.

Other types of deposit accounts need to be considered carefully to assess whether

they are classified as cash equivalents. Examples include:

 fixed-term deposits (i.e., deposits with a fixed maturity, often referred to

simply as ‘term deposits’)
 open-ended or perpetual deposits requiring a period of notice for
withdrawal without penalty
 longer-term deposits with early withdrawal provisions subject to some form
of penalty, such as loss of interest.

Inclusion of these other deposit accounts within cash equivalents depends on

both:
 the terms of the deposit or investment account (short maturity, convertible
to known amounts of cash, insignificant risk of changes in value)
 the purpose for which it is held (to meet short-term cash commitments
rather than for investment or other purposes).

Many open-ended or perpetual deposit accounts (i.e., those with no stated

maturity date) offer a marginally better rate of interest than demand deposits but
require some period of notice for withdrawal without penalty (i.e., interest is earned at
the stated rate until the date of withdrawal). Entities will often use such accounts to
temporarily hold cash required for working capital cash management if the withdrawal
period is reasonably short. If the notice period is less than three-months, then the
deposit account can be classified as a cash equivalent if the cash is intended to be
used to meet short-term cash commitments.
Longer-term deposits with early withdrawal provisions subject to a penalty
present particular issue. If an entity places cash in a deposit account with a stated
maturity of over three months, but with early access subject to a significant penalty, it
is unlikely that the intended purpose is to meet short-term cash commitments. The
significant penalty also casts doubt on whether the conversion into cash is possible
without a significant loss of value. The investment is unlikely to be classified as a cash
equivalent for those reasons.

However, there may be limited circumstances where classification of a longer

term deposit with early withdrawal provisions subject to a penalty as a cash equivalent
is appropriate. The entity may be hopeful that identified short-term cash
commitments can be satisfied from its budgeted cash flows but place some cash in a
term deposit with early access in case the forecasted cash inflows do not materialize.
In such cases, the terms and conditions of these deposits need to be carefully reviewed
at the inception of the deposit to identify if it can be classified as cash equivalent. It is
critical that, at inception, the term deposit can be converted to known amounts of cash
with insignificant risk of change in value. More specifically, term deposits with original
maturity of more than three months but can be redeemed at any time before maturity
can still qualify as cash equivalents provided that the interest earned is substantially
consistent with what the entity would have earned on a similar deposit type for a
similar term of less than three months. The entity’s past practices in managing these
deposits, and their role in the entity’s overall cash and treasury management strategy,
are also relevant.

Money market funds

Money market funds are investment vehicles that invest in relatively short-term
(usually between one day and one year) debt instruments such as treasury bills,
certificates of deposit and commercial papers. As the main purpose of the investment
is usually preservation of principal with modest dividends, they are generally regarded
as being at low risk of significant changes in value.

Shares or units in these funds are typically redeemable with little or no notice
period, at a redemption value based on the share of net assets of the fund. Because
the redemption value is based on a net asset value, rather than a fixed amount of
cash, the legal form is not consistent with the definition of cash equivalents. However,
in limited cases these investments are nonetheless regarded as cash equivalents in
substance.

It is acceptable to classify an investment in a money market fund as a cash

equivalent only if there is sufficient evidence that, in substance, the definition of cash
equivalents is satisfied. In particular, it is not sufficient that the investment can
readily be realized in cash. The investment must be readily convertible (normally
through redemption with the fund) to an amount of cash that is subject to an
insignificant risk of change. The assessment of risk must be done at the time of the
initial investment. This assessment would include a review of the fund's investment
rules, the nature of its underlying investments and the stability of the redemption
value. Again, the entity’s past practices in managing these investments, and their role
in its overall cash and treasury management strategy, are also relevant. It is
preferable for an entity to confirm the classification of the money market funds at each
reporting period

Restricted Cash
Petty cash, payroll, and dividend funds are examples of cash set aside for a
particular purpose. In most situations, these fund balances are not material.
Therefore, companies do not segregate them from cash in the financial statements.
When material in amount, companies segregate restricted cash from “regular” cash for
reporting purposes. Companies classify restricted cash either in the current assets or
in the non-current assets section, depending on the date of availability or
disbursement. Classification in the current section is appropriate if using the cash for
payment of existing or maturing obligations (within a year or the operating cycle,
whichever is longer). On the other hand, companies show the restricted cash in the
non-current section of the statement of financial position if holding the cash for a
longer period of time. Cash classified in the non-current section is frequently set aside
for plant expansion and retirement of long-term debt. Infosys’s (IND) restricted cash
disclosure is shown in Illustration 7-2.

