Intermediate Accounting 1

CHAPTER 1: Cash and Cash Equivalents

INTRODUCTION

The new Conceptual Framework for Financial Reporting defines asset as economic resources controlled
by the entity as a result of past events. An economic resource is a right that has the potential to produce
economic benefits embodied in any of the following ways (a) used singly or with other assets in the
production of revenues; (b) used to acquire other assets, or settle a liability, or distribute to the enterprise
owners.

A factor that determines which accounting standard is applicable to its recognition and measurement is
its nature. One such nature is the group of assets evidenced by financial instruments. These are called
financial assets.

NATURE OF FINANCIAL ASSETS

As defined in International Accounting Standards (IAS) 32 Financial Instruments: Presentation, a financial

instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity (par. 11, IAS 32). From the point of view of the holder, the instrument is a
financial asset; while from the viewpoint of the issuer, the same instrument represents a financial liability
or a component of shareholders' equity.

From the definition, a financial asset arises from a contract that entitles the holder to receive cash or
another financial asset. Examples of financial assets are cash and cash equivalents, investments in equity
instruments of other entities, contractual rights to receive from another entity cash or another financial
asset (trade receivables, loans and other receivables), and investments in debt instruments of another
entity classified by the latter entity as financial liabilities investments in bonds and commercial papers).

Financial assets also include derivatives held by an entity. A derivative is a financial instrument that meets
all of the following characteristics: (a) its value changes in response to change in specified interest rate,
commodity price, financial instrument price, foreign exchange rate, price index, credit rating or credit
index, or other variables; (b) it requires no initial net investment, or initial net investment smaller than
that required in similar contracts; and (c) it is settled at a future date. Examples of derivative assets are
options and warrants that enable holders to acquire equity shares of other entities.

Financial assets and financial liabilities are within the scope of IFRS 9 Financial Instruments. IFRS 9
becomes effective on January 1, 2018. Non-financial assets are discussed in some other specific
International Financial Reporting Standards.

RECOGNITION OF FINANCIAL ASSETS

According to the new Conceptual Framework, the recognition of financial statement elements depends
on the attributes of relevance and faithful representation. The probability of a flow of economic benefits
and existence uncertainty affect the relevance of information. This means that in judging as to whether
an economic resource is to be recognized as an asset, the likelihood that it will provide inflow of economic
benefits has to be considered. Likewise, the entity has to be honest to its users regarding measurement
uncertainty which affects presentation and disclosure. Thus, circumstances, such as the entity's intention
for acquiring and holding the financial asset and the environment affecting the probability of inflow of
economic benefits are considered in recognizing and measuring the financial statement elements.

In addition to the above consideration, IFRS 9 provides that an entity shall recognize a financial asset in
its statement of financial position when and only when the entity becomes a party to the contractual
provisions of the instrument (par. 3.1.1, IFRS 9). This means that the entity recognizing the financial asset
has the enforceable right to the inflow of economic benefits from the instrument, as this inflow is
embodied in the agreement with the other entity

CASH AS A FINANCIAL ASSETS

Among the financial assets, "Cash" is considered by most financial statement users as one of the most
significant because of its ability to settle an obligation, acquire another asset, pay operating costs, or
provide returns to enterprise owners. Because of this power of cash, it is most often the first asset item
listed on the face of the statement of financial position.

Cash is any item that is used as standard medium of exchange. From a limited viewpoint, cash refers to
currency and coins that are in circulation. For accounting purposes, however, an item is considered "Cash"
if it is acceptable by bank or other financial institutions for deposit at face value. Thus, cash items include
bills and coins on hand, demand credit instruments, such as checks, bank drafts, postal money orders and
currency demand deposits with banks.

To qualify for reporting as part of the account title "Cash" or "Cash on Hand and in Banks in the statement
of financial position, a cash item must be unrestricted and must be immediately available for use in current
operations.
Figure 1.1 presented overleaf clarifies this requirement.

