INTERMEDIATE ACCOUNTING 1A – MODULE #1

CHAPTER 1 – CASH & CASH EQUIVALENTS (PART 1)

Learning objectives:

 The students are expected to learn about the concept of cash and cash equivalents, its components, and the
ways for it to be accounted on different situations and transactions.
 The students are expected to know how to classify cash from non-cash assets and calculate the total amount
under various situations.
 The students are expected to learn how to journalize various transactions pertaining to cash, adjust and reverse
entries arising from erroneous recognition and year-end adjustments.
 The students are expected to know how to compute and solve basic to complex problems associated with cash
and cash equivalents.

WHAT IS CASH?

Cash includes money or equivalent that is readily available for unrestricted use. Money is the standard medium
of exchange and the basis of accounting measurements. Other negotiable instruments that can be used to settle
obligations and are readily available for unrestricted use may form part of cash.

Cash includes:

a. Cash on hand – refers to the undeposited collections awaiting deposit and other current funds held as of the
reporting date.

b. Cash in bank – refers to deposits in banks that are available for immediate withdrawal and unrestricted use.

Examples of cash: (Mnemonics: CoDe-Check-FuD-Mo)

1. Coins and currencies

2. Demand deposits (checking or current accounts) and savings account
3. Checks – such as cashier’s checks, personal checks, manager’s check, traveller’s check, and certified checks
received from customers or other external parties.
4. Cash Funds set aside for use in current operations (*refer to note 4.1 for examples)
5. Bank Drafts – guarantees by bank to advance funds on the demand by the party to whom the draft was directed.
6. Money orders – similar to bank drafts but are drawn from post offices or other financial institutions.

*Note 4.1:
a. Petty Cash fund
b. Revolving fund
c. Payroll fund
d. Change fund
e. Dividend fund
f. Tax fund
g. Travel fund
 h. Interest fund
i. Other types of imprest bank account used in current operations

Examples of items NOT included in cash:

1. Postdated checks – treated as receivable

2. IOUs or advances to employees – treated as receivable
3. Cash funds not available for use in current operations (such as: Sinking Fund, Plant expansion fund, Depreciation
fund, Contingency fund, Preference Share Redemption, etc.
4. Postage stamps – treated as prepaid supplies.

CHECKS

1. Postdated checks – these are checks with a future date received by the company as payment.
If a postdated check is recorded upon receipt, it will be recorded as:

Cash xx
Accounts Receivable xx

This is an erroneous journal entry since postdated checks are to be recorded as cash upon the arrival of the date
indicated on the check. To correct the previous entry, we should record an adjusting entry as follows:

Accounts Receivable xx
Cash xx

2. Unreleased checks drawn and postdated checks drawn (by the company) – these are checks with future date or
still undelivered which is made by the company as a form of payment to a supplier, merchant or creditor. If
these kind of checks are recorded despite being undelivered or postdated, it will be recorded as:

Accounts Payable xx
Cash xx

This is an erroneous journal entry since the checks were still undelivered/postdated. Cash is to be recognized
upon the delivery of the check (if not postdated) or upon arrival of the date indicated. To correct the previous
entry, we should record an adjusting entry as follows:

Cash xx
Accounts Payable xx
3. Stale checks – these are checks delivered to payees which are not encashed within a relatively long period of
time, normally 6 months or more (but depending on company policy).
The same concepts applied on undelivered checks/postdated checks will be used on stale checks.

CASH EQUIVALENTS
- Are short-term, highly liquid investments that are readily convertible to known amounts of cash and which
are subject to an insignificant risk of changes in value. (PAS 7.6)

Examples of cash equivalents are as follows:

a. Treasury bills, notes, or bonds acquired 3 months before maturity date
o Treasury bill is a short-term obligation issued by the government at a discount usually less than a
year.
o Treasury notes and treasury bonds are long-term obligations issued by the government. Notes
usually have a maturity of 1 to less than 10 years, while bonds have a maturity of 10 years or more.
 b. Money market instrument or commercial paper acquired 3 months before maturity date
o Money market instruments are investments in portfolios of short-term securities.
o Commercial papers consist of short-term, unsecured, notes payable issued in large denominations
by large companies with high credit ratings to other companies and institutional investors. The
maturity date of commercial paper is normally less than 270 days and is traded in money market
and, thus, is highly liquid. A commercial paper acquired 3 months or less before its maturity date
may qualify as cash equivalent.
c. 3-month time deposit
o Time deposit is a form of a bank deposit normally made in fixed denomination, bears interest higher
than that of regular deposits, and has a pre-agreed maturity. A time deposit is evidenced by a
certificate of deposit.