Measurement of Cash

Cash is measured at face value. Cash in foreign currency at the current

exchange rate.

Fig 1. Summary of Cash and Cash Equivalents

 Exercises

1. The accountant of SANTIAGO COMPANY is in the process of preparing the

company’s financial statements for the year ended December 31, 2020. He is
trying to determine the correct balance of cash and cash equivalents to be
reported as a current asset on the statement of financial position. The
following items are being considered:

• Balances in the company’s accounts at the Metropolitan Bank:

 Current account P81,000
 Savings account P132,600
• Undeposited customer checks of P22,200 (including a customer check dated
January 2, 2021 or P3,000).
• Currency and coins on hand of P3,480
• Savings account at the Northern Philippines Bank with a balance of
P2,400,000. This account is being used to accumulate cash for future plant
expansion (in 2021).
• Petty cash of P4,000 (currency of P1,200 and unreplenished vouches for
P2,800).
• P120,000 in a current account at the Northern Philippines Bank. This
represents a 20% compensating balance for P600,000 loan with the bank.
Santiago company is legally restricted to withdraw the funds until the loan is
due in 2023.
• Treasury bills:
Two-month maturity bills P90,000
Seven-month bills 120,000
Time Deposit P100,000

What is the correct balance of cash and cash equivalents to be reported in the
current assets section of the statement of financial position?
A.P547,480 C. P430,280
B.P427,480 D. P327,480

2. Which of the following items should be included in the cash balance at

December 31, 2020?
I. A check payable to the company, dated January 3, 2011 in payment of a
sale made in December 2020.
II. A check payable to a vendor, dated and recorded in the company’s books
on December 31, 2020, but not released until January 4, 2011.

A.I only B: II only C. Both I and II D. Neither I nor II

3. Your audit of the December 31, 2020, financial statements of DIONISIO CORP.
reveals the following:

Current account at Prime Bank P (30,000)

Current account at Prudent Bank 135,000
Treasury bills (acquired 3 months before maturity) 300,000
Treasury bills (maturity date is Dec. 31, 2021) 1,500,000
Payroll account 390,000
Foreign bank account – restricted (translated using the
December 31, 2020, exchange rate) 2,000,000
 Postage stamps 1,250
Employee’s postdated check 4,500
IOU from the vice-president 8,000
Credit memo from a supplier for a purchase return 8,100
Traveler’s check 21,000
Money order 12,900
Petty cash fund (3,000 in currency and expense
receipts for P12,000) 15,000

What amount would be reported as “cash and cash equivalents” on the statement of
financial position on December 31, 2020?
A.P840,050 B.P873,90 C.P849,400 D.P861,900

4. The Cash account of the BEA CORPORATION as of December 31, 2020 was
composed of the following:

On deposit in current account with the Bank of PI P900,000

Cash collection not yet deposited to the bank 350,000
A customer’s check returned by the bank for
Insufficient fund 150,000
A check drawn by the Vice-President of the
Company dated January 15, 2021 70,000
A check drawn by a supplier dated December 28, 2020
for goods returned y the company 60,000
A check dated May 31, 2020 drawn by the company the
Bank of Manila in payment of custom duties. Since
the importation did not materialize, the check was
returned by the customs broker. This check was an
outstanding check in the reconciliation of the Bank
of Manila. 410,000
Petty cash fund of which P10,000 is in currency, P7,200 in form
of employee’s IOUS; and P2,800 is supported by approved petty
cash vouchers for expenses all dated prior to closing of the books
on December 31, 2020 20,000
Total P1,960,000
Less: Overdraft with the Bank of Manila secured by
a chattel mortgage on the inventories 300,000
Cash balance per ledger P1,660,000

What is the amount of cash to be reported on the December 31, 2020 statement
of financial position of Bea Company?