Cash items are unrestricted if they are on hand, or in the case of deposits with banks, they can be
withdrawn immediately. Deposits with banks that cannot be withdrawn immediately because of some
regulatory or court restrictions (such as cash restricted as a result of a court order) shall be presented
separately using some other descriptive account titles. Cash deposits that have been restricted because
of an unforeseen circumstance must be reclassified as receivable under current assets or non-current
assets, depending on the expected timing of settlement

Cash items are immediately available for use in current operations, if they are available for payment of
current obligations or current operating expenses or for acquisition of current assets.

The presentation of the cash item must parallel the intention of the management for which cash is held.
Cash funds that are intended for current operations qualify to be reported as Cash in the current assets
section of the statement of financial position. Examples of these items are payroll fund, working fund,
change fund, petty cash fund, interest fund and dividend fund.
Cash funds that are intended for acquisition of non-current assets do not qualify to be reported as part of
current assets. The expected timing of disbursement of these cash funds is not a consideration in
classifying them into current or non-current, because even if they are expected to be disbursed currently,
such disbursement shall give rise to the recognition of a non-current asset. These cash funds are presented
under a non-current asset heading using some other descriptive account titles, such as plant expansion
fund or equipment acquisition fund.

Likewise, cash funds that are intended for settlement of long-term obligations in the future are also
classified as non-current (using another account title, e.g., Sinking Fund). unless the long-term obligation
or a portion thereof becomes due within 12 months after the end of the reporting period. In the latter
case, the maturing obligation or a maturing portion thereof as well as the cash funds set aside for its
liquidation shall both be classified as current. The cash fund shall be presented as part of Cash.

To summarize, "Cash" in the statement of financial position, includes the following:

1) Cash on hand
a. Undeposited cash collections - currencies such as bills and coins, customers' checks, traveler's
checks, manager's checks, cashier's checks, bank drafts, money orders.
b. Working funds - cash funds segregated for current use in the ordinary conduct of business.
✓ petty cash fund
✓ change fund
✓ payroll fund
✓ dividend fund
✓ tax fund
✓ interest fund

2) Cash in bank - includes demand deposits. There are unrestricted funds deposited in a bank that can
be withdrawn upon demand such as amounts in checking and savings account.

NATURE AND COMPOSITION OF CASH EQUIVALENTS

An enterprise may hold short-term commercial papers and money market instruments (e.g., short-term
trust funds held in banks and Philippine treasury bills) that could be converted into cash within a relatively
short period of time. It may also maintain time deposits with banks that earn interest at a rate higher than
the rate on the savings deposit. These highly liquid financial instruments that are so near their maturity
and that there is insignificant risk of change in value due to fluctuation of interest rates are known as cash
equivalents. An enterprise sets its own accounting policy to determine which financial instruments qualify
as cash equivalents. A financial instrument qualifies as cash equivalent if it matures within a short period
of time, normally three months or less, from the date of acquisition.

Regardless of management's policy. the determination of the maturity date starts from the date of the
acquisition of the instrument and not from the date indicated on the face of the instrument. For example,
a company may adopt the policy to treat as cash equivalents debt instruments with maturity of not more
than 90 days from the date of acquisition. For this company, treasury bills purchased on December
15.2020 and maturing on or before March 15, 2021, quality to be reputed as cash equivalents in the
company's December 31, 2020, statement of financial position. On the other hand, treasury bills
purchased on July 15, 2020, and maturing on January 15, 2021, would not qualify as cash equivalents in
the company's December 31, 2020, statement financial station, even if they are maturing in only 15 days
from reporting date, because the instruments have a remaining term 6 months from the date of
acquisition.

Temporary investments in equity shares are generally, not included as part of cash equivalents because
these equity securities do not have maturity dates. They are appropriately classified as either as equity
investments at fair value through profit or loss or equity investments at fair value through other
comprehensive income, subject to the entity's intention for holding the shares and on the guidelines
provided by IFRS 9. However, redeemable preference shares that are to be reacquired by the issuing
corporation at a determined redemption date, are in substance debt instruments, and as such, may qualify
to be reported as cash equivalents if purchased within, say, three months or less before redemption date.

Although cash equivalents are not cash, they are generally presented in the statement of financial position
together with cash using the account title "Cash and Cash Equivalents."

