CHAPTER FIVE

6. CASH AND SHORT TERM INVESTMENT

Cash is a medium of exchange that a bank will accept for deposit and immediate credit to the
depositors account. To achieve efficient use of all resources, management of business enterprises
frequently turns unproductive cash balances in to productive resources through the acquisition of
short-term investments.

6.1 Introduction; Cash

Meaning and elements of cash
Cash refers to coin, currency and other items that are;
- A standard medium of exchange or acceptable by knowledgeable parties in exchange
for goods or services
- The basis for measuring and accounting all other items
- Acceptable for deposit at face value by banks
Criteria: - An item to be reported as cash it must be
- Serve as a medium of exchange
- Readily available for the payment of current obligations
- It must be free from any contractual restriction that limits its use in satisfying debts.
Based on the criteria listed above we can classify negotiable instruments and other highly liquid items
as cash and non cash (cash equivalents).
Cash equivalents are short term, highly liquid investments that are both
i. Readily convertible to known amounts of cash and
ii. So near their maturity that they present insignificant risk of changes in interest rates.
If the item cannot be converted to coin or currency on short notice, it is separately classified as an
investment, as a receivable, or as prepaid expenses. Cash that is not available for payment of currently
maturing liabilities is segregated and classified in the long term assets section.
The following table summarizes the classification of cash related terms.

Item Classification Comment

cash Cash If unrestricted, report as cash.
If restricted, identify as current
and non-current assets
Petty cash and change funds Cash Report as cash
short term paper Cash equivalents Investments with maturity of
less than 3 months
Short term paper Temporary investments Investments with maturity of
3 to 12 months
post dated checks and IOUs Receivables Assumed to be collectible
Travel advance Receivables Assume to be collected from
employees or deducted from
their salaries

Postage on hand (as stamps or Prepaid Expenses May also be classified as

in postage meters)
Bank Overdrafts
Compensating balances
1. Legally restricted
2. Arrangement without legal
restriction
office supplies inventory
Current liability if right of offset exists, reduce
cash.
Cash separately classified as a Classify as current or non
deposit maintained as current in the balance sheet
compensating balance
Cash with note disclosure Disclose separately in notes
details of the arrangement.

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Based on the above criteria and table 1 items termed as cash like
 Coin and currency
 Negotiable instruments such as money orders, certified checks, personal checks, bank drafts,
saving accounts, (if prior notice is rarely demanded by banks) are classified as cash because
these items are readily available for the payment of current obligations and free from any
contractual restrictions.
In addition petty cash funds, change funds and other funds, even though these funds are intended to
be used for specific purposes they are used to meet current operating expenses and to liquidate
current liabilities so that they are included in current assets as cash accounts.
However cash balances deposited and maintained in checking or saving accounts as a minimum
requirements or compensating balances for borrowing are reported as follows. Legally restricted
deposits held as compensating balances against:
- Short term borrowing arrangements to be stated separately among the cash and cash
equivalent items in current assets
- Long term borrowing arrangements should be classified as non-current assets in the
investment or other Assets sections. As "cash on Deposit maintained as compensating
balance."
- In cases where compensating balance arrangements exist without legal restrictions, the
arrangements and the amounts involved should be described in the notes.

Money market funds, money market savings certificates, certificates of deposit, short term papers that
give an opportunity to earn high rates of interest are more appropriately classified as temporary
investments (cash equivalents) than as cash. The reason is that these securities usually contain
restrictions or penalties on their conversion to cash.

6.2 Cash Management and Control

6.2.1 Cash management
In any business enterprise management of cash is very important because cash is a means of acquiring
goods and services and cash can be easily misappropriated or lost. The management of cash is
centered on fore casting and internal controls.

