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Unit 5

Cash and Cash Equivalents

Cash

Money is the standard medium of exchange in business

transactions. It refers to the currency and coins which are in
circulation and legal tender.

Accordingly, cash includes checks, bank drafts and money

orders because these are acceptable by the bank for deposit
and immediate encashment.

Cash Items includes:

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

Cash in bank – this includes demand deposit or checking

account and saving deposit which are unrestricted as to
withdrawal.

Cash fund – set aside for current purposes such as petty

cash fund and dividend fund.

Cash Equivalents
Cash Equivalents are short-term and highly liquid
investments that are readily convertible into cash and so near
their maturity that they present insignificants risk of changes in
value because of changes in interest rates.

Examples of Cash Equivalents:

a. Three – month BSP treasury bill

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b. Three – year BSP treasury bill purchased three months

before date of 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.

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.

Classification of Investment of Excess Cash

If the term is three months or less, such instruments are

classified as cash equivalents and are included in the caption
“cash and cash equivalents”.

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.

If the term is more than one year, such investments are

classified as noncurrent or long-term investments.

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. It
is included as part of cash and cash equivalents.
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If the cash fund is set aside for noncurrent purpose or

payment of noncurrent obligation, it is shown as long-term
investment.

Classification of Cash Fund

The classification of a cash fund as current or noncurrent

should parallel the classification of the related liability.

However, a cash fund set aside for the acquisition of a

noncurrent asset should be classified as noncurrent regardless
of the year of disbursement.

Bank Overdraft

When the cash in bank account has a credit balance, it is

sad 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.

Exception to the Rule on Overdraft

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 a debit
balance in order to show “cash, net of bank overdrafts” or
“bank overdraft, net of other bank account.”

Compensating Balance

A compensating balance generally takes the form of

minimum checking or demand deposit account balance that
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must be maintained in connection with a borrowing

arrangement with a bank.

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 the reduction of the

amount borrowed because the compensating balance provides
a source of fund to the bank as partial compensation for the
loan extended.

Classification of Compensating Balance

If the balance is not legally restricted as to withdrawal by

the borrower it 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 loan 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

delivery to the payee at the end of reporting period.
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The 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 as follows:

Cash xxx

Accounts payable or appropriate account xxx

In practice, the foregoing adjustments 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.

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 as follows:

Cash xxx

Accounts payable or appropriate account xxx

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.
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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.

Thus even after three months only, the entity may

issue as “stop payment order” to the bank for the
cancelation of a previously issued check.

If the amount of stale check is immaterial, it is simply

accounted for as miscellaneous income as follows:

Cash xx

Miscellaneous income xx

However, if the amount is material and liability is

expected to continue, the cash is restored and the liability is
again set up. The journal entry is as follows:

Cash xx

Accounts payable or appropriate account xx

Accounting for Cash Shortage

Where the cash count shows cash which is less than

the balance per book, there is a cash shortage to be recorded
as follows:

Cash short or over xx

Cash xx

The cash short or over account is only a temporary

or suspense account. When financial statements are
prepared the same should be adjusted.
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Hence, if the cashier or cash custodian is held

responsible for the cash shortage, the adjustment should be:

Due from cashier xx

Cash short or over xx

However, if the reasonable efforts fail to disclose the

cause of the shortage, the adjustment is:

Loss from cash shortage xx

Cash short or over xx

Accounting for Cash Overage

Where the cash count shows cash which is more

than the balance per book, there is a cash overage to be
recorded as follows:

Cash xx

Cash short or over xx

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 xx

Miscellaneous income xx

But where the cash overage is properly found to be

the money of the cashier, the journal entry is:
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Cash short or over xx

Payable to cashier xx

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.

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.

Consequently, in such instances, it may be more

economical and convenient to pay in cash rather than issue
checks.

Petty Cash Fund

The petty cash fund is money set aside to pay small

expenses which cannot be paid conveniently by means of
check.

The two methods of handling the petty cash;

Imprest Fund System

Fluctuating Fund System

Imprest Fund System

The imprest fund system is the one usually followed in

handling petty cash transactions.
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Accounting Procedures:

a. A check is drawn to establish the fund.

Petty cash fund xx

Cash in bank xx

b. Payment of expenses out of the fund.

No formal journal entries are made. The petty

cashier generally requires a signed petty cash voucher for such
payments and simply prepare memorandum entries in the
petty cash journal.

c. Replenishment of petty cash payments.

Whenever the petty cash fund runs low, a check is drawn

to replenish the fund.