PRESENTATION AND MEASUREMENT OF CASH IN THE STATEMENT OF FINANCIAL POSITION

Cash is generally measured at face value, which is its amortized cost and fair value at the same time. Cash
deposits denominated in foreign currency are measured using the exchange rate in effect at the end of
the reporting period.

Unless the statement of financial position is prepared for a special purpose, it is not necessary to classify
cash to distinguish between currencies on hand, cash in banks, or deposits at various locations. The
details, however, are preferably disclosed in the notes to the financial statements.

The following summarizes several noteworthy considerations in reporting cash balance in the statement
of financial position:

1) Foreign currency Cash in foreign currency and deposits in foreign banks which are subject to
immediate and unrestricted withdrawal, should be translated to Philippine currency using the
exchange rate at the end of the reporting period. Cash in foreign banks that are restricted as to use,
or withdrawal should be reported separately.

2) Cash in closed banks or in banks having financial difficulty or in bankruptcy should be reclassified as
receivable and should be written down to its recoverable amount.
3) Customers’ post-dated checks, NSF checks (no sufficient fund checks) are those that cannot be
covered by funds in the debtor’s bank account, and IOU's ("l owe you” notes) should be reported as
receivables rather than cash. NSF checks in the Philippines, are oftentimes described as DAIF checks
or DAUD checks. DAIF means "drawn against insufficient funds," while DAUD literally means "drawn
against unclear deposits."

4) Postage stamps and expense advances, such as advances for employees' travel, are not cash, but are
reported as prepaid expenses in the current asset section.

5) A bank overdraft that cannot be offset against another account is reported as a liability. A bank
overdraft occurs when a depositor has written checks for a sum greater than the amount in the
depositor's bank account, resulting in a credit balance in that cash account. A bank overdraft may be
offset against a positive balance in another bank account with the same bank if a right of offset exists
between the bank and the depositor. In such a case, the depositor reports the net positive amount as
"Cash'.

For instance, an enterprise maintains an account with Bank A and another account with Bank B. If, at
the end of the reporting period, the account with Bank A has a positive balance and the account with
Bank B is overdrawn (credit balance), the cash balance with Bank A is reported as "cash" while the
credit balance with Bank B is reported as a liability.

On the other hand, assume that an enterprise maintains both a general account and a payroll account
with Bank A. At year-end, the general account has a positive balance while the payroll account is
overdrawn. The overdrawn account can be offset against the cash balance in the general account, as
normally there exists a right of offset within the same bank. If the net amount represents an excess
of cash balance over the credit balance, it is shown as "cash" while if the net amount represents an
excess of overdrawn account over the cash balance, it is shown under liabilities.

6) Undelivered or unreleased checks are the company's checks drawn and recorded as disbursed but are
not actually issued or delivered to the payees as of the reporting date. Technically, checks drawn by
a company should not be deducted from the company's cash balance until they have been mailed or
otherwise delivered. Therefore, these checks should be reverted to the cash balance. As a result,
liabilities that the checks are intended to liquidate still exist and should be reported as current
payables.

7) Company's postdated check, which has been recorded as issued and delivered to payee before or at
the end of the reporting period should be reverted to cash and the corresponding liability shall
continue to be recognized, because there is no actual payment yet, as of that date. Such a check
cannot possibly clear with the bank until the date indicated in the check.

8) Compensating balances are minimum amounts that a company agrees to maintain in a bank checking
account as support or collateral for a loan by the depositor. When the compensating balance is not
legally restricted as to withdrawal by the depositor and the loan for which it is used as a collateral is
a short-term loan, the amount is reported as part of Cash. The nature of the arrangement is disclosed
in the notes to financial statements.
 A compensating balance that is legally restricted should be classified separately either as current asset
or non-current asset depending on the nature of the loan for which the compensating balance is set
up.

9) Cash set aside for long-term specific purpose or for acquisition of a non-current asset, such as bond
sinking fund and plant expansion fund, is reported as non-current financial asset.

CASH MANAGEMENT

An enterprise is expected to maintain sufficient amount of cash for current operations and for paying
obligations as they come due. On the other hand, excessive amount of cash balance also indicates that
the resources of the enterprise are not efficiently managed because excessive cash balance represents
unproductive assets. This must be converted into productive resources to generate more inflow of
resources, and eventually cash, back to the enterprise

Because of its liquidity, cash is so attractive, that it is most susceptible to theft and misappropriation.
Effective cash management requires controls to protect cash from loss through theft or fraud.

