826 R. Papa St.

Sampaloc, Manila
Philippine School of Business Administration
CPA REVIEW

THEORY OF ACCOUNTS Gutierrez/Ocampo

HAND OUT NO. 05-35 MAY 2006

ACCOUNTING FOR CASH AND CASH EQUIVALENTS

CASH – as defined in PAS 7 comprises cash on hand and demand deposit.

Nature of Cash

Cash consists of coin, currency, bank deposits, and negotiable instruments

such as money orders, checks, and bank drafts. Cash that has been
designated for some specific use, other than for payment of currently maturing

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obligations, is segregated from the general cash account. This amount may be

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classified as a current asset if it will be disbursed within one year or the

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operating cycle, whichever is longer. Otherwise, the amount should be shown
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as a noncurrent asset.

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Postdated checks and I.O.U.s should be reported as receivables.
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Travel advances to employees should be reported as receivables or as

prepaid expenses.
Postage stamps on hand should be reported as office supplies or as prepaid
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expenses.
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Petty cash funds and change funds should be included in cash.

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Bank overdrafts should be reported as current liabilities. They are not offset
against the cash account unless there is available cash in another account at
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the same bank.

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Management of Cash

Two problems of accounting for cash transactions for management: (1) Proper
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controls must be established to ensure that no unauthorized transactions are

entered into by officers or employees; (2) Information necessary to the proper
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management of cash on hand and cash transactions must be provided.

Restricted Cash
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It is common practice for an enterprise to have an agreement with a bank

concerning credit and borrowing arrangements. When such an agreement
exists, the bank usually requires the enterprise to maintain a minimum cash
balance on deposit. This minimum balance is known as a compensating
balance. Compensating balances that result in legally restricted deposits must
be separately classified in the balance sheet. The nature of the borrowing
arrangement determines whether the compensating balance is classified as a
current asset or a noncurrent asset.

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 PSBA CPA REVIEW SCHOOL 2

Cash equivalents

PAS NO. 7 DEFINES CASH EQUIVALENTS AS short-term, highly

liquid investments that are readily convertible to known amounts of cash and which
are subject to an insignificant risk of change in value.

a. This category includes items that are both :

(1) readily convertible to known amounts of cash, examples are:

Money market funds, money market savings certificates,
certificates of deposit, and similar types of deposits are nearly
"equivalent to cash" in terms of liquidity. However, these
securities usually contain restrictions or penalties on their
conversion to cash. These items should be reported as
temporary investments.

(2) and so near their maturity that they present insignificant risk of
changes in interest rates (generally 3 months or less).

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b. Many companies now report these items in a current asset category

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called cash and cash equivalents, which includes cash plus these
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items.

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Petty Cash
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In an imprest petty cash system, a petty cash custodian is given a small amount
of currency from which to make small payments (minor office supplies, taxi,
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postage, etc.). Each time a disbursement is made, the petty cashier obtains a
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signed receipt for the payment. When cash in the fund runs low, the petty
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cashier submits the signed receipts to the general cashier and a check is
prepared to replenish the petty cash fund. This process is designed to promote
control over small cash disbursements which would be awkward to pay by
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check.
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Bank Reconciliation

A basic cash control is preparation of a monthly bank reconciliation. The bank

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reconciliation, when properly prepared, proves that the cash balance per bank
and the cash balance per book are in agreement. The items that cause the
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bank and book balances to differ, and thus require preparation of a bank
reconciliation, are the following:

I. Bank reconciling items

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a. Deposits in Transit. Deposits recorded in the cash account in one period

but not received by the bank until the next period.

b. Outstanding Checks. Checks written by the depositor that have yet to be

presented at the bank for collection.

c. Bank Errors. Errors made by the bank that must be corrected for the
reconciliation to balance.

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 PSBA CPA REVIEW SCHOOL 3

II. Book reconciling items

a. Bank Debit memos and Bank Charges. These are NSF or DAIF and
charges by the bank for services that are deducted from the account by the
bank and which the company learns of when it receives the bank statement.

b. Bank Credits. Collections or deposits in the company's account that the

company is not aware of until receipt of the bank statement.

c. Depositor or book Errors. Errors made by the company that must be

corrected for the reconciliation to balance.

FORMS OF BANK RECONCILIATION

1. Adjusted balance - the reconciliation of bank and book balances to

corrected cash balance. This form is composed of two separate sections
that begin with the bank balance and book balance, respectively.
Reconciling items that apply to the bank balance are added and subtracted
to arrive at the corrected cash balance. Likewise, reconciling items that

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apply to the book balance are added and subtracted to arrive at the same

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corrected cash balance. The corrected cash balance is the amount that

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should be shown on the balance sheet at the reconciliation date.
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2. Bank to book – reconciles from the bank statement balance to the book
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balance.
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3. Book to bank - reconciles from the book balance to the bank statement
balance.
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Exercise 1—Asset classification.

