Cash Equivalents

By JAMES CHEN
Updated Jul 25, 2019
What Are Cash Equivalents?
Cash equivalents are investments securities that are meant for short-
term investing; they have high credit quality and are highly liquid.

Cash equivalents, also known as "cash and equivalents," are one of

the three main asset classes in financial investing, along with stocks
and bonds. These securities have a low-risk, low-return profile and
include U.S. government Treasury bills, bank certificates of deposit,
bankers' acceptances, corporate commercial paper, and other money
market instruments.

KEY TAKEAWAYS

• Cash equivalents are the total value of cash on hand that

includes items that are similar to cash; cash and cash equivalents
must be current assets.
• A company's combined cash or cash equivalents is always
shown on the top line of the balance sheet since these assets are
the most liquid assets.
• Along with stocks and bonds, cash and cash equivalents make
up the three main asset classes in finance.
• These low-risk securities include U.S. government T-bills, bank
CDs, bankers' acceptances, corporate commercial paper, and
other money market instruments.
• Having cash and cash equivalents on hand speaks to a
company's health, as it reflects the firm's ability to pay its short-
term debt.
Cash Equivalents
Understanding Cash Equivalents
Cash equivalents also serve as one of the most important health
indicators of a company’s financial system. Analysts can also
estimate whether it is good to invest in a particular company through
its ability to generate cash and cash equivalents since it reflects how a
company is able to pay its bills throughout a short period of time.
Companies with large amounts of cash and cash equivalents are
primary targets of bigger companies who are planning to acquire
smaller companies.

There are five types of cash equivalents: Treasury bills, commercial

paper, marketable securities, money market funds, and short-
term government bonds.

Treasury Bills
Treasury bills are commonly referred to as “T-bills." These are
securities issued by the United States Department of Treasury. When
issued to companies, companies essentially lend the government
money. T-bills are provided in denominations of $1,000 to $5 million.
They do not pay interest but are provided at a discounted price. The
yield of T-bills is the difference between the price of purchase and the
value of redemption.

Commercial Papers
Commercial papers are used by big companies to receive funds to
answer short-term debt obligations like a corporations’ payroll. They
are supported by issuing banks or companies that promise to fulfill
and pay the face amount on the designated maturity date provided on
the note.

Marketable Securities
Marketable securities are financial assets and instruments that can
easily be converted into cash and are therefore very liquid.
Marketable securities are liquid because maturities tend to happen
within one year or less and the rates at which these may be traded
have minimal effect on prices.

Money Market Funds

Money market funds are like checking accounts that pay higher
interest rates provided by deposited money. Money market funds
provide an efficient and effective tool for companies and
organizations to manage their money since they tend to be more stable
compared to other types of funds like mutual funds. Its share price is
always the same and is constantly at $1 per share.

Short-Term Government Bonds

Short-term government bonds are provided by governments to fund
government projects. These are issued using the country’s domestic
currency. Investors take a look at political risks, interest rate risks,
and inflation when investing in government bonds.

Companies often store money in cash and cash equivalents in order to

earn interest on the funds while they wait to use them.
What Cash Equivalents Are Used For
There are several reasons a company might store their capital in cash
equivalents. One, they are part of the company's net working capital
(current assets minus current liabilities), which it uses to buy
inventory, cover operating expenses and make other purchases. They
also provide a buffer for the company to quickly convert to cash if
times become lean. Finally, they may be used to finance an
acquisition.
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4 Min. Read

Are Supplies a Current Asset? How to Classify Office Supplies on

Financial Statements
Hub > Accounting

In general, supplies are considered a current asset until the point at

which they’re used. Once supplies are used, they are converted to an
expense. Supplies can be considered a current asset if their dollar
value is significant. If the cost is significant, small businesses can
record the amount of unused supplies on their balance sheet in the
asset account under Supplies. The business would then record the
supplies used during the accounting period on the income
statement as Supplies Expense.

Explore these topics to find out how to report supplies on your

financial statements:

Are Supplies an Expense?

What is Materiality?

Are Supplies Credit or Debit?

What Is the Difference Between Supplies and Inventory?

NOTE: FreshBooks Support team members are not certified

income tax or accounting professionals and cannot provide advice
in these areas, outside of supporting questions about FreshBooks.
If you need income tax advice please contact an accountant in
your area.