The following are some characteristics of a system of cash control:

1) Segregation of duties for handling cash and recording cash transactions. No one person should be in
complete control of a transaction. The employee handling cash receipts should not have access to
the accounting records for cash. This prevents simultaneous misappropriation and manipulation of
accounting records to cover up stolen cash.
2) Imprest system, which is characterized by daily deposit or All cash receipts intact to the bank and
making disbursements through issuance of checks. This system prevents the presence of significant
amount of cash balance within the business vicinity. Expenditures involving small amounts, on the
other hand, are made from petty cash fund.
3) Voucher system, which is a system to control cash disbursements. Under the voucher system, all
disbursements must be supported by properly approved vouchers, which must be recorded in the
voucher register. Actual payments are recorded in the check register. The use of the voucher system
provides for review and authorization of disbursements.
4) Internal audits at irregular intervals. Cash counts conducted by the internal control department are
made without advance notice to the cash custodian, such that the cash custodian is always conscious
of his accountability, keeping the cash on hand intact. A cash count involves test checking of
transactions and record keeping, which prevents connivance among employees and manipulation of
cash records. Surprise internal audits likewise ensure that internal controls over an entity's assets are
properly implemented.
5) Periodic reconciliation of bank statement balance and cash balance in the company's accounting
records. Regular reconciliation of bank balance and book balance for cash uncovers immediately any
error or irregularities in recording cash transactions. Any error or irregularity is, therefore,
immediately rectified.

These measures may not totally eliminate the possibilities of misappropriation or errors but can
significantly reduce the chances of theft, loss, or inadvertent errors in the management of cash.

Petty Cash Fund

Under the imprest system of cash control described in the preceding page, all cash receipts are deposited
intact, and all cash payments should be made by means of checks. However, an enterprise considers it
inconvenient and impractical to write checks for small items such as taxi fares, newspaper delivery
charges, postage, express charges, and minor supplies. A company usually pays for these kinds of
expenditures from a petty cash fund. The amount established as petty cash fund may vary among
companies depending on their specific needs. The amount should not be too small that may require
frequent replenishment of the fund, nor should it be too large that the person in charge of the fund may
be tempted to use the funds for other purposes. An imprest petty cash fund provides simple but effective
control over small amounts of expenditures.

The petty cash fund works as follows:

1) A responsible employee is designated as petty cash custodian. A check drawn payable to petty
cash is encashed, and the petty cash custodian places the money in the petty cash fund (which is
often kept in a locked box or petty cash drawer). The check, which establishes the fund, is usually
for an amount that the company estimates will last from two to four weeks. The journal entry for
the establishment of the petty cash fund is as follows:

Petty Cash Fund xx

Cash in Bank xx

2) As time passes, the petty cash custodian disburses money from the fund, but only upon
authorization of a responsible officer designated to authorize payment from the fund. To request
payment from the petty cash fund, a petty cash voucher must be prepared by the petty cash
custodian. The petty cash vouchers are sequentially numbered, so that they could be easily
accounted for. The voucher must be signed by the approving officer and must be returned to the
petty cash custodian for payment. Upon payment, the payee signs the voucher and returns it to
the petty cash custodian. Any receipt or invoice supporting the payment must be attached to the
signed voucher. Ideally at any time, the remaining bills and coins and the total amount of the paid
petty cash vouchers must equal the amount at which the petty cash fund was established.

The company does not make journal entries at the time petty cash is disbursed, as the petty cash
vouchers are still with the petty cash custodian.

3) When the amount of cash in the fund is low, the petty cash custodian submits the signed petty
cash vouchers and accompanying receipts and invoices to the general cashier to request for
reimbursement. Reimbursement is made equal in amount to the sum of the petty cash vouchers
submitted. The reimbursement, therefore, is for an amount that will increase the amount of bills
and coins remaining in the fund to its original amount. The replenishment of the fund is recorded
as:

Expenses (various)* xx
Cash in Bank xx
* or any other appropriate account title/s.

