CHAPTER 2

CASH AND CASH EQUIVALENTS

DEFINITION OF CASH

From the point of view of a layman, “cash” simply means money.

Money is the standard medium of exchange in business transactions. It refers to the currency and coins
which are in circulation and legal tender.

However, in the accounting parlance, the term “cash” has a special and broader meaning. It connotes
more than money.

As contemplated in accounting, cash includes “money and any other negotiable instrument that is
payable in money and acceptable by the bank for deposit and immediate credit.”

Accordingly, cash includes checks, bank drafts and money orders because these are acceptable by the
bank for deposit or immediate encashment.

For example, when checks are received in full settlement of an account receivable, cash is immediately
debited.

But postdated checks received cannot be considered as cash yet because these checks are unacceptable
by the bank for deposit and immediate credit or outright encashment.

UNRESTRICTED CASH

There is no specific standard dealing with “cash”.

The only guidance is found in PAS1, paragraph 66, which provides that “an entity shall classify an asset
as current when the asset is cash or a cash equivalent unless it is restricted from being exchanged or
used to settle a liability for at least twelve months after the end of the reporting period.”

Accordingly, to be reported as “cash”, an item must be unrestricted in use.”

This means that the cash must be readily available in the payment of current obligations and not be
subject to any restrictions, contractual or otherwise.

The following cash items are included in “cash”:

a. Cash on hand- This includes undeposited cash collections and other cash items awaiting deposit
such as customers’ checks, cashiers’ or managers’ checks, travelers’ checks, bank drafts and
money orders.

b. Cash in bank- This includes demand deposit or checking account and saving deposit which are
unrestricted as to withdrawal.

c. Cash fund- set aside for current purposes such as petty cash fund, payroll fund and dividend
fund.

CASH EQUIVALENTS

PAS7, paragraph 6, defines “cash equivalents” as short- term and highly liquid investments that are
readily convertible into cash and so near their maturity that they present insignificant risk of changes in
value because if changes in interest rates

The standard further states that “only high liquid investments that are acquired three months before
maturity can qualify as cash equivalents.”

Examples of cash equivalents are:

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CHAPTER 2- CASH AND CASH EQUIVALENTS
 a. Three- month BSP treasury bill
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 maturity date.

However, 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.

Thus, a BSP treasury bill that was purchased one year ago cannot qualify as cash equivalents even if the
remaining maturity is three months or less.

MEASUREMENT OF CASH

Cash is measured at face value.

Cash in foreign currency is measured at the current exchange rate.

If a bank or financial institution holding the funds of an entity is in bankruptcy or financial difficulty, cash
should be written down to estimated realizable value if the amount recoverable is estimated to be lower
than the face value.

FINANCIAL STATEMENT PRESENTATION

The caption “cash and cash equivalents” should be shown as the first item among the current assets.

This caption includes all cash items, such as cash on hand, cash in bank, petty cash fund and cash
equivalents which are unrestricted in use for current operations.

However, the details comprising the “cash and cash equivalents” should be disclosed in the notes to
financial statements.

Investment of excess cash

The control and proper use of cash is an important aspect of cash management. Basically, the entity
must maintain sufficient cash for use in current operation.

Any cash accumulated in excess of that needed for current operations should be invested even
temporarily in some type of revenue earning investment.

Accordingly, excess cash may be invested in time deposits, money market instruments and treasury bills
for the purpose of earning interest income.

Investments in time deposit, money market instruments and treasury bills should be classified as
follows:

a. If the term is three months or less, such instruments are classified as cash equivalents and
therefore included in the caption “cash and cash equivalents.”
b. 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.
c. If the term is more than one year, such investments are classified as noncurrent or long-term
investments.

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 However, if such investments become due within one year from the end of the reporting period,
they are reclassified as current or temporary investments.

Foreign Currency

Cash in foreign currency should be translated to Philippine pesos using the current exchange rate.

Deposits in foreign countries which are not subject to any foreign exchange restrictions are included in
“cash”.

Deposits in foreign bank which are subject to foreign exchange restrictions, if material, should be
classified separately among noncurrent assets and the restriction clearly indicated.

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.

Examples of this fund are petty cash fund, payroll fund, travel fund, interest fund, dividend fund, and tax
fund.

On the other hand, if the cash fund is set aside for noncurrent purpose or payment of noncurrent
obligation, it is shown as long-term investment.

Examples of this fund are sinking fund, preference share redemption fund, contingent fund, insurance
fund and fund for acquisition or construction of property, plant and equipment.