The replenishment check is usually equal to the petty

cash disbursements. It is at this time that the petty cash
disbursements are recorded as follows:

Expenses xx

Cash in bank xx

It is to be pointed out that the petty cash disbursements

should be replenished only by means of checks and not from
undeposited collections.

a. At the end of the accounting period, it is necessary to

adjust the unreplenished expenses in order to state the correct
petty cash balance as follows:
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Expenses xx

Petty cash fund xx

The adjustment is to be reversed at the beginning of

the next accounting period. The reversal is made in order that
the normal replenishment procedures may be followed by
simply debiting expenses and crediting cash in bank without
distinguishing whether the expenses pertain to the current
period or prior period.

e. An increase in the fund is recorded as follows:

Petty cash fund xx

Cash in bank xx

f. A decrease in the fund is recorded as follows:

Cash in bank xx

Petty cash xx

Illustration:
2018

Nov. 10 The entity established an imprest fund of

P10,000.

Petty cash fund 10,000

Cash in bank 10,000

29 Replenished the fund. The petty cash items

include the following:
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Currency and coin 2,000

Supplies 5,000

Telephone 1,800

Postage 1,200

Nov. 29 The journal entry to record the replenishment is:

Supplies 5,000
Telephone 1,800

Postage 1,200

Cash in bank 8,000

Dec. 31 The fund was not replenished.

The fund is composed of the following: currency and

coin, P7,000; supplies P1,500; postage,P500miscellaneous
expense, P1,000.

Supplies 1,500

Postage 500

Miscellaneous expense 1,000

Petty cash fund 3,000

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2019

Jan. 1 The adjustment made on December 31, 2018 is

reversed.

Petty cash fund 3,000

Supplies 1,500

Postage 500

Miscellaneous expense 1,000

2019

Feb. 1 The fund is replenished and increased to

P15,000.

The composition of the fund: currency and coin P1,000,

supplies P4,500, postage P3,000 and miscellaneous expense
P1,500.

Petty cash fund 5,000

Supplies 4,500

Postage 3,000

Miscellaneous expense 1,500

Cash in bank 14,000

The total amount of the check drawn is P14,000 representing

the petty cash disbursements of P9,000 and the fund increase
of P5,000.
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Fluctuating fund system

The system is called “fluctuating fund system” because

the checks drawn to replenish the fund do not necessarily
equal the petty cash disbursements.

The replenishment checks are simply drawn upon the

request of the petty cashier.

Moreover, petty cash disbursement are immediately

recorded thus resulting in fluctuating petty cash balance per
book from time to time:

a. Establishment of the fund:

Petty cash fund xx

Cash in bank xx

b. Payment of expenses out of the petty cash fund:

Expenses xx

Petty cash fund xx

Under this system, the disbursements from the petty cash fund
are immediately recorded in contradistinction with the imprest
fund system where the disbursements are recorded upon the
replenishment of the fund.

c. Replenishment or increase of the fund:

Petty cash fund xx

Cash in bank xx

The replenishment check may or may not be the same as

the petty cash disbursements.
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b. At the end of the reporting period, no adjustment is

necessary because the petty cash expenses are recorded
outright.

e. Decrease of the fund is recorded as follows:

Cash in bank xx

Petty cash fund xx

Illustration:
Nov. 10 The entity established a petty cash fund of
P10,000.

Petty cash fund 10,000

Cash in bank 10,000

Nov. 11-28 Petty cash disbursements amounted to

P8,000.

Expenses 8,000

Petty cash fund 8,000

Nov. 29 Issued a check for P10,000 to replenish the

fund.

Petty cash fund 10,000

Cash in bank 10,000

At this point, the petty cash balance per book

is P12,000.
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Dec. 1-30 Petty cash expenses amounted to P9,000.

Expenses 9,000

Petty cash fund 9,000

31 Issued a check for P15,000 to replenish the fund.

Petty cash fund 15,000

Cash in bank 15,000

At this point, the petty cash balance is P18,000.

Activity 6 :Lets try this:

Answer briefly:

1. Distuinguised Cash from Cash Equivalents. Give examples.

2. How should we measure cash?

3. Describe the following:

a) Bank overdraft
b) Undelivered check
c) Postdated check delivered
d) Imprest system of internal control
e) Petty cash fund

4. Using your textbook Intermediate Accounting Vol.1 (2020 ed.) By:

Valix, Peralta and Valix . Answer the following:

4.1 Problem 1-2 Argentina Company page 19

4.2 Problem 1-7 Laborious company page 23