Are Supplies an Expense?

Supplies become expenses once a business uses them. However,

there’s another case in which a company can treat supplies as an
expense instead of as current assets. If the value of the supplies is not
considered significant and as a result would not make an impact on
the business’s financial reports, the business can instead debit
the Supplies Expense account at the time of purchase. By doing so,
the supplies are considered an expense immediately from the time of
purchase. Companies can do this, even though it goes against
accounting standards, because of an accounting principle known as
materiality.

What is Materiality?

Materiality is an accounting principle stating that an accounting

standard can be ignored if doing so has an insignificant impact on the
business’s financial statements, and therefore doesn’t mislead anyone
reviewing the business’s financial reporting. Under the generally
accepted accounting principles, you do not have to follow an
accounting standard if an item is immaterial.

According to guidelines set by the U.S. Securities and Exchange

Commission in 1999, any item representing five percent or more of a
business’s total assets should be deemed material and listed separately
on its balance sheet. So, in the case of supplies, if the value of the
supplies is significant enough to total at least five percent of your total
assets, you should report it as a current asset on your balance sheet.
That being said, there is no hard rule about when an item should be
considered immaterial, so you have to use your judgement to
determine that. Items that account for less than five percent of your
total assets can still be considered material. For example, if a low-
value item would nonetheless change a net profit to a net loss, that
item should be considered material, no matter how insignificant its
value may be.

Are Supplies Credit or Debit?

In the world of double-entry bookkeeping, every financial transaction

affects at least two accounts. In the case of office supplies, if the
supplies purchased are insignificant and don’t need to be classified as
a current asset, you can simply debit the supplies as an expense to
your Office Supplies account. You would then credit
your Cash account if you paid for the supplies in cash.

What Is the Difference Between Supplies and Inventory?

Supplies are the items a company uses to run its business and drive
revenue, whereas inventory refers to items the business has made or
purchased to sell to customers. It’s important that you classify
supplies and inventory correctly, because their classification has tax
implications.

Your business has to pay sales tax on supplies, but you don’t have to
pay sales tax on inventory. That’s because goods are typically only
taxed once, at the retail level. So, in the case of inventory, the items
will be taxed when you sell them to your customers. But when you
purchase supplies for your business, such as pens, paper or printer
toner, you’re the end consumer and as a result, you have to pay sales
tax on the supplies.
Accumulated Depreciation

By ALICIA TUOVILA
Reviewed By DAVID KINDNESS
Updated Aug 21, 2020
What Is Accumulated Depreciation?
Accumulated depreciation is the cumulative depreciation of an asset
up to a single point in its life. Accumulated depreciation is
a contra asset account, meaning its natural balance is a credit that
reduces the overall asset value.

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Accumulated Depreciation
Understanding Accumulated Depreciation
The matching principle under generally accepted accounting
principles (GAAP) dictates that expenses must be matched to the
same accounting period in which the related revenue is generated.
Through depreciation, a business will expense a portion of a capital
asset's value over each year of its useful life. This means that each
year a capitalized asset is put to use and generates revenue, the cost
associated with using up the asset is recorded.

Accumulated depreciation is the total amount an asset has been

depreciated up until a single point. Each period, the depreciation
expense recorded in that period is added to the beginning accumulated
depreciation balance. An asset's carrying value on the balance sheet is
the difference between its historical cost and accumulated
depreciation. At the end of an asset's useful life, its carrying value on
the balance sheet will match its salvage value.

When recording depreciation in the general ledger, a company debits

depreciation expense and credits accumulated
depreciation. Depreciation expense flows through to the income
statement in the period it is recorded. Accumulated depreciation is
presented on the balance sheet below the line for related capitalized
assets. The accumulated depreciation balance increases over time,
adding the amount of depreciation expense recorded in the current
period.

KEY TAKEAWAYS

• Depreciation is recorded to tie the cost of using a long-term

capital asset with the benefit gained from its use over time.
• Accumulated depreciation is the sum of all recorded
depreciation on an asset to a specific date.
• Accumulated depreciation is presented on the balance sheet just
below the related capital asset line.
• The carrying value of an asset is its historical cost minus
accumulated depreciation.
Example of Accumulated Depreciation
Straight-line depreciation expense is calculated by finding the
depreciable base of the asset, which equals the difference between the
historical cost of the asset and its salvage value. The depreciable base
is then divided by the asset's useful life in order to get the periodic
depreciation expense. In this example, the historical cost of the asset
is the purchase price, the salvage value is the value of the asset at the
end of its useful life, also referred to as scrap value, and the useful life
is the number of years the asset is expected to provide value.

