ACC 205 | INTERMEDIATE ACCOUNTING 1

BATANGAS STATE UNIVERSITY – MAIN 1

Module 2.1

CASH and CASH EQUIVALENTS

Week 2

This module discusses the concept of cash. It will help the users of this module to also understand the
concept of cash equivalents. This will also aid the users to determine which items shall be considered as
cash and/or cash equivalents. An addition to the identified focus topics, this module will also discuss
accounting treatments for petty cash fund.

INTENDED LEARNING OBJECTIVES

ILO 1 – Identify the applicable accounting standards for the recognition and measurement of cash and
cash equivalents

ILO 2 – Compute for the amount appropriate for the presentation in the financial statements

ILO 3 – Understand the concept of petty cash fund, its accounting treatments and presentation in the
financial statements

CASH

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. Money refers to the currency and
coins which are in circulation and legal tender1. 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 instrument2 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

1
Legal tender means such currency which in a given jurisdiction can be used for the payment of debts, public and
private, and which cannot be refused by the creditor (Tolentino, Obligations and Contracts, 2002). These are coins
or banknotes that must be accepted if offered in payment of a debt.

2
Negotiable instrument is any document in writing and signed by the maker or drawer which contains an
unconditional promise or order to pay a sum certain in money and payable on demand, or at a fixed or
determinable future time payable to order or to bearer (so called badges of negotiability). If addressed to a
drawee, he must be named or otherwise indicated with reasonable certainty. (Sec. 1 of R.A. 2031)

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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 PAS 1, 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 to settle a liability for more than 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.

CASH ITEMS INCLUDED IN CASH

1. Cash on hand – this includes undeposited cash collections and other cash items awaiting deposit
such as customer’s checks, cashier’s or manager’s checks, traveler’s checks, bank drafts and
money orders.
2. Cash in bank – this includes demand deposit or checking account and saving deposit which are
unrestricted as to withdrawal
3. Cash fund set aside for current purposes such as petty cash fund, payroll fund, and dividend fund.

CASH EQUIVALENTS

PAS 7, paragraph 6, defines cash and 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 of changes in interest rates.

The standard further states that only highly liquid investments that are acquired three months before
maturity can qualify as cash equivalents.
DATE OF PURCHASE
Examples of cash equivalents are:

1. Three-month BSP treasury bills

2. Three-year BSP treasury bill purchased three months before date of maturity
3. Three-month time deposit
4. Three-month money market instrument or commercial paper issuer: private companies

EQUITY SECURITIES PREFERENCE SHARES

cannot qualify as cash equivalents because shares can qualify as cash if with specified redemption
do not have a maturity date date AND acquired three months before
redemption date
it connoted ownership
redeemable preference share: from the time na ginawa sya ng corp ay may maturity date
in form - sya ay share pero dahil may maturity date therefore sya ay liability

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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 equivalent even if the
remaining maturity is three months or less.

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 operations.

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.

CLASSIFICATION OF INVESTMENT OF EXCESS CASH

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

• 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”
• 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
• If the term is more than one year, such investments are classified as noncurrent or long-term
investments.

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

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 AND CLASSIFICATION OF CCE

FINANCIAL POSITION NOTES TO FINANCIAL STATEMENT

should be shown as the line item among the details comprising the "cash and cash equivalents"
current assets which reflects the total cash items should be disclosed here which may include 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.

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In financial position:

In notes to financial statements:

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CLASSIFICATION OF TIME DEPOSIT, MONEY MARKET INSTRUMENT AND TREASURY BILLS

If the term is
3 months or less more than 3 months but within more than one year
one year
Current Asset (CA) Current Asset (CA) Noncurrent Asset (NCA)
Cash Equivalents Short-term Investment Long-term Investment
under CCE separate from CCE separate from CA
If such long-term investment becomes due within one year from the end of the reporting period, they
are reclassified as temporary investments; from NCA to CA.

FOREIGN CURRENCY

Deposits in foreign countries which are

not subject to any foreign exchange restriction subject to foreign exchange restriction
Current Asset (CA) Noncurrent Asset (NCA)
Cash Restricted Cash in Foreign Bank

CASH FUND FOR A CERTAIN PURPOSE

If the cash fund is set aside for

USE IN CURRENT OPERATIONS FOR NONCURRENT PURPOSES
Current Asset (CA) Noncurrent Asset (NCA)
Cash and Cash Equivalents Long-Term Investment
petty cash fund, payroll fund, travel sinking fund, preferred redemption
fund, interest fund, dividend fund and tax fund fund, contingent fund, insurance fund and fund
for acquisition or construction of property, plant
and equipment
GENERAL RULE:
Classification of a cash fund as current or noncurrent should parallel the classification of the related
liability.
EXCEPTION:
A cash fund set aside for acquisition of noncurrent should be classified as noncurrent regardless of
the year

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 asset when
the bond payable is already due within one year after the end of the reporting period.

However, a cash fund set aside for the acquisition of a noncurrent asset should be classified as noncurrent
regardless of the year of disbursement.

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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.

General Rule:

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:

• Cash in bank – First Bank, which is overdrawn by P10,000

• 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,
Cash in Bank – First Bank account is maintained in the ledger with a credit balance. It is to be stated that
generally overdrafts are not permitted in the Philippines.