The main objectives and responsibilities of management with respect to cash are
 To maintain liquidity (solvency) that is; to assure that there is sufficient cash to settle
maturing obligations, pay for operating expenses and also to finance unexpected
circumstances
 To invest any idle cash so as to maximize returns
 To prevent loss of cash due to theft, misuse or wastage
6.2.2 Control of cash
In organizations internal control methods, procedures, rules and policies are adopted;
The main purpose of having internal control systems in organizations is
- To assure that assets that belong to business enterprise are received when tendered
- Protected while in the custody of the enterprise and
- Used only for authorized business purposes
Cash controlling consists of administrative control and accounting control
Administrative controls
- Promote operational efficiency ( to ensure no authorized transactions are entered into
by officers or employees)
- Encourage adherence to prescribed managerial policies and achieving the objectives
of the organization
Accounting Controls
- Ensure the protection of assets for it is susceptible to improper diversion and use
- Ensure the accuracy and reliability of accounting data
- To have access to assets only in accordance with management's authorization

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 - To maintain accountability for assets

6.2.2.1 Internal control procedures

A system of internal control is not designed primarily to detect errors but rather to reduce the
opportunity of errors or dishonesty to occur. Effective system of internal control procedures should
consider the following points:
i. Segregation of duties; like separating one that works on custody with record keeper,
purchaser or receiver of purchased item. Here the separation of duties enables to protect assets
against either fraud or error. In addition the work of one helps to cross check the of the other
ii. Assignment of Responsibilities and Authorities; giving a specific authority to a specific
body helps a company to create responsibility and accountability in the actions of each party,
department or division. For example, to set an internal control procedure for cash payments
on enterprise could set a purchase procedure which gives responsibility to order and acquire
goods to purchase department maintain a record and make payments for invoices to
accounting and finance department and receive the purchased stocks to receiving department.
iii. Using mechanical devices and pre-numbered documents; using cash registers, check
protector holes and pre-numbered business forms are very helpful to ensure the accuracy and
reliability of accounting data.
iv. Maintaining physical safeguarding tools; for example safe boxes, drawers with lockers,
having daily deposits etc.
v. Implementing periodical performance evaluation methods; evaluating helps to take
periodical corrections and to take sure that regulations are properly implemented.
vi. Hiring competent employee and having computer help, creates to have efficient and
accurate record keeping and report preparation function
vii. Planning (budgeting):- forecasting cash necessary for future operations such as through
preparing periodic cash budgets

6.2.2.2 Control over cash receipts

Control over cash is required to safeguard all cash inflows or assure that all cash receivables by the
enterprise is collected and recorded without loss.
It includes
 Immediate counting
 Daily recording
 Intact deposit
6.2.2.3 Control over cash payments
The main objective of control over cash payments is to ensure no authorized payments are made. It
includes;
 Verifying and approving payments for example by using voucher system.
 Making payments by checks
 Periodic preparation of Bank reconciliation
1. Elements of internal control over cash payments.
Cash is safeguarded by keeping it in a safe box, depositing it in banks and through use of special
(imprest) cash funds

i. Petty cash fund

A petty cash fund refers to a fund of fixed amount used for small expenditures that are most
conveniently paid in cash such as payments for taxi fare, postage stamps, minor amount of supplies
etc.
 Establishment
- Estimate the required amount of payment to meet minor expenditures for specified period.
Journal Entry
Petty Cash fund xx
Cash xx

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  Operation
As each cash payment is made from the petty cash fund, prepare a voucher or other receipts
* No Journal entry
 Replenishment: petty cash fund is replenished
- When it reaches a minimum cash balance and
- At the end of the accounting period to recognize the periodic expenses paid from the fund and
to report the year end cash balance correctly.
- The vouchers or receipts will be reviewed and a check will be issued on the total amount of
the vouchers to restore the petty cash fund to its original amount.
Journal Entries at the time of replenishment will be
Various expenses xx
Cash xx
Illustration:
On January 1, 2006 ABC Company established a petty cash fund to make payments for minor
expenditures, for $ 500. During January the petty cash vouchers indicate payments are made for the
following transactions
Postage Expenses 189.60
Office Supplies 112.75
Minor repair Expenses 60.05
Miscellaneous expense 40.00
On January 28, the custodian requested replenishment for items paid to date and the cash balance in
the petty cash box is $ 95.20
Now let us see the record that ABC Company will have at the establishment of petty cash fund and at
the replenishment of the fund respectively.
Petty cash funds 500
Cash 500
Replenishment Entry

Postage Expenses 189.60

Office Supplies 112.75
Minor repair Expenses 60.05
Miscellaneous expense 40.00
Cash short and over 2.40
Cash ............................................... 404.80
The cash shortage and overage ledger account is classified as revenue when it has credit balance and
as expense when it has a debit balance.