Company A buys a piece of equipment with a useful life of 10 years

for $110,000. The equipment is estimated to have a salvage value of
$10,000. The equipment is going to provide the company with value
for the next 10 years, so the company expenses the cost of the
equipment over the next 10 years. Straight-line depreciation is
calculated as (($110,000 - $10,000) / 10), or $10,000 a year. This
means the company will depreciate $10,000 for the next 10 years until
the book value of the asset is $10,000.

Each year the contra asset account referred to as accumulated

depreciation increases by $10,000. For example, at the end of five
years, the annual depreciation expense is still $10,000, but
accumulated depreciation has grown to $50,000. That is, accumulated
depreciation is a cumulative account. It is credited each year as the
value of the asset is written off and remains on the books, reducing
the net value of the asset, until the asset is disposed of or sold. It is
important to note that accumulated depreciation cannot be more than
the asset's historical cost even if the asset is still in use after its
estimated useful life.

Bank Draft

By JULIA KAGAN
Reviewed By KHADIJA KHARTIT
Updated May 21, 2020
What Is a Bank Draft?
The term bank draft refers to a negotiable instrument that can be used
as payment just like a check. Unlike a check, though, a bank draft is
guaranteed by the issuing bank. The total amount of the draft is drawn
from the requesting payer's account—their bank account balance
decreases by the money withdrawn from the account—and is usually
held in a general ledger account until the draft is cashed by the payee.
Bank drafts provide the payee with a secure form of payment.

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Bank Draft
How a Bank Draft Works
Consumers have several avenues available when they need secure,
certified payment options. They may require them to secure an
apartment or for a deposit for a very large purchase. Certified
payment options give the payee security, knowing that the funds are
available. These options include certified checks, wire transfers, and
bank drafts.

Bank drafts—also called banker's drafts, bank check, or teller's

check—are just like cashier's checks. They are secure payment
options that are guaranteed by the issuing bank—in many cases, for a
large amount of money. When a customer requests a bank draft, the
representative ensures they have enough money in their account to
cover the amount requested. Once verified, the bank withdraws the
funds from the customer's account and transfers it to a general ledger
or internal account. The bank prepares the draft with the payee's name
and the amount. The draft has a serial number—which identifies the
remitting customer—watermarks, and may even have micro-
encoding—identifying it as a legitimate financial instrument that can
be negotiated when presented by the payee to their bank. Since the
funds are already withdrawn from the requesting customer's account,
the issuing bank ultimately becomes the payer.

As mentioned above, bank drafts act as a viable and secure form of

payment. They may be required by a seller when they have no
relationship with a buyer, when a transaction involves a large sale
price, or if the seller believes collecting payment may be difficult. For
example, a seller may request a bank draft when selling a home or an
automobile. Of course, a seller may not collect funds with a bank
draft if the bank becomes insolvent and does not honor outstanding
drafts, or if the draft is fraudulent.

Banks normally charge customers for drafts. This means that in

addition to the amount of the draft, the requesting customer may be
liable for a fee—usually a flat rate, a flat fee based on the total
amount of the draft, or for a percentage of the draft. Banks may waive
the fee for customers who have a good relationship with the
institution or for those who are considered high-net-worth
individuals (HNWIs).

KEY TAKEAWAYS

• A bank draft is a negotiable instrument where payment is

guaranteed by the issuing bank.
• Banks verify and withdraw funds from the requester's account
and deposit them into an internal account to cover the amount of
the draft.
• A seller may require a bank draft when they have no
relationship with the buyer.
• Banks normally charge a fee for a bank draft.
Special Considerations
Some banks may not put stop payments on drafts once they're issued.
That's because the transaction has already taken place, according to
their records. If the purchaser wishes to reverse the transaction, the
bank usually requires that they redeem the draft for the full amount. In
some cases, it is possible to cancel or replace a lost, stolen, or
destroyed draft as long as the customer has the right documentation.