Exceptions:

1. When the entity maintains two or more accounts in one bank and one account results in an
overdraft, such overdraft may be offset against the other bank account with a debit balance.
2. Moreover, an overdraft may also be offset against the other bank account if the amount is not
material.
3. Under IFRS, bank overdraft can be offset against other bank account when payable on demand
and often fluctuates from positive to negative as an integral part of cash management.

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.

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CLASSIFICATION OF COMPENSATING BALANCE

If the deposit, as to withdrawal, is

NOT LEGALLY RESTRICTED
Current Asset (CA)
Cash and Cash Equivalent
LEGALLY RESTRICTED
and the loan is short-term and the loan is long-term
Current Asset (CA) Noncurrent Asset (NCA)
Cash Held as Compensating Noncurrent Investment or Long-
Balance term 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 the reporting period. There is no payment when the check is pending delivery to the
payee at the end of the 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.

Journal Cash xx
Entry: Accounts payable or appropriate account xx

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 a check drawn, recorded and already given to the payee but it bears a
date subsequent to the end of the reporting period. The original entry recording a delivered postdated
check shall also be reversed and therefore restored to the cash balance.

Journal Cash xx
Entry: Accounts payable or appropriate account xx

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?

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The Negotiable Instruments Law provides that where the instrument is payable on demand,
presentment must be made within a reasonable time after issue. In determining 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 checks must be presented for encashment.
Reference is made to usage of trade or business practice. 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
cancelation of a previously issued check.

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

Journal Cash xx
Entry: Miscellaneous Income xx

However, if the amount is material and liability is expected to continue, the cash is restored and the
liability is again set up.

Journal Cash Xx
Entry: Accounts payable or appropriate account xx

ACCOUNTING FOR CASH SHORTAGE

like an expense account
Cash count < balance per book = SHORTAGE

Initial entry:

Journal Cash short or over xx

Entry: Cash xx

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

Adjustment:

If the cashier or cash custodian is held responsible for the cash shortage:

Journal Due from cashier xx

Entry: Cash short or over xx

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If reasonable efforts fail to disclose the cause of the shortage, and amount is material:

Journal Loss from cash shortage xx

Entry: Cash short or over xx

If reasonable efforts fail to disclose the cause of the shortage, and amount is immaterial:

Journal Miscellaneous Expense xx

Entry: Cash short or over xx

ACCOUNTING FOR CASH OVERAGE

Cash count > the balance per book there = OVERAGE

Initial entry:

Journal Cash xx
Entry: Cash short or over xx

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 statements were made.

Adjustment:

If claimed by cashier:

Journal Cash short or over xx

Entry: Payable to cashier xx

If the responsible personnel cannot be traced and amount is material:

Journal Cash short or over xx

Entry: Gain from cash overage xx

If the responsible personnel cannot be traced and amount is immaterial:

Journal Cash short or over xx

Entry: Miscellaneous income xx

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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. Small disbursements
are paid out of the petty cash fund.

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 in cash rather than
issue checks.

PETTY CASH FUND included in cash ( 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:

IMPREST FUND SYSTEM FLUCTUATING FUND SYSTEM

Pretty cash expenses are recorded upon Petty cash expenses. are immediately recorded.
replenishment. The amount of replenishment may be equal to,
more or less than, the petty cash disbursements.

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 xx

Cash in bank xx

b. Payment of expenses out of fund

No formal journal entries are made.

petty cash custodian
The petty cashier generally requires a signed petty cash voucher for such payments 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.

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Expenses xx
Cash in bank xx
It is 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.

Expenses xx
Petty cash fund xx

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

Petty cash fund xx

Cash in bank xx

f. A decrease in the fund is recorded as

Cash in bank xx
Petty cash fund xx

ILLUSTRATION

2020
Nov 10 The entity established an imprest fund of P10,000
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:

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

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Cash in bank 8,000

Dec 31 The fund was not replenished

The fund is composed of the following: currency and coins – 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

2021
Jan 1 The adjustment made on December 31, 2020 is reversed.
Petty cash fund 3,000
Supplies 1,500
Postage 500
Miscellaneous expense 1,000

Feb 1 The fund is replenished and increased to P15,000

The composition of the fund:
Currency and coins 1,000
Supplies 4,500
Postage 3,000
Miscellaneous expense 1,500
Total 10,000

The journal entry for the replenishment and increase is:

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 is P5,000.

FLUCTUATING FUND SYSTEM

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

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Accounting Procedures:

a. Establishment of the fund

Petty cash fund xx
Cash in bank Xx

b. Payment of expenses out of the petty cash fund

Expenses xx
Petty cash fund xx

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 fund

Petty cash fund xx
Cash in bank xx

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 reverted to the general cash

Cash in bank xx
Petty cash fund xx

ILLUSTRATION
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

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.

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BATANGAS STATE UNIVERSITY – MAIN 1

Dec 1-30 Petty cash expenses amounted to P9,000

Expenses 9,000
Petty cash fund 9,000

Dec 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.

- END OF MODULE –

References
Ayala Land, Inc. (2020). Consolidated Audited Financial Statements.

Valix, C. T., Peralta, J. F., & Valix, C. A. (2020). Intermediate Accounting (Vol. 1). Manila City: GIC
Enterprises & Co., Inc. .

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