ii. Cash Change Fund

A change fund is used to facilitate the collection of cash from customers
 Establishment
- Estimate the required types and amounts denominations.
Journal entry
Cash change fund xx
Cash xx
 Operation
Make the necessary changes and deduct the amount of the change fund from the total cash money on
hand at the close of each business day to determine the daily collections.
* No Journal entry will be required.

iii. Bank checking account (Reconciliation of bank balances)

Enterprises usually open checking account in a bank to have a daily deposits of all cash collections
and to make payments from the bank by issuing checks. Periodically banks prepare bank statement,
which is a summary of cash deposit and out lays made from each checking account of the depositor.
Similarly the depositor will have a ledger account to record daily cash transactions in the bank

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account. Usually the cash balance in dictated in a bank statement seldom agrees with cash balance
indicated by the depositors ledger account for the specific period.
Bank reconciliation:- is a schedule that analyzes and explains the difference between the ending
balance of cash in a bank and bank statement.
The possible reasons for the difference between two balances could be
 Delay in recording transactions
For example: Deposit in transit (deposits made after the bank closes it records for the statement
period), outstanding checks (checks issued but not presented for payment in the bank), bank service
charges, collections made bank.
 Errors or omissions in recording transactions

Note that, adjustment entries are required for transactions and events that are not included in the
depositor record and for the errors, which are made in recording by the depositor. However for
transactions that are not recorded by bank and for the differences that are self-correcting such as,
deposit in transit, outstanding checks, adjustment entries, will not be required. But for the errors made
by the bank it should be called for correction by writing a memorandum to the bank.

The two commonly used forms of bank reconciliation are:

1. Reconcile both bank balance and depositors balance to correct cash balance (Direct method).
2. Reconcile the bank balance to the balance in the depositor's record (Indirect method)

1. Reconcile both bank balance and depositors balance to correct cash balance.
Illustration:
On August 31, 2006 the cash ledger account in Awash international company shows a debit balance
of Birr 82, 461 while the bank statement provided by Abyssinia bank indicates a balance of birr
110,632. A receipt of August 31, for 12,924 birr was not included in August bank statement. In
addition the checks, which were issued but not paid by, bank during this month totals birr 11,458.
Credit memorandums send by the bank indicated that notes receivable left with the bank for birr
10,200 had been collected and credited for 10,240 birr including interest revenue of birr 40. In
addition the maturing value of Treasury bill birr 20,000 collected during this month. The bank
acquired for Awash Company at a discount for birr 18,800 and had been recorded at cost in the short
term investment ledger account by Awash Company. The bank statement included in debit
memorandum includes birr 28 as a service charge for the month of August. A check for 521 birr
drown by ABC Company (Creditor) returned and marked as NSF. Check number 1334 issued for 328
birr had been recorded by bank as 382 birr.
Required:
i) Prepare bank recondition schedule for Awash company for the month of August.
ii) Make the necessary journal entries.
1. Reconciling the bank balance and depositor’s balance to correct cash balances
(direct Method).
Under this method reconciliation will be made to bring both unadjusted balance in a bank and a
depositor’s record to the adjusted or correct balances.

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 Awash International Company
Bank Reconciliation
August 31,2006
Balance in depositor’s record Br 82,461
Add: Note and interest of Br.40 collected by bank 10,240
: Proceeds from Treasury bill that had been
Acquired for br.18, 800 and interest revenue.br 1,200 20,000 30, 240
Subtotal 112,701
Less: NSF checks drown by ABC company 521
: Bank service charges for August 28 549
Correct cash balance 112, 152
Balance in bank statement Br 110,632
Add: Deposit in transit 12,924
Error in recording check number 1334 54 12,978
Subtotal 123,610
Less: Outstanding checks 11,458
Correct cash balance 112,152

Preparing the above bank reconciliation will have the following three functions.
1. It helps to determine the correct cash balance to be reported in the balance sheet.
2. To disclose errors made in recording cash transactions, either by the bank or by the depositor,
and
3. To provide information necessary to bring the accounting records up to date.
After bank reconciliation statement is made, all items appearing in the reconciliation as additions to or
deductions from the “balance in the depositor’s record" must be included in the journal entry. The
journal entry on August 31, 2006 to adjust the accounting records of Awash Company is shown
below:

Cash 29,691
Account Receivable 521
Miscellaneous Expenses 28
Interest revenue ( Br 40 + 1,200) 1,240
Notes Receivable 10,200
Short term investments (Treasury bill) 18,800
The cash at bank account in the depositor's record before the above adjustment has a debit balance for
82,461 Birr.
Cash
82,461
Adjustment 29,691
---------------
112, 152

And after the above journal entry is posted it will show the correct balance of 112,152 Birr.
2. Reconcile bank balance to the balance in the depositor’s record (indirect method)
Steps to use this method;
1st Reconcile the bank balance to the unadjusted cash account balance in the general ledger.
- Include all items that are not included in the bank statement
- Add the items that were deducted in the bank statement but not in the depositor’s cash
account record.
- Deduct the items that were added in the bank statement but not in the depositor’s cash
account record.
nd
2 Enter the required adjustments in the bank reconciliation to the cash account in the depositor’s
record.

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 Awash International Company
Bank reconciliation
August 31, 2006
Balance in Bank statement Br 110,632
Add: Deposit in transit 12,924
: Error in recording check no. 1334 54
: NSF check drown by ABC company 521
: Bank service charges for August 28 13,527
Subtotal 124,159
Less: outstanding checks 11,458
Note and interest of Br 40 collected 10,240
by bank
: Proceeds from treasury bill that 20,000
had been acquired for br, 18,800
and interest revenue br 1,200 ________ 41,698
Balance in depositor’s records; unadjusted 82,461
Add: Adjustment to cash ledger account (See the above journal entry) 29,691
Correct cash balance (adjusted) 112,152

iv. Reconciliation of Cash Receipts and cash payments (Proof of cash)

A full reconciliation of cash receipts and payments (known as proof of cash) may be made to establish
the accuracy of the cash balance and the effectiveness of internal controls over cash receipts and cash
payment for a selected month or a longer period.

To prepare a proof of cash summary for a specific period:

- Determine the cash receipts and cash payment data for the period from both the company and
the bank.
- Present the bank reconciliation statement for the last period
Step 1 Reconcile cash receipts in bank statement and in depositor's record.

Here the deposit in transit of the lost period is deducted from the deposits recorded by the bank in
current period because it was a receipt of cash of the last period. And the deposit in transit of the
current period that is a receipt of cash of the current period should be included in total cash receipts of
the current period. Besides if there are proceeds on the notes and interest collected by the bank, it
must be deducted from the deposits recorded by the bank because the proceeds had not been entered
in the before adjustment accounting records in the current period.

Step 2. Reconcile cash payment in bank statement and in depositor’s record.

The outstanding checks of the last period are included in the bank debits for current period but
because they are payments of the last period they must be deducted from the current period payments.
The outstanding checks of the current period are not included in the bank balance and they need to be
included. Similarly the bank service charges and any NSF cheeks are included in the bank’s debits for
current period but not in the unadjusted balance of depositor’s record.

Step 3: Reconciliation of bank and depositor cash balances. The last column of the reconciliation is
identical to the reconciliation of the bank and depositor balances to the correct cash balance and make
the necessary journal entry required to adjust the accounting records the depositor.
Illustration:
The following data were taken from Awash international private company.
- The Bank statement cash balance for May indicated 14,621 birr and 21,406 birr
for June.
- Deposit in transit amounts 12,000 birr for May and 15,000 birr for June.
- Out Standing checks total 208 birr on May and 502 birr on June.

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 -During May there had been error in recording a check and May bank
reconciliation by adding birr 14 to the bank balance. In addition on June
check number 3280 issued and paid for 766 birr was erroneously recorded
by bank as 668 birr.
- The book balance per depositor record indicated 26,413 birr on May 31 and
35,716 birr on June 30.
- During June cash receipts total 69,236 birr and cash payments total 59,933 birr in the
depositor cash ledger. But the bank statement indicates cash receipts of 66,436 birr and cash
payments for 59,651 birr.
- Note collected by bank were 197 birr and 200 birr on May and June respectively.
- Bank service charges were 7 birr on May and 10 birr on June.
- NSF checks returned 190 birr on May and 100 birr on June
Required:- prepare proof of cash report for the month of June.