5. At year-end, Myra Company reported cash and cash equivalents which comprised
the following:

Cash on hand 500,000

Demand deposit 4,000,000
Certificate of deposit 2,000,000
Postdated customer check 300,000
Petty cash fund 50,000
Traveler’s check 200,000
Manager’s check 100,000
 Money order 150,000

What total amount should be reported as “cash” at year-end?

a. 7,000,000 c.6,800,000
b. 4,800,000 d.5,000,000

6. Everlast Company reported the following information at year-end

 Share investments of P 1,000,000 that are very actively traded in the stock
market.
 Government treasury bills of P 2,000,000 with a 10-year term but purchased on
December 31 at which time they had two months to go until maturity.
 Cash of P 3,400,000 in the form of coin, currency, savings account and checking
account.
 Commercial papers of P 1,500,000 with term of nine months but purchased on
December 31 at which they had three months to go until maturity.

1. What total amount should be reported as cash?

a. 3,400,000 c. 4,400,000
b. 4,900,000 d. 5,400,000
2. What total amount should be reported as cash equivalents?
a. 2,000,000 c. 3,500,000
b. 1,500,000 d. 4,500,000

7. Burr Company had the following account at year-end:

Cash in bank 2,250,000
Cash on hand 125,000
Cash restricted for addition to plant and
expected to be disbursed next year 1,600,000

Cash in bank included P 600,000 of compensating balance against short-term

borrowing arrangement.
The compensating balance is not legally restricted as to withdrawal.

What total amount of cash should be reported under current assets at year-end?
a. 1,775,000 c. 2,375,000
b. 2,250,000 d. 3,975,000

8. On December 31, 2019, West Company had the following cash balances:
Cash in bank-current account 1,800,000
Petty cash fund-all funds were reimbursed at year-end 50,000
Time deposit due February 1, 2020 250,000
Time deposit in bank closed by BSP ` 1,000,000

Cash in bank included P 600,000 of compensating balance against short-term

borrowing arrangement on December 31, 2019. The compensating balance is legally
restricted as to withdrawal.

On December 31, 2019, what total amount should be reported as cash and cash
equivalents?
a. 2,500,000 c. 2,100,000
b. 1,250,000 d.1,500,000
9. Ral Company reported the checkbook balance on December 31, 2019 at P
5,000,000 and held the following items on same date:
Check payable to Ral, dated January 2, 2020 in payment of a sale
made in December 2019, not included in December 31
checkbook balance 2,000,000
Check payable to Ral, deposited December 15 and included in
December 31 checkbook balance, but returned by bank
December 30 stamped “NSF”. The check was redeposited
On January 2, 2020 and cleared on January 9, 2020 500,000
Check drawn on Ral’s account, payable to a vendor, dated and
Recorded in Ral’s book on December 31, 2019 but not
Mailed until January 10, 2020 300,000
Certificate of time deposit 1,000,000

What amount should be reported as cash on December 31, 2019?

a. 4,800,000 c.6,500,000
b. 5,300,000 d.5,800,000

10.Liwanag Company reported an imprest petty cah fund of P 50,000 with the
following details:
Currencies 20,000
Coins 2,000
Petty cash vouchers:
Gasoline payments for delivery equipment 3,000
Medical supplies for employees 1,000
Repairs of office equipment 1,500
Loans to employees 3,500
A check drawn by the entity payable to the order of Grace
dela Cruz, petty cash custodian, representing her salary 5,000
An employee check returned by the bank for insufficiency of fund 3,000
A sheet of paper with names of several employees together
with contribution for a birthday gift of a co-employee. Attached
to the sheet of paper is a currency of 5,000

What is amount of petty cash fund should be reported in the statement of financial
position?
a. 42,000 c. 37,000
b. 27,000 d. 22,000

11.Campbell Company had the following account balances on December 31, 2019:
Petty cash fund
Cash in bank- current account 50,000
Cash in bank- payroll account 4,000,000
Cash in bank- sinking fund 1,200,000
Cash on hand 2,000,000
Cash in bank- restricted account for plant addition and
expected to disbursed in 2020 1,500,000
Treasury bills 1,000,000

The petty cash fund included unreplenished December 2019 petty cash expense
vouchers P 5,000 and employee IOU P 5,000.
The cash on hand included a P 1,000,000 customer check payable to Campbell dated
January 15, 2019.
In exchange for a guaranteed line of credit, the entity has agreed to maintain a
minimum balance of P200,000 in the unrestricted current bank account.
The sinking fund is set aside to settle a bond payable that is due on December 31,
2020.