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Below is a list of items. Classify each into one of the following balance sheet categories:
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a. Cash c. Trading Securities or Short-term Investments

b. Receivables d. Other
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____ 1. Compensating balances held in long-term borrowing arrangements

____ 2. Savings account

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____ 3. Trust fund

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____ 4. Checking account

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____ 5. Postage stamps

____ 6. Treasury bills maturing in six months

____ 7. Post-dated checks from customers

____ 8. Certificate of deposit maturing in five years

____ 9. Common stock of another company (to be sold by December 31, this year)

____ 10. Change fund

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 PSBA CPA REVIEW SCHOOL 4

TRUE/FALSE

1. Certificates of deposit and money market savings certificates are examples of time
deposits.

2. Demand deposits would include amounts in checking, savings, and money market
deposit accounts.

F 3. Deposits in foreign banks are always reported as receivables.

4. A cash overdraft should be reported as a current liability.

F 5. Compensating balance requirements as a result of short-term financing

arrangements are reported separately in the investment section of the balance sheet.

F 6. A trade discount is offered by some companies to encourage customers to pay bills

promptly.

F 7. A bank reconciliation should be prepared by the individual responsible for cash

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receipts and disbursements.

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In a bank reconciliation statement, the amount of a not-sufficient-funds check must
be added to the depositor's cash balance in determining the correct cash balance.

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9. In a bank reconciliation statement, an outstanding check must be subtracted from
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the bank statement balance in determining the correct cash balance.

F 10. The term "internal control" includes only accounting controls.

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11. Cash in foreign currency is considered cash.

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F 12. Original maturity, for the determination of cash equivalency, is defined as the date of
original issuance.
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F 13. A two-year treasury note purchased six weeks prior to maturity would not qualify as a
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cash equivalent.
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14. To qualify as a cash equivalent, an item generally must be readily convertible to cash
and have an original maturity of three months or less.
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15. Any change made in a company's policy concerning which securities are to be
treated as cash equivalents should be disclosed.
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MULTIPLE CHOICE:
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1. Deposits held as compensating balances

a. usually do not earn interest.
b. if legally restricted and held against short-term credit may be included as cash.
c. if legally restricted and held against long-term credit may be included among
current assets.
d. none of these
D
2. Which of the following is not true?
a. The imprest petty cash system in effect adheres to the rule of disbursement by
check.
b. Entries are made to the Petty Cash account only to increase or decrease the size
of the fund or to adjust the balance if not replenished at year-end.

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 PSBA CPA REVIEW SCHOOL 5

c. The Petty Cash account is debited when the fund is replenished.

d. All of these are not true.
C
3. A Cash Over and Short account
a. is not generally accepted.
b. is debited when the petty cash fund proves out over.
c. is debited when the petty cash fund proves out short.
d. is a contra account to Cash.
C
4. The journal entries for a bank reconciliation
a. are taken from the "balance per bank" section only.
b. may include a debit to Office Expense for bank service charges.
c. may include a credit to Accounts Receivable for an NSF check.
d. may include a debit to Accounts Payable for an NSF check.
B
5. When preparing a bank reconciliation, bank credits are
a. added to the bank statement balance.
b. deducted from the bank statement balance.
c. added to the balance per books.
d. deducted from the balance per books.
C

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6. What is the major purpose of an imprest petty cash fund?

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a. To effectively plan cash inflows and outflows

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b. To ease the payment of cash to vendors
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c. To determine the honesty of the employees

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d. To effectively control cash disbursements
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D
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7. A cash over or short account

a. Is not generally accepted
b. Is debited when the petty cash fund proves out over
c. Is debited when the petty cash fund proves out short
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d. Is a contra account to cash

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C
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8. The payments of accounts payable made subsequent to the close of the accounting
period are recorded as if they were made at the end of the current period.
a. Window dressing b. Kiting c. Lapping d. Imprest
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system
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A
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9. Bank reconciliation
a. Is the process of transferring money in or out of a bank account.
b. Requires that every transaction which will result in a cash payment be verified,
approved and recorded before a bank check is prepared.
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c. Is an analysis that reflects the bank transactions made by a depositor.

d. Explains the difference between the bank balance and the balance shown in the
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depositor’s records.
D
10. If the cash balance shown in a company’s accounting records is less than the correct
cash balance and neither the company nor the bank has made any errors, there
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must be
a. Deposits credited by the bank but not yet recorded by the company
b. Deposits in transit
c. Outstanding checks
d. Bank charges not yet recorded by the company
A
11. The amount reported as "Cash" on a company's balance sheet normally should
exclude
a. postdated checks that are payable to the company.
b. cash in a payroll account.
c. undelivered checks written and signed by the company.
d. petty cash.