A Wash International Company

Proof of Cash
June 30, 2006
Balance Receipts Payments Balance June
may 30,2006
31,2006
Balances in bank statement 14,621 66,436 59,651 21,406
Deposits in transit
May 31, 2006 12,000 (12,000)
June 30,2006 15,000 15,000
Outstanding checks
May 31,2006 (208) (208)
June 30,2006 502 (502)
Other reconciling items
Bank service charges (7) (10) 10
NSF check drawn 190 (100) 100
Error in recording by bank 14 98 (98)
Note and interest collected by bank (197) (200) (200)
Balances in depositor’s records 26,413 69,236 59,933 35,716
Add: Adjustment of cash 90
ledger account on
June 30,2006 (see the following cash
balance)
Correct Cash Balance 35,806

6.3 Cash Overdraft

Sometimes banks allow their good customers to issue a check in excess of the balance on their deposit
and this creates an overdraft in the bank account.
In the rare situation in which a business enterprise maintains only one bank account and that account
is overdrawn on the balance sheet date, the overdraft amount is reported as a current liability.
However, if an enterprise has other accounts in the same bank with larger positive balances, it is
reasonable to present the net balance of cash as a current asset. But an overdraft in an account in one
bank should not be offset against positive balances in other banks because no right of offset exists.

6.3.1 Disclosure of compensating cash balances.

A compensating cash balance is portion of a deposit maintained by a depositor that constitutes support
for existing borrowing arrangements with banks. Disclosure of compensating balance arrangements is

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required because such cash balances are not available for discretionary use by management on the
balance sheet date.
6.4 Short term investments
Short-term investments are highly liquid type of temporarily held investments that can be easily
converted in to cash when needed.
Characteristics
- Short-term investments are investments, which are readily marketable
- They are held for sales within a short period of time
- They are held for earning return on idle cash
The objectives of acquiring short-term investments are
1. To maximize the return on assets and
2.To minimize the risk of loss from price fluctuations.
Investments in securities of other companies acquired by a business enterprise as a means of
exercising influence or control over the operations of such companies are of a quire different character
and should not be considered as short term investment.

Long term bonds and common stocks, occasionally used as a medium for investing idle cash, do not
meet the objective of limited price fluctuation. Long term bond prices fluctuate with changes in the
level of interest rates and the degree of fluctuation is greater for bonds with longer maturities.
6.4.1 Types of short-term investments
1. Debt securities for example
- Treasury bills which are issued at a discount by government units with maturities of thirteen
weeks to fifty two weeks
- Certificates of deposit are promissory notes issued by banks for various periods of time.
- Commercial paper is the term used for short term unsecured promissory notes issued by
corporations and sold at a discount to investors or other companies.
- Bonds: (Short term kinds) are issued to borrow for the short term and it is because the amount
of capital needed is too large for one lender to supply.
 Bond securities include specified interest rates.
1. Equity Securities:- indicate short term investments made in acquiring of other companies
common stock and preferred stocks .
 Dividends are received as compensation for short-term investment.

6.4.2 Recording transactions in short term investments.

i) Acquisition: - Short-term investments are recorded at cost.
The cost includes purchase price, brokerage commission and any costs incident to the
acquisition.
Debt securities acquired between interest dates are traded on the basis of market price plus the interest
accrued since the most recent interest payment. The occurred interest is a separate asset acquired with
the bonds. The cost of these two assets should be separated in the accounting records to see the results
of investment in marketable securities separately.
ii. Sales before maturity
Enterprises may sell short-term investments before maturity and the net proceeds on sales will be
sales price minus any incidental selling costs. When there are several acquisitions of the same bond or
stock at different dates and prices and if a portion of the holding is sold, some procedure of cost
selection must be employed. Among the methods commonly used are specific identification, first in
first out and average cost methods stock and bond certificates generally have serial numbers that
facilitate determination of the cost of specific investments.
Example: - Assume in the previous example of Alpha Company, on April 30, 2006 the company sold
half of the bonds of 110% plus occurred interest. The cash paid for brokerage commission was $ 200.
Required:-
i). Determine the cash received from sale of bonds and
ii). Prepare the necessary journal entry.