OTHER ITEMS

 Equity securities (investment in stocks) – cannot qualify as cash equivalents because shares of stocks do not
have a maturity date.
 Redeemable preference shares (preference shares with mandatory redemption) – if acquired 3 months or less
before their specified redemption date can qualify as cash equivalents because redeemable preference shares
are debt instruments.
 Deposit in foreign banks – If unrestricted, included as cash at face amount at the current exchange rate as of
the reporting date. If restricted, excluded from cash, and presented as receivable subject to appropriate
allowances for uncollectability and impairment.
 Compensating balance – a minimum amount that must be maintained in an entity’s bank account as support for
funds borrowed from the bank. If legally restricted as to withdrawal, it shall be excluded from cash and instead
be part of other current assets or other non-current asset depending on the nature of its restriction. (If
restriction is within a year, current, otherwise non-current). If not legally restricted as to withdrawal, it shall be
included in cash.
 Bank overdraft – also known as cash overdraft, is a negative (credit) balance in bank account resulting from
overpayment of checks in excess of the amount of deposit. It may only occur in checking accounts, but not in
savings and time deposits. Overdrafts are payable on demand, thus they are presented as current liabilities,
except in cases where offsetting is permitted. Offsetting will be allowed if the following conditions are present:
1. When two or more bank accounts are maintained in the same bank (at least 1 of the bank
account is positive and can absorb the negative balance.)
2. Provided that the positive balance account is unrestricted.

INTERNAL CONTROLS OVER CASH

Internal control is any action or process effected by management that is designed to help an entity achieve its
objectives. Such objectives may be categorized as follows:

a. Reliability of financial reporting,

b. Effectiveness and efficiency of operations,
c. Compliance with laws and regulations, and
d. Safeguarding of assets.

Examples of internal controls over cash:

1. Segregation of incompatible duties
2. Imprest system
3. Bank reconciliation
4. Cash counts
5. Minimum cash balance
6. Lockbox accounts
7. Non-encashment of personal checks from petty cash fund
8. Voucher system
CASH SHORTAGES AND OVERAGES

Shortages and overages arise when the cash count is not equal to the balance per records. If the cash
count is less than the balance per records, there is a shortage, and an overage if vice versa. Initially, a shortage is
recorded as follows:

Cash shortage or overage xx

Cash on hand xx

If upon investigation that the shortage is due to the fault of an employee, it shall be charged to a
receivable account. Otherwise, it shall be charged to loss. The following entry shall be recorded to close the
shortage account depending on the result of the investigation:

Receivable from cashier / Loss on cash shortage xx

Cash shortage or overage xx

If the employee pays the receivable, the following entry is to be recorded:

Cash on hand xx
Receivable from cashier xx

On the other hand, cash overage is recorded as follows:

Cash on hand xx
Cash shortage or overage xx

If upon investigation that the overage is due to a fund of an employee mixed up with the company’s
fund, it shall be charged to a payable account. Otherwise, it shall be charged to gain. The following entry shall be
recorded to close the overage account depending on the result of the investigation:

Cash shortage or overage xx

Payable to cashier / Gain on cash overage xx

If the company pays the employee, the following entry is to be recorded:

Payable to cashier xx
Cash on hand xx

 Note: Having a cash overage does not mean it is beneficial to the company even if it results to a gain because it
is an indication of a weak internal control for cash.
CONCEALMENT OF CASH SHORTAGES

There are ways to fraudulently conceal cash shortages.

1. Lapping – it occurs when collection of receivable from one customer is stolen or misappropriated and then
concealed by applying a subsequent collection from another customer. Most of the time, it is made possible
when the incompatible duties of recording and cash custody are combined.

Example:

December 29 Cashier/Bookkeeper collects P10,000 from customer A, puts money in her pocket and
makes no journal entry.

January 1 Cashier/Bookkeeper collects P15,000 from customer B, puts P5,000 in her purse, and
makes the following journal entry:

Cash 10,000
Accounts Receivable – Mr. A 10,000

January 5 Auditor comes to audit and decided to confirm payments amounting to P20,000 and
above. As a result, the lapping was not detected by the audit conducted.

To show the effect of lapping, take a look at the following:

Let’s say Mr. A has a P100,000 AR Balance and Mr. B has a P90,000 AR Balance. Considering the transactions
that transpired, we can see the effect as follows:

December 29 payment:

Should be balance Recorded balance

Client AR Balance Client AR Balance

Mr. A P 90,000.00 Mr. A P100,000.00
Mr. B P 90,000.00 Mr. B P 90.000.00

January 1 payment:

Should be balance Recorded balance

Client AR Balance Client AR Balance

Mr. A P 90,000.00 Mr. A P 90,000.00
Mr. B P 75,000.00 Mr. B P 90.000.00

- Since the employee was assigned as a cashier and bookkeeper at the same time, she had the power to
receive the money (cashier) and record the transaction (bookkeeper). To avoid such circumstances, some
procedures may be applied by the auditor. One is through confirmation of balances of the clients and
advising the management to split the duty of the employee.

2. Kiting – occurs when cash shortage is concealed by overstating the balance of cash thru exploitation of the
float period of checks (usually 3 days). This normally occurs at month-end.