4) At year-end, prior to the preparation of financial statements, an adjusting entry is made to

recognize the payments from the fund that are not replenished. This adjustment likewise updates
and brings the petty cash fund general ledger account to an amount equal to actual cash balance
in the petty cash fund as of the end of the reporting period. This would avoid understatement of
expenses and overstatement of cash. This adjustment is usually reversed at the beginning of the
ensuing period. The year-end adjustment is recorded as follows:
 Expenses (various)* xx
Petty Cash Fund xx
*or any other appropriate account title/s.

5) In instances that the amount in the petty cash fund may be deemed inadequate to satisfy the
company's needs, the fund balance is increased, and the following journal entry is made:
Petty Cash Fund xx
Cash in Bank xx

Cash Short and Over

Cash short and over is a nominal account that is debited for shortages and credited for overages in the
petty cash fund. Such shortages and overages usually result from errors in making change or failure to
obtain receipts for very small amounts. In addition, receipts may have been written for an incorrect
amount, or money from the fund may have been lost or stolen.

A debit balance in Cash Short and Over account at the end of the period should be reported as a
miscellaneous expense, while a credit balance is reported as a miscellaneous revenue. However, a
material cash shortage resulting from a non-negligible cause, such as theft or misappropriation should be
charged to a receivable account if it is probable that the shortage is to be recovered. For internal control
purposes, a significant amount of cash shortage in the petty cash fund should be properly documented.

A petty cash voucher should be prepared covering the shortage, for transmittal to the general cashier,
together with the other paid petty cash vouchers, for reimbursement. On the other hand, cash items
representing cash overage, should be taken out of the petty cash fund and should be deposited to the
general cash account of the company. This is to maintain the petty cash fund account at its imprest
balance. The deposit of the cash overage is recorded by a debit to "Cash in Bank and a credit to
Miscellaneous Income. To document the existence of material cash overage, an official receipt may be
prepared by the company.

To illustrate, assume that the petty cash fund was originally established at P10,000 on December 1, 2020.
To record this transaction, the entry is

Petty Cash Fund 10,000

Cash in Bank 10,000

From December 1 through December 20, payments were made from petty cash fund for the following
items:

Transportation P 2,300
Representation expenses P 3,400
Office supplies P 4,200

No entry is taken up to record the above payments.

On December 21, petty cash vouchers were submitted to request reimbursement for the above
expenditures. A check for P9,900 was issued to replenish the petty cash fund. The entry for the
replenishment is
 Transportation Expense 2,300
Representation Expense 3,400
Office Supplies Expense 4,200
Cash in Bank 9,900

On December 31, no replenishment of the petty cash fund is made. A count and review of the fund
revealed the following composition:

Bills and coins 2,200

Petty cash vouchers for
Transportation 1,500
Office supplies 2,500
An employee advance 3,000
Representation 720

The total of bills and coins counted and paid vouchers above. which is P9,920, is less than the amount of
imprest petty cash balance of P10,000. Thus, the difference of P80 is missing cash, which is reported as
cash shortage. The adjusting entry on December 31 to remove the non-cash items from the petty cash
fund and to show the correct amount of petty cash fund on the statement of financial position is
Transportation Expense 1,500
Office Supplies Expense 2,500
Advances to Employees 3,000
Representation Expense 720
Cash Short or Over 80
Petty Cash Fund 7,800
After the above adjusting entry, the petty cash fund is brought to its correct balance of P2,200,
representing the actual amount of cash in the petty cash fund at the reporting date.

Assume, instead, that the following was the composition of the fund on December 31.