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 Market price of bonds ($100,000 /2 X 110%) 55,000
Less: brokerage commission 200
Net proceeds on sale of bonds 54,800
Add: Accrued interest for 5 months
On & 50,000 of 9% a year
(50,000 x 9/100 x 5/12) 1,875
Total cash received 56, 675
Here half of the short-term investments (bonds) are sold by receiving 54,800 cash. The gain on sale of
short-term investments will be:
Net proceeds on sales 54,800
Minus: original cost ($109,000/2) 54,500
Gain on sale of short term investments 300

The journal entry required at the time of sale (April 30) will be as follows:
2006 Cash 56,675
April 30 Short term investments 54,500
Interest receivable ($750/2) 375
Interest revenue 1,500
Gain on sale of short term investment 300

Interest Accrued for 5 months indicate interest revenue earned in 2005 for the month of December ($
50,000 x 9/100 x 1/12) and interest revenue accumulated from January 1 up to April 30 ($50, 000 x
9/100 x4/12). Since the December interest revenue is recognized (recorded) and reported in 2005
income statement at the time of cash collection the receivable account will be credited.
i. Discount or premium on short-term investments (bonds)
Amortization of premiums or accumulation of discounts will not be made for short term investments
in bonds. Because such temporarily held investments generally matures with a short period and any
premium or discount is likely to be negligible

6.4.3 Price fluctuations and valuation of short-term investments.

Normally, an asset is recorded at cost, and this cost is associated with the revenue generated from the
use of the asset. If the asset loses its value without generating revenue, the cost is written off as a loss.
The revenue realization principle usually allows recognition of increases in the value of an asset only
when it is sold. However, Short-term investments are readily salable at quoted market price and hence
the traditional tests of revenue realization should not control the valuation of short-term investments.
The use of market prices to value short-term investments at the end of an accounting period has some
advantages.
1. The income statement will show the results of decision to hold or sell such
investments from period to period
2. Valuation at current market price eliminates the difference of carrying identical
securities at different amounts because they were acquired at different prices.
3. Market value is more meaningful to creditors to judge the debt paying ability of the
business enterprise.

6.4.3.1 Valuation at cost or lower of cost or market method.

The lower of cost or market method is usually applied on the portfolio of marketable
securities. That is
 If market price is lower than cost, cost should be written down to market
 If market price is greater than cost, cost is maintained as value of the portfolio.
Valuation of lower of cost or market was required when the decline in market value was substantial
and was not “due to a mere temporary condition”

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The difference between the aggregate market Value and aggregate costs on any date is called Net
unrealized gain or loss.

Unrealized gain or loss = Market Value of Cost of marketable

Marketable equity - equity security
Securities

In marketable equities securities portfolio the net unrealized loss in that portfolio (excess of cost over
market) would be presented as valuation allowance. The journal entry to establish valuation allowance
for current portfolio of marketable equity securities is

Unrealized loss in value of marketable equity sectaries XX

Allowance to reduce marketable Equity securities to market value XX

The amount at which portfolio of marketable equity securities is reported in the balance sheet known
as carrying amount would be presented as follows:

Cost of marketable equity securities XX

Minus: Valuation allowance XX
Carrying amount XX

Changes in the valuation allowance for marketable equity securities are included in the determination
of net income of the current accounting period in which they occur. Such changes in the valuation
allowance balance result in unrealized gains or losses.

A recovery in the aggregate market Value of securities that had been written down to market value
below cost requires the recognition of unrealized gains however, increases in unrealized gains above
unrealized losses are not recognized in the accounting records.
Allowance to reduce marketable equity
Securities to market Value .......................... xx
Unrealized gain in value of equity securities ................. xx
Unrealized gains and losses on marketable equity securities are not used to compute taxable income.
Such gains and losses result in temporary differences between taxable in come and pretax accounting
income reported in the income statement.
Example: Nas Company began investing idle cash in marketable equity securities in 2002.
The cost and market Value of the securities held in its current port folio at the end of
December were as follows
End of Year Cost Market Value
2001 $ 200,000 210,000
2002 310,000 260,000
2003 280,000 210,000
2004 425,000 400,000
2005 400.000 410.000

Required: - Prepare the journal entries at the end of each year to adjust the valuation allowance if the
lower of cost or market method is used.