CLASSIFICATION OF CASH FUND

The classification of a cash fund as current or noncurrent should parallel the classification of the related
liability.

For example, a sinking fund that is set aside to pay a bond payable shall be classified as current assets
when the bond payable is already due within one year after the end of the reporting period.

Bank overdraft

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

For example, an entity maintains two bank accounts:

a. Cash in bank- First Bank, which is overdrawn by P10, 000.

b. Cash in bank- Second Bank, with a debit balance of P100, 000.

The net cash balance is P90, 000.

The proper statement classification of the two accounts is as follows:

Current Asset:
Cash in bank- Second Bank 100, 000

Current Liability:
Bank overdraft- First Bank 10, 000

Note that it is not necessary to adjust and open a bank overdraft account in the ledger. In other words,
the Cash in Bank- First Bank account is maintained in the ledger with a credit balance.

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It is to be stated that generally overdrafts are not permitted in the Philippines.

Exception to the rule on overdraft

As stated earlier, a bank overdraft should not be offset against other bank accounts with debit balances.
This rule, however, is not without exception.

When an entity maintain 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 overdraft” or ”bank overdraft, net of other bank account.”

Moreover, an overdraft can also be offset against the other bank account if the amount is not material.

Compensating Balance

A compensating balance generally takes the form of minimum checking or demand deposit account
balance that 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 deposit is not legally restricted as to withdrawal by the borrower because of an informal
compensating balance agreement, the compensating balance 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.

The reason is that undelivered 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 adjustment is sometimes ignored because the amount is not very substantial
and there is no evidence of actual cancelation of the check in the subsequent period.

Postdated Check delivered

A postdated check delivered is 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:

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 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.

The question is how long a time must the check remain outstanding?

The Negotiable Instruments Law provides that where the instrument is payable on demand and this
includes checks, presentment must be made within a “reasonable time” after its issue.

In determining what is “reasonable time”, consideration should be made regarding the nature of the
instrument, the usage of trade or business, if any, with respect to such instrument and the facts of the
particular case,

Clearly, the law does not specify a definite period within which checks must be presented for
encashment. Reference is made to usage of trade or business practices.

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 a “stop payment order” to the bank for the
cancellation of a previously issued check.

If the amount of stale check is immaterial, it is simply accounted for as miscellaneous income as follows:

Cash xxx
Miscellaneous Income xxx

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 xxx
Accounts payable or appropriate account xxx

WINDOW DRESSING

The books of an entity should be closed at the end of every reporting period in order that financial
statements will show fairly the financial position and performance of the entity.

Window dressing is a practice of opening the books of accounts beyond the close of the reporting period
for the purpose of showing a better financial position and performance.

Window dressing is usually accomplished as follows:

a. By recording as of the last day of the reporting period collections made subsequent to the close
of the period.

b. By recording as of the last day of the reporting period payments of accounts made subsequent
to the close of the period.

Such practices are unacceptable and undesirable. The entries made to window dress must be reversed
to correct the statements.

In a very broad sense, window dressing is any deliberate misstatement of the assets, liabilities, equity,
income and expenses.

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CHAPTER 2- CASH AND CASH EQUIVALENTS
When the statements contain any untruthful or falsity, the statements are said to be window dressed.

Illustration

The correct current position at the end if the current year is as follows:

Current assets 8, 400, 000

Current liabilities 4, 000, 000
Current ratio (current assets / current liabilities) **(8, 400, 000/ 4, 000, 000) 2: 1

The books were kept open and two transactions which occurred in January of the following year were
recorded as of the end of the current year.

Journal Entries:

a. Sale for P2, 000, 000 of merchandise costing P800, 000:

Accounts Receivable 2, 000, 000

Sales 2, 000, 000

Cost of Sales 800, 000

Merchandise Inventory 800, 000

b. Payment of accounts payable, P800, 000:

Accounts Payable 800, 000

Cash 800, 000

Consequently, the resulting balances would be:

Current assets 8, 800, 000

Current liabilities 3, 200, 000
Current ratio (current assets / current liabilities) **(8, 800, 000/ 3, 200, 000) 2.75

The original current assets balance of P8, 400, 000 is increased by the accounts receivable of P2,
000, 000 but decreased by the cost of the merchandise sold of P800, 000 and payment of accounts
payable of P800, 000.

The current liabilities balance of P4, 000, 000 is reduced by the payment of accounts payable of
P800, 000.

As a consequence of the window dressing, the effects are:

a. The current ratio increased from 2.1 to 2.75, an apparent improvement in the current financial
position.

b. Sales are overstated by P2, 000, 000.

