Chapter 1

Cash and Cash Equivalents

 Definition of cash
• Money is the standard medium of exchange in
business transactions. It refers to the currency
and coins which are in circulation and legal
tender.
• Cash connotes more than money.
• It includes “money and any other negotiable
instrument that is payable in money and
acceptable by the bank for deposit and immediate
credit”.
• Cash includes checks, bank drafts and money
orders because these are acceptable by the bank
for deposit or immediate encashment.
 Unrestricted cash
• PAS 1, par. 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 exchange 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.
 Unrestricted cash
• 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, cashier’s or
manager’s checks, traveler’s 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
• PAS 7, par. 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 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”.
 Cash equivalents
• Examples are:
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 a maturity date
Preference shares with specified redemption date
and acquired three months before redemption date
can qualify as cash equivalents
What is important is the date of purchase which
should be three months or less before maturity
 Investment of excess cash
• 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.
• Excess cash may be invested in time deposits,
money market instruments and treasury bills
for the purpose of earning interest income.
 Investment of excess cash
• 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.
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.
 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
• 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, details comprising the “cash and
cash equivalents” should be disclosed in the
notes to financial statements
 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 restriction are
included in “cash”.
• Deposits in foreign bank which are subject to
foreign exchange restriction, if material,
should be classified separately among
noncurrent assets and the restriction clearly
indicated.
 Cash fund for a certain purpose
• If the cash fund set aside for use in current
operations or for the payment of current
obligation, it is a current asset. It is part of cash
and cash equivalents. (e.g. petty cash fund,
payroll fund, travel fund, interest fund, dividend
fund and tax fund)
• If the cash fund is set aside for noncurrent
purpose or payment of noncurrent obligation, it
is shown as long-term investment. (e.g. sinking
fund, preference share redemption fund,
contingent fund, insurance fund, and fund for
acquisition or construction of PPE
 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
reporting period.
 Bank Overdraft
• When a 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 current liability and should
not be offset against other bank accounts with debit
balances.
• Generally overdrafts are not permitted in the Philippines.
Exception to the rule on overdraft
• When an entity maintains 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.
• An overdraft can also be offset against the other bank
account if the amount is not material.
 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 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
• Is one that is merely drawn and recorded but not
given to the payee before 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 xx
Accounts Payable or appropriate account XX
 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
reporting period.
• The original entry recording a delivered
postdated check shall also be reversed and
therefore restored to the cash balance as
follows:
Cash XX
Accounts payable or appropriate account XX
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 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 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.
Stale check or check long outstanding
• If the amount of stale check is immaterial, it is
simply accounted for as miscellaneous income
as follows:
Cash xx
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. The journal entry is
as follows:
Cash xx
Accounts Payable or appropriate account xx
 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.
• Window dressing is any deliberate misstatement of the
assets, liabilities, equity, income and expenses.
 Lapping
• Is a practice used for concealing a cash
shortage.
• 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.
 Kiting
• Device used to conceal a cash shortage. Kiting
is possible when an entity maintains current
accounts in different banks. It is 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 shortage in the latter
bank. No entry is made for both the drawing
and deposit of the check.
 Accounting for cash shortage
• Where the cash count shows cash which is less than the
balance per book, there is cash shortage to be recorded as
follows:
Cash short or over xx
Cash xx
• The cash short or over account is only a temporary or
suspense account.
• If the cashier or cash custodian is held responsible for the
cash shortage, the adjustment should be:
Due from cashier xx
Cash short or over xx
• If reasonable efforts fail to disclose the cause of the
shortage, the adjustment is
Loss from cash shortage xx
Cash short or over xx
 Accounting for cash overage
• Where the cash count shows cash which is more than
the balance per book, there is a cash overage to be
recognized as follows:
Cash xx
Cash short or over xx
• The cash overage is treated as miscellaneous income if
there is no claim on the same. The journal entry is:
Cash short or over xx
Miscellaneous income xx
• But where the cash overage is properly found to be
the money of the cashier, the journal entry is:
Cash short or over xx
Payable to cashier xx
 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.
• 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.
 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
• 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 the fund.
no entry required
c. Replenishment of petty cash payments.
Whenever the petty cash fund runs low, a check is
drawn to replenish the fund.
Expenses xx
Cash in bank xx
 Imprest fund system
• Accounting procedures
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:
Expenses xx
Petty cash fund xx
The adjustment is to be reversed at the beginning of the next
accounting period.
e. An increase in the fund is recorded as follows:
Petty cash fund xx
Cash in bank xx
f. A decrease in the fund is recorded as follows:
Cash in bank xx
Petty cash fund xx
 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.
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
imprest fund system where the disbursements are
recorded upon the replenishment of the fund.
 Fluctuating fund system
c. Replenishment or increase of the fund
Petty cash fund xx
Cash in bank xx
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 xx
Petty cash fund xx