Bills and coins P 2,400

Petty cash vouchers for
Transportation 1,500
Office Supplies 2,500
An employee advance 3,000
Representation 720

The total of the bills and coins counted and paid petty cash vouchers of P10,120 exceeds the amount of
the imprest petty cash balance of P10,000. This excess of the items counted over the petty cash fund
balance is to be recorded as cash overage or miscellaneous income. The adjusting entry on December 31
is

Transportation Expense 1,500

Office Supplies Expense 2,500
Advances to Employees 3,000
Representation Expense 720
Petty Cash Fund 7,720
Proper internal control suggests that the amount of cash representing the overage of P120 be taken out
of the fund, for deposit to the general cash account of the company. This will bring the remaining balance
of bills and coins equal to P2,280 (P2,400 minus P120 cash overage). The entry for the deposit of the cash
overage is

Cash in Bank 120

Miscellaneous 120
(or Cash Overage)

After the deposit of the cash overage, the total composition of the fund would be P10,000 (P2,280 bills
and coins and paid petty cash vouchers of P7,720), which is the amount at which the petty cash fund is
originally established.

A business keeps most of its cash in one or more checking accounts. The checking account gives the
depositor company double record of its cash transactions, i.e., the accounting records maintained by the
depositor and the records provided by the bank.
A bank statement is a monthly report provided by the bank to the depositor which shows the following
information:

a. beginning-of-month cash balance,

b. total deposits made by the depositor and other bank credits during the month,
c. total checks paid by the bank and other bank charges during the month,
d. and end-of-month cash balance.

The depositor records the transactions affecting the checking account using the account Cash in Bank,
while the bank maintains a record for the depositor's account. The bank treats the depositor's account as
a liability. Thus, the Cash in Bank account maintained by the depositor as an asset and the depositor's
account maintained by the bank as a liability are reciprocal accounts.

Ideally, any debit balance in the Cash in Bank account maintained by the depositor should equal the credit
balance of the depositor's account maintained by the bank. However, because of timelapse differences
and possible errors existing in the records of either the bank or the depositor, these reciprocal accounts
may not be in agreement at month-end. A bank reconciliation is, therefore, prepared to explain any
differences between a company's book balance of cash and the bank statement balance for the depositor
company. Items that may cause the difference are any or combination of the following:

Deposit in transit or undeposited collection. This is a cash receipt that has been added to the company's
cash balance but has not been added to the balance reported on the bank statement, either because it is
not yet received by the bank as of cut-off time (deposit in transit) or it has not yet been deposited as of
the end of the month (undeposited collection).
The amount of the deposit in transit or undeposited collection can be determined by comparing the
receipts as reflected in the company's accounting records with the deposits as reflected in the bank
statement. The amounts reflected in the accounting records but not in the bank statement are totaled as
cither deposits in transit or undeposited collections. These are usually the receipts towards the end of the
month. Deposits in transit or undeposited collections understate the bank balance.

In order to correct this understatement, the collections awaiting deposit or are in transit should be added
to the bank balance in arriving at the correct cash balance.

Outstanding checks. These are checks that were written by the company, issued to the payees, and
deducted from the company’s cash balance but they have not yet been reflected in the bank statement
since they have not been presented yet to the bank for payment. The amount of the outstanding checks
is determined by comparing the checks written during the month as reflected in the company's check
register or cash disbursements journal with the cancelled checks included in the bank statement. The
amounts of the checks issued (as reflected in the check register or cash disbursements journal) but have
not been presented for payment (as reported in the bank statement) are then totaled and referred to as
outstanding checks. Outstanding checks at month-end result in an overstatement of the bank balance.

In order to correct the overstatement, the amount of the outstanding checks should be deducted from
the bank balance.

Debit memos. Debit memos are changes to the depositor's account made directly by the bank. Typical
examples of debit memos are: No sufficient fund (NSF) checks (otherwise known as DAIF or DAUD) that
were previously credited by the bank as deposits, technically defective checks (e.g. checks that lack
authorized signatures, checks with alterations), bank service charge, charge for the cost of check booklets
and payment of bank loans.

NSF, DAIF and DAUD are terms used for a customer's check that has been deposited in a company's bank
account but has not been paid by the customer's bank because there is insufficient fund in the customer's
bank account. Ideally, the bank should immediately inform the company of each NSF check to enable the
latter to update its accounting records. In such a situation, the balances per books and per bank statement
are in agreement, thereby requiring no adjustment. However, there may be some NSF checks included in
the bank statement that have not been recorded by the company. Thus, the balance per books is
apparently overstated.