12.What total amount should be reported as cash and cash equivalents on

December 31, 2019?
a. 8,640,000 c. 7,640,000
b. 7,440,000 d. 5,640,000

13.Yasmin Company provided the following information on December 31, 2019:

Petty cash fund 50,000
Current account- First Bank 4,000,000
Current account- Second Bank (overdraft) (250,000)
Money market placement- Third Bank 1,000,000
Time deposit- Fourth Bank 2,000,000

 A check for P 100,000 was drawn against First Bank current account dated and
recorded December 29, 2019 but delivered to payee on January 15, 2020.
 The Fourth Bank time deposit is set aside for land acquisition in early January
2020.

What amount should be reported as cash and cash equivalents on December 31,
2019?
a. 5,050,000 c. 4,900,000
b. 5,150,000 d. 4,150,000

14.On December 31, 2019, Erika Company reported cash account balance per
ledger of P 9,500,000 which included the following:
Cash in bank- demand deposit 3,000,000
Time deposit- 30 days 500,000
NSF check of customer 200,000
Money market placement due on June 20, 2020 2,000,000
Saving deposit 1,000,000
IOU from an employee 300,000
Pension fund 1,500,000
Customer check dated January 31, 2020 600,000
Customer check outstanding for 18 months 400,000
9,500,000

 Check of P100,000 in payment of accounts payable was dated and recorded on

December 31, 2019 but mailed to creditors on January 15, 2020.
 Check of P300,000 dated January 31, 2020 in payment of accounts payable was
recorded and mailed on December 31, 2019.
 The cash receipts journal was held open until January 15, 2020, during which
time P200,000 was collected and recorded on December 31, 2019.

What amount should be reported as cash and cash equivalents on December 31,
2019?
a. 4,700,000 c. 4,900,000
 b. 6,700,000 d. 5,100,000

15.On December 31, 2019, Roma Company reported cash of P9,950,000 which
comprises the following:
Undeposited collections 600,000
Cash in bank-BDO checking account 4,000,000
Undeposited check from customer, dated December 1, 2019 150,000
Undeposited check from customer, dated January 15, 2019 250,000
Cash in bank-BDO fund for payroll 1,000,000
Cash in bank-BDO money market instrument, 90 days 2,000,000
Cash in foreign bank restricted 1,500,000
Cash in bank-BDO value added tax account 450,000
Total 9,950,00

On December 31, 2019, what total amount should be reported as cash and cash
equivalents?
a. 7,600,000 c. 6,050,000
b. 8,200,000 d. 8,050,000

16.Love Company reported the following information in relation to cash on

December 31, 2019:
 Checkbook balance, P4,000,000
 Undeposited collections, P400,000
 A customer check amounting to P200,000 dated January 2, 2020 was included
in the December 31, 2019 checkbook balance.
 Another customer checks for P500,000 deposited on December 22, 2019 was
included in the checkbook balance but returned by the bank for insufficiency of
fund.
This check was redeposited on December 26, 2019 and cleared two days later.
 A P400,000 check payable to supplier dated and recorded on December 30,
2019 was mailed on January 16, 2020.
 A petty cash fund of P50,000 comprised the following on December 31, 2019:
Coins and currencies 5,000
Petty cash vouchers 40,000
Refundable deposit for returnable containers 5,000
50,000
 A check of P40,000 was drawn on December 31, 2019 payable to Petty Cash.

1. What is the adjusted cash in bank on December 31, 2019?

a. 4,600,000 c. 4,400,000
b. 4,200,000 d. 3,700,000
2. What total amount should be reported as cash on December 31,
2019?
a. 4,645,000 c. 4,600,000
b. 4,845,000 d. 4,650,000