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 PSBA CPA REVIEW SCHOOL 6

12. If the balance shown on a company's bank statement is less than the correct cash
balance, and neither the company nor the bank has made any errors,
there must be
a. deposits credited by the bank but not yet recorded by the company.
b. outstanding checks.
c. bank charges not yet recorded by the company.
d. deposits in transit.
D
13. If the cash balance shown in a company's accounting records is less than the correct
cash balance, and neither the company nor the bank has made any errors, there must be
a. deposits credited by the bank but not yet recorded by the company.
b. deposits in transit.
c. outstanding checks.
d. bank charges not yet recorded by the company.
A
14. Which of the following would not be classified as cash?
a. Personal checks
b. Travelers' checks
c. Cashiers' checks

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d. Postdated checks

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15. Which of the following is not a basic characteristic of a system of cash control?
a. Use of a voucher system

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b. Combined responsibility for handling and recording cash
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c. Daily deposit of all cash received
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d. Internal audits at irregular intervals

B
16. Bank statements provide information about all of the following except
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a. checks cleared during the period.

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b. NSF checks.
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c. bank charges for the period.

d. errors made by the company.
D
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17. Which of the following items would be added to the book balance on a bank
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reconciliation?
a. Outstanding checks
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b. A check written for $63 entered as $36 in the accounting records

c. Interest paid by the bank
d. Deposits in transit
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C
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18. The following statements relate to cash. Which statement is true?

a. The term “cash equivalent” refers to demand credit instruments such as
money order and bank drafts.
b. The purpose of establishing a petty cash fund is to keep enough cash on
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hand to cover all normal operating expenses for a period of time.

c. Classification of a restricted cash balance as current or noncurrent should
parallel the classification of the related obligation for which the cash was
restricted.
d. Compensating balances required by a bank should always be excluded from
“cash and cash equivalent”.
C
19. Cash equivalents are
a. Short-term and highly liquid investments that are readily convertible into cash.
b. Short-term and highly liquid investments that are readily convertible into cash
with remaining maturity of three months.

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 PSBA CPA REVIEW SCHOOL 7

c. Short-term and highly liquid investments that are readily convertible into cash
and so near their maturity that they represent insignificant risk of changes in
value because of changes in interest rates.
d. Short term and highly liquid marketable equity securities.

C
20. Which of the following statements is false?
a. Not all items included in cash constitute legal tender.
b. Cash may be offset against a liability if the deposit of funds in restricted
account clearly constitutes the legal discharge of the liability.
c. Legally restricted bank deposit held as compensating balances should be
segregated from the cash account and reported under a separate caption.
d. One-year BSP treasury bills with remaining maturity of three months on
balance sheet date may be shown as part of “cash and cash equivalents”
provided this is disclosed.
D
21. All cash receipts are deposited intact and all cash disbursements are made
by means of check. This internal control is known as
a. Administrative control c. Accounting control
b. Imprest system d. Auditing control

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B

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22. Entries to record the replenishment of petty cash fund result in a debit to
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various expense accounts and a credit to cash in bank. This accounting

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procedure typically exemplifies the
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a. Imprest petty cash system c. Internal control
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b. Fluctuating petty cash system d. Administrative control

A
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23. Which of the following is not considered cash for financial reporting purposes?
a. Petty cash funds and change funds
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b. Money orders, certified checks, and personal checks

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c. Coin, currency, and available funds

d. Postdated checks and I.O.U.'s
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D
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24. Which of the following is considered cash?

a. Certificates of deposit (CDs)
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b. Money market checking accounts

c. Money market savings certificates
B d. Postdated checks
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25. Travel advances should be reported as

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a. supplies.
b. cash because they represent the equivalent of money.
c. investments.
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d. none of these.
D
26. Bank overdrafts, if material, should be
a. reported as a deduction from the current asset section.
b. reported as a deduction from cash.
c. netted against cash and a net cash amount reported.
d. reported as a current liability.
D
27. Deposits held as compensating balances
a. usually do not earn interest.
b. if legally restricted and held against short-term credit may be included as cash.
c. if legally restricted and held against long-term credit may be included among
current assets.

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 PSBA CPA REVIEW SCHOOL 8

d. none of these.
D

ANSWER
EXERCISE 1
1. d 3. d 5. d 7. b 9. c
2. a 4. a 6. c 8. d 10. a

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