Bank Drafts vs. Money Orders

A bank draft and a money order are both prepaid, with a specified
amount printed on the instrument itself. Each is considered a secure
method of payment from a third-party institution. The payer does not
need to carry large amounts of money when using a bank draft or
money order. However, a bank draft is a check drawn on a bank’s
funds after accepting the amount from the issuer’s account, whereas
cash is used when purchasing a money order.

You can only purchase bank drafts from a bank, while money orders
can be purchased from certified stores, post offices, or banks.

Only a bank may issue a bank draft, while an approved institution,

such as a certified store, post office, or bank, can issue a money order.
Since money orders are often used to launder money, many
governments limit how much money can be converted into a money
order. Bank draft amounts can be much higher. Due to the limited
amounts printed on money orders— and the process banks go through
when issuing drafts—money orders cost less than bank drafts.
Obtaining a bank draft is more difficult than obtaining a money order
because the payer must go to his bank to purchase the draft, rather
than using one of the more accessible institutions that sell money
orders.

Overdraft

By JULIA KAGAN
Reviewed By SOMER ANDERSON
Updated Apr 20, 2020
What Is an Overdraft?
An overdraft is an extension of credit from a lending institution that is
granted when an account reaches zero. The overdraft allows the
account holder to continue withdrawing money even when the
account has no funds in it or has insufficient funds to cover the
amount of the withdrawal.

Basically, an overdraft means that the bank allows customers to

borrow a set amount of money. There is interest on the loan, and there
is typically a fee per overdraft. At many banks, an overdraft fee can
run upwards of $35.

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Overdraft
How an Overdraft Works
With an overdraft account, a bank is covering payments a customer
has made that would otherwise be rejected, or in the case of actual
checks, would bounce and be returned without payment.

KEY TAKEAWAYS

• Overdraft protection is a loan provided by some banks to

customers when their account reaches zero.
• The overdraft allows the customer to continue paying bills even
when there is insufficient money in the customer's account(s).
• An overdraft is like any other loan, the customer pays interest on
the loan and, in the case of overdrafts, will typically have a one-
time insufficient funds fee.
As with any loan, the borrower pays interest on the outstanding
balance of an overdraft loan. Often, the interest on the loan is lower
than the interest on credit cards, making the overdraft a better short-
term option in an emergency. In many cases, there are additional fees
for using overdraft protection that reduce the amount available to
cover your checks, such as insufficient funds fees per check or
withdrawal.

An Example of Overdraft Protection

Overdraft protection provides the customer with a valuable tool to
manage their checking account. If you're short a few dollars on your
rent payment, overdraft protection ensures that you won't have a
check returned against insufficient funds, which would reflect poorly
on your ability to pay. However, banks provide the service because of
how they benefit from it—namely, by charging a fee. As such,
customers should be sure to use the overdraft protection sparingly and
only in an emergency.

The dollar amount of overdraft protection varies by account and by

the bank. There are pros and cons to using overdraft protection. Often,
the customer needs to request the addition of overdraft protection. If
the overdraft protection is used excessively, the financial institution
can remove the protection from the account.

Special Considerations
Your bank can opt to use its own funds to cover your overdraft.
Another option is to link the overdraft to a credit card. If the bank
uses its own funds to cover your overdraft, it typically won't affect
your credit score. When a credit card is used for the overdraft
protection, it's possible that you can increase your debt to the point
where it could affect your credit score. However, this won't show up
as a problem with overdrafts on your checking accounts.

If you don't pay your overdrafts back in a predetermined amount of

time, your bank can turn over your account to a collection agency.
This collection action can affect your credit score and get reported to
the three main credit agencies: Equifax, Experian, and TransUnion. It
depends on how the account is reported to the agencies as to whether
it shows up as a problem with an overdraft on a checking account.

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Mortgage payable
October 18, 2018
A mortgage payable is the liability of a property owner to pay a
loan that is secured by property. From the perspective of the
borrower, the mortgage is considered a long-term liability. Any
portion of the debt that is payable within the next 12 months is
classified as a short-term liability. The total amount due is the
remaining unpaid principal on the loan.

Related Courses

What are bonds payable?