In the date of initial application, December 31, 2001 the cost of marketable equity securities included
in current part folio is less than the market value. By considering the objectivity principle and the idea
of lower of cost or market method the gain will not be recorded and hence there will not be valuation
allowance at end the of 2001.

December 31, 2002, a valuation allowance of $50,000 is required for marketable equity securities
included in current portfolio to reflect the excess of cost, $310.000, over market value $ 260,000. The

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unrealized loss of $ 50,000 is included in net income for year 2002. The journal entry to record
unrealized loss and the valuation allowance is:

Unrealized loss in value of marketable

Equity securities 50,000
Allowance to reduce marketable equity
Securities to market value 50,000
The Unrealized loss of $ 50,000 is included in 2003 net income
On December 31, 2003 there is increase (Change) in valuation allowance amount.

A valuation allowance of $ 70,000 is required for marketable equity securities in the current portfolio
to reflect the excess of total cost $ 280,000 over total market value $210,000. Because the balance in
the valuation allowance account is $ 50,000 an adjustment will be made only for $ 20,000. The
journal entry to record the increase in the valuation allowance is:

Unrealized loss in value of marketable equity 20,000

securities to market value
Allowance to reduce marketable equity
Securities to market value 20,000
Therefore, after the above adjustment entry is made the valuation allowance account will have a
balance of $ 70,000 or current required (desired) balance.

In December 31, 2004 there has been recovery and hence we need to reduce the valuation allowance
account, which has a balance of $ 70,000 to $25,000 (Which is the current period excess of cost $
425,000 over $400, 000 market value). The difference of 145,000 (which is $70,000- 25,000) is a
recovery from market value or unrealized gain and is included in net income of year 2005. The
journal entry to record the reduction in the valuation allowance is as follows.

Allowance to reduce marketable equity 45,000

Securities to market value
Unrealized gain in value of marketable equity securities 45,000

In December 31, 2005 the cost of marketable equity securities is lower than the market Value and
hence there is no valuation allowance in 2006. There has been unrealized gain by 10,000 but the
unrealized gain will not be presented in the income statement but a recovery for valuation allowance
account that had a balance of $25,000 will be made as follows:
Allowance to reduce marketable equity
Securities to market value 25,000
Unrealized gain in value of marketable
Equity securities 25,000

Realized gain or loss

The net realized gain or loss represents the difference between the net proceeds from the sale of
marketable equity security and its cost.

Realized gain Net proceeds from Cost of marketable

Or loss = Sale of marketable - equity securities.
Equity securities

The realized gains and losses from sale of current or non-current marketable equity securities
portfolio are included in the determination of periodic net income.

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Example :- Assume in the above example of Nas company the enterprise on January 1,2006 sold one
half of its marketable equity securities for $220,000.

Required:- Determine any gain or loss from sale of marketable equity securities and make the
necessary journal entry.

Proceeds from sale of marketable

Equity securities 220,000
Leas: Cost of marketable equity securities 200,000
($ 400,000 x ½)
Realized gain on sale of marketable
Equity securities 20,000

2006 Cash 220,000

January 1. Short term investments 200,000
Realized gain on sale of marketable
equity securities 20,000

6.4.4. Disclosures required for current portfolio of Marketable Equity securities

Disclosure is made either in the financial statements or in a note to the financial statements
- To show the gross unrealized gains representing the excess of market value over cost for all
marketable equity securities in the portfolio, and the gross unrealized losses representing the
excess of cost over market value on the balance sheet date
- To show net realized gain or loss included in the determination of net income.
- The basis on which cost was determined in the computation of realized gain or loss.
- To show significant net realized and net unrealized gains and losses arising after the date of
the financial statements, but prior to their issuance, applicable to securities owned on the date
of the most recent balance sheet
6.4.4.1 Balance sheet Presentation of short term Investments

Short-term investments rank next to cash in liquidity and thus are listed below cash in the current
assets section of the balance sheet. Whether short-term investments are reported at cost or at the lower
of cost or market, disclosure of the current market value is required.

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