LAPPING

Lapping is a practice used for concealing a cash shortage.

Lapping consists of misappropriating a collection from one customer and concealing this defalcation
by applying a subsequent collection made from another customer.

Lapping involves a series of postponements of the entries for the collection of receivables.

This is possible when an entity has poor internal control and especially when the bookkeeper and
cashier are one and the same person.

KITING

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 Kiting is another device used to conceal a cash shortage.

Kiting is possible when an entity maintains current accounts in different banks. Kiting is usually
employed at the end of the month.

Kiting occurs when a check is drawn against a first bank and depositing the same check in a
second bank to cover the shortage in the latter bank. No entry is made for both the drawing and
deposit of the check.

This fraudulent device is made possible because when the check is drawn against the first bank at
the end of the month, the bank statement for such month does not yet show the check drawn
because the said check is yet to be cleared or presented for payment to the first bank.

Hence, the cash balance in the first bank at the end of the month is not affected.

On the other hand, when the check is deposited in the second bank at the end of the month, the
bank statement for such month will already show the deposit thereby increasing the cash in the said
bank and covering the cash shortage therein.

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 xxx

Cash xxx

The cash short or over account is only temporary or suspense account. When financial statements
are prepared the same should be adjusted.

Hence, if the cashier or cash custodian is held responsible for the cash shortage, the adjustment
should be:

Due from cashier xxx

Cash short or over xxx

However, if reasonable efforts fail to disclose the cause of the shortage, the adjustment is

Loss from cash shortage xxx

Cash short or over xxx

If the amount of cash shortage is not material, it can be debited to miscellaneous expense.

Accounting for cash overage

Where the cash count shows cash which is more than the balance per book, there is cash overage to
be recognized as follows:

Cash xxx
Cash short or over xxx

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 the statements are made.

The cash overage is treated as miscellaneous income if there is no claim on the same. The journal
entry is:

Cash short or over xxx

Miscellaneous income xxx

But where the cash overage is properly found to be the money of the cashier, the journal entry is:

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CHAPTER 2- CASH AND CASH EQUIVALENTS
 Cash short or over xxx
Payable to cashier xxx

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.

While internal control ideally requires that all payments should be made by means of check, this is
sometimes impossible.

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 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.

There are two methods of handling the petty cash, namely:

a. Imprest fund system

b. Fluctuating fund system

Imprest Fund System

The imprest fund system is the one usually followed in handling petty cash transactions.

Accounting procedures

a. A check is drawn to establish the fund.

Petty Cash Fund xxx

Cash in Bank xxx

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 payment and simply prepares 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 xxx
Cash in bank xxx

It is to be pointed out that the petty cash disbursements should be replenished only by
means of check and not from undeposited collections.

d. 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 xxx
Petty cash fund xxx

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 xxx

Cash in bank xxx

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

Cash in bank xxx

Petty cash fund xxx

Illustration:

2019
Nov. 10 The entity established an imprest fund of P 10, 000

Petty cash fund 10, 000

Cash in bank 10, 000

Nov. 29 Replenished the fund. The petty cash items include the following:

Currency and coin 2, 000

Supplies 5, 000
Telephone 1, 800
Postage 1, 200

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, P500; miscellaneous expense, P1, 000.

Supplies 1, 500
Postage 500
Miscellaneous expense 1, 000
Petty Cash Fund 3, 000

2020
Jan. 01 The adjustment made on December 31, 2019 is reversed.

Petty cash fund 3, 000

Supplies 1, 500
Postage 500
Miscellaneous expense 1, 000

Feb. 01 The fund is replenished and increased to P15, 000.

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 The composition of the fund: currency and coin P1, 000, supplies P4,
500, postage P3, 000 and miscellaneous 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.

FLUCTUATING FUND SYSTEM

The system is called “fluctuating fund system” because the checks drawn to replenish the fund do not
necessarily equal to the petty cash disbursements.

The replenishment checks are simply drawn upon the request of the petty cashier.

Moreover, petty cash disbursements are immediately recorded thus resulting in a fluctuating petty cash
balance per book from time to time:

a. Establishment of the fund:

Petty Cash Fund xxx

Cash in bank xxx

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

Expenses xxx
Petty Cash Fund xxx

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 xxx

Cash in bank xxx

The replenishment check may or may not be the same as the petty cash disbursements.

d. 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 xxx

Petty cash fund xxx

Illustration:

2019
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

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 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.

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.

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