Definition of Bonds Payable

Bonds payable are a form of long term debt usually issued by
corporations, hospitals, and governments. The issuer of
bonds makes a formal promise/agreement to pay
interest usually every six months (semiannually) and to pay
the principal or maturity amount at a specified date some years in the
future. The agreement containing the details of the bonds payable is
known as the bond indenture.

U. S. corporations issue bonds instead of common stock for the

following reasons:
• Debt is less costly than common stock

• The interest on bonds is deductible for income tax purposes

• Bondholders are not owners and therefore the ownership interest of

the existing stockholders will not be diluted
Example of Bonds Payable
Usually public utilities issue bonds to help finance a new electric
power plant, hospitals issue bonds for new buildings, and
governments issue bonds to finance projects, operating deficits, or to
redeem older bonds that are maturing.
For example, a profitable public utility might finance half of the cost
of a new electricity generating power plant by issuing 30-year bonds.
If the current market interest rate for the bonds is 4%, the cost after
the income tax savings may be only 3%.

Allowance For Doubtful Accounts

By ALICIA TUOVILA
Updated Jul 3, 2019
What is an Allowance For Doubtful Accounts?
An allowance for doubtful accounts is a contra-asset account that nets
against the total receivables presented on the balance sheet to reflect
only the amounts expected to be paid. The allowance for doubtful
accounts is only an estimate of the amount of accounts
receivable which are expected to not be collectible. The actual
payment behavior of customers may differ substantially from the
estimate.

KEY TAKEAWAYS

• The allowance for doubtful accounts is a contra-asset account

that records the amount of receivables expected to be
uncollectible.
• The allowance is established in the same accounting period as
the original sale, with an offset to bad debt expense.
• The percentage of sales method and the accounts receivable
aging method are the two common ways to estimate
uncollectible accounts.
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Allowance for Doubtful Accounts
Understanding the Allowance For Doubtful Accounts
The allowance is established by recognizing bad debt expense on
the income statement in the same period as the associated sale is
reported. Only entities that extend credit to their customers use an
allowance for doubtful accounts. Regardless of company policies and
procedures for credit collections, the risk of the failure to receive
payment is always present in a transaction utilizing credit. Thus, a
company is required to realize this risk through the establishment of
the allowance account and offsetting bad debt expense. In accordance
with the matching principle of accounting, this ensures that expenses
related to the sale are recorded in the same accounting period as the
revenue is earned.

Because the allowance for doubtful accounts is established in the

same accounting period as the original sale, an entity does not know
for certain which exact receivables will be paid and which will
default. Therefore, generally accepted accounting principles
(GAAP) dictate that the allowance must still be established in the
same accounting period as the sale but can be based on an anticipated
and estimated figure. The allowance can accumulate across
accounting periods and may be adjusted based on the balance in the
account. Two primary methods exist for estimating the dollar amount
of accounts receivables not expected to be collected.

Recording the Allowance for Doubtful Accounts

Percentage of Sales Method
The sales method applies a flat percentage to the total dollar amount
of sales for the period. For example, based on previous experience, a
company may expect that 3% of net sales are not collectible. If the
total net sales for the period is $100,000, the company establishes an
allowance for doubtful accounts for $3,000 while simultaneously
reporting $3,000 in bad debt expense. If the following accounting
period results in net sales of $80,000, an additional $2,400 is reported
in the allowance for doubtful accounts, and $2,400 is recorded in the
second period in bad debt expense. The aggregate balance in the
allowance for doubtful accounts after these two periods is $5,400.
Accounts Receivable Aging Method
The second method of estimating the allowance for doubtful accounts
is the aging method. All outstanding accounts receivable are grouped
by age, and specific percentages are applied to each group. The
aggregate of all groups results is the estimated uncollectible amount.

For example, a company has $70,000 of accounts receivable less than

30 days outstanding and $30,000 of accounts receivable more than 30
days outstanding. Based on previous experience, 1% of accounts
receivable less than 30 days old will not be collectible and 4% of
accounts receivable at least 30 days old will be uncollectible.
Therefore, the company will report an allowance of $1,900 (($70,000
* 1%) + ($30,000 * 4%)). If the next accounting period results in an
estimated allowance of $2,500 based on outstanding accounts
receivable, only $600 ($2,500 - $1,900) will be the adjusting entry
amount.

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