Charges made by the bank for service fees, bank loans or check booklets are recorded also by the bank as
direct deductions from the depositor's account balance. Such charges are documented by bank debit
memos. If these deductions have not yet been recorded by the depositor at month-end, the balance per
books is overstated.
Debit memos charged directly by the bank should be deducted from the balance per books in determining
the correct cash balance.

Credit memos. These are deposits made directly by the bank to the company's account. Typical examples
of credit memos are: notes or drafts collected by bank in favor of the depositor, proceeds of bank loan
credited directly to the account of the depositor, and interest earned on the company's checking account.

A bank often acts us a collecting agent for its depositors on items such as notes receivable. When a note
in collected, the bank records the principal and interest as an increase in the depositor's bank account.
Generally, the bank immediately informs the company of the deposit to enable the depositor to update
its records. Otherwise, the cash balance per books does not reflect this collection of notes receivable.

Many checking accounts nowadays earn interest. The company, however, does not typically know the
amount of interest earned by them, until it receives the bank statement. The interest on this checking
account is directly credited by the bank to the depositor’s account.
These credits made by the bank increased the bank statement balance and, therefore, should be added
to the cash balance per books in order to obtain the correct cash balance.

Errors. Despite the internal control procedures established by the bank and the company, errors may still
arise in either the bank’s records or the company’s records. These errors may not be detected until the
bank reconciliation is prepared.

For example, the bank may include in the bank statement a charge for a check written by another
company (say, the company’s name is ABC Corporation, but a check written by ABC Trading was
erroneously charged to ABC Corporation’s account). Since the bank erroneously deducted the amount of
ABC Trading’s check from the account of ABC Corporation, in the bank reconciliation for ABC Corporation,
this ABC Trading’s check should be credited or added back to the bank statement balance in order to
obtain the correct cash balance.

In another situation, the company may have recorded a customer's check for P24,500 whereas the correct
amount is P25,400. A customer's check represents a collection; therefore, the error resulted in an
understatement of cash balance per books for the difference of P900. In order to arrive at the correct cash
balance, the amount of P900 is added to the cash balance per books.

The amount of the error, or the discrepancy caused by the error is, therefore, either added to or deducted
from the balance of the party that committed the error (either bank or books), depending on whether
said balance is overstated or understated as a result of the error.

Deposits in Transit and Outstanding Checks

The determination of deposits in transit and outstanding checks were described earlier and this is done in
an actual scenario by comparing the company's accounting records with the data provided the bank
statement. If there were no errors existing in the records of both the depositor and the bank, the
computations for deposits in transit and outstanding checks, respectively, may be summarized as follows:
Types of Bank Reconciliation Statement
Bank reconciliation may be prepared in either of these types:

1. Reconciliation of ending balances, where the balance per bank and the balance per company's
records are reconciled as of the end of a period. This is otherwise known as single-date bank
reconciliation.
2. Reconciliation of beginning cash balances, receipts and disbursements during the period, and
ending cash balances. This is more popularly known as proof of cash, or four-column
reconciliation, or reconciliation of receipts, disbursements and bank balances

Forms of Bank Reconciliation Statement

A bank reconciliation statement may be prepared using any of the following forms:

1. Both bank and book balances are reconciled to a correct balance. This form is prepared in two
sections: the bank statement balance being adjusted to the correct cash balance in the first
section, and the book balance being adjusted to the same corrected cash balance in the second
section. The first section (bank section) reflects items not yet recognized by the bank (e.g.,
deposits in transit or outstanding checks) as well as corrections for any errors made by the bank.

The second section (book section contains items that the depositor has not yet recognized (e.g.,
debit and credit memos by bank for direct deposits, NSF, bank service charges, notes and crafts
 collected by bank in behalf of the depositor and repayment of loans) and any corrections for errors
made on the depositor's books.

This form has the advantage of clearly identifying items requiring adjustments in the depositor’s
accounting records. In addition, it develops a corrected cash balance that is reported in the
statement of financial position.

2. Bank balance reconciled with book balance. This form reconciled the bank balance to the
unadjusted balance of the depositor’s cash account in the general ledger. This is the form
frequently used by many auditors to trace the accounting entries taken up by the company’s
bookkeeper.

3. Book balance reconciled with bank balance. This form starts with the cash balance per ledger and
reconciled to the balance per bank statement.

ILLUSTRATIVE PROBLEM
The following unadjusted cash balance are available for Pilar Company for the month ended September
30, 2020.

Cash balance pe bank statement, September 30, 2020 P124,611.50

Cash balance per company records, September 30, 2020 P124,379.40

The bank statement disclosed the following information:

1. Charges by bank included a returned customer's check for P1,381.40 because of insufficient funds
(NSF) and service charge for September of P150.
2. Credits by the bank included a customer's note for P12,000 plus interest of P120 that was collected
on September 29, 2020.

A review of the company records disclosed the following information:

1. A deposit for P11,428.70 made on September 29, 2020 did not appear on the bank statement.
2. Customers checks totaling P3,274.00 were still on hand at September 30, 2020 awaiting deposit.
3. The following company checks were still outstanding as of September 30, 2020:
Check #0157823 P 961.90
Check #0157827 P1,471.80
Check #0157830 P2,632.50
4. Check #0157805 for P912.00 in payment of a creditor account and included with the canceled
checks in the bank statement has been erroneously recorded in the company records as P192.00

REQUIRED:
Prepare a bank reconciliation statement for Pilar Company as of September 30, 2020. Use the three forms
of bank reconciliation.

Proof of Cash
When the person preparing the bank reconciliation requires details for the disposition of the reconciling
items and when there are reasons to believe that fraud exist in handling cash balances, a more detailed
reconciliation may be prepared in the form of a proof of cash. A proof of cash reconciles beginning and
ending balances of cash for the month, as well as the recorded receipts and disbursements made by the
bank and by the depositor company.
To illustrate the preparation of a proof of cash, assume the following information for Jose Corporation for
the months of November and December 2020:

Balances per company’s ledger

November 30 P 520,000
December 31 P 700,000

Total debits to cash per company's books

(recorded receipts) during December 2,500,000
Total credits to cash per company's books
(recorded disbursements during December 2,320,000
Balances per bank statement
November 30 537,400
December 31 678,200
December receipts recorded by bank
during December 2,474,400
December disbursement recorded by bank
during December 2,333,600

Deposits in transit
November 30 160,000
December 31 225,000
Outstanding checks
November 30 143,000
December 31 118,000
Bank service charges (recorded by the
depositor in the month following the
month of charge)
November 1,200
December 800

Bank credit memo for customer's note

collected by bank in November (face value
P60,000 plus interest of P600), recorded
by the company only in December 60,600
Bank credit memo for proceeds of bank loan
granted by the bank on December 31 100,000
Customer's DAF check returned by the bank
(recorded by the company in the following month)
November 25,000
December 14,000
DISCLOSURE RELATING TO CASH AND CASH EQUIVALENTS

IAS 1 Presentation of Financial Statements requires "Cash and Cash Equivalents (either combined or
separate account titles) as a separate line presentation on the face of the statement of financial position.
Furthermore, the entity shall disclose its policy in determining which financial instruments shall qualify to
be reported as cash equivalents.

An example of such disclosure is as follows:

On the face of the statement of financial position of a bank:

2020 2019
Current Assets:
Cash and Cash Equivalents P xxx P xxx

In the notes to the financial statements:

Note 5: Cash and Cash Equivalents consist of the following:
2020 2019
Cash and other cash items P xxx P xxx
Cash equivalents:
Due from Bangko Sentral ng Pilipinas xxx xxx
Due from other banks xxx xxx
Securities purchased under resale agreements xxx xxx
Total cash and cash equivalents P xxx P xxx

As part of Note 12 (Summary of Significant Accounting Policies, example only.)

Cash and Cash Equivalents:

For purposes of reporting cash flows, cash and cash equivalents include cash and other cash items, due
from BSP and other banks, and securities purchased under resale agreement (SPURA) that are convertible
to known amounts of cash which have original maturities of three months or less from dates of
placements and that are subject to an insignificant risk of changes in value. Due from BSP includes the
statutory reserves required by the BSP which the entity considers as cash equivalents wherein
withdrawals can be made to meet the entity's cash requirements as allowed by the BSP.