CASH AND CASH Equivalents intermediate Accounting 1 PDF

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CASH AND CASH EQUIVALENTSCash = from the point of view of a layman, it simply means money. = as contemplated in accounting, it includes “money and any other negotiable instrument that is payable in money and acceptable by the bank for deposit and immediate credit”. = includes checks, bank drafts, an...

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CASH AND CASH EQUIVALENTS

Cash = from the point of view of a layman, it simply means money. = as contemplated in accounting, it includes “money and any other negotiable instrument that is payable in money and acceptable by the bank for deposit and immediate credit”. = includes checks, bank drafts, and money orders because they are acceptable by the bank for deposit or immediate encashment. = if checks received are postdated, they cannot be considered as cash yet because these checks are unacceptable by the bank for deposit and immediate credit or outright encashment. Money = is the standard medium of exchange in business transactions. = it refers to the currency and coins which are in circulation and legal tender.

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 from being exchanged or used to settle a liability for at least twelve months after the end of the reporting period”. 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 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, 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 Equivalent = PAS 7, 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 of changes in interest rates”. = standard further states that “only highly liquid investments that are acquired three months before maturity can qualify as cash equivalents”. Examples of cash equivalents 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 services cannot qualify as cash equivalents because shares do not have a maturity date. However, preferences 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 equivalent 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 institutions holding the funds of an entity is is 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 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. Investments in time deposits, 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. 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 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 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 non-current purpose or payment of noncurrent obligation, it is shown as long-term investment. Examples of this fund are sinking fund, preference share redemption fund, insurance fund and fund for acquisition or construction of property, plant and equipment. Classification of a cash fund as current or noncurrent should parallel the classification applied to the related liability.

Bank overdraft = it happens when the cash in bank account has a credit balance. = is classified as a current liability and should not be offset against other bank accounts with debit balances. The credit balance in the cash in bank account results from the issuance of checks in excess of the deposits. 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. 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 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”. Moreover, an overdraft can also be offset against the other bank account if the amount is not material.

Compensating balance = it 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 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 checks = 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: Dr. Cash xxx Cr. 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 = 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: Dr. Cash xxx Cr. Accounts payable or appropriate amount 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 = 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 determining what is a “reasonable time”, consideration should be made regarding the nature of the instrument, the usage of trade of 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 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 “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. The accounting entry is as follows: Dr. Cash xxx Cr. Miscellaneous income xxx However, if the entity is material and liability is expected to continue, the cash is restored and the liability is again set up. The accounting entry is as follows: Dr. Cash xxx Cr. Accounts payable or appropriate account xx

Windows 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. When the statements contain any untruth or falsity, the statements are said to be window dressed.

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. = 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.

Kitting = is another device used to conceal a cash shortage = is possible when an entity maintains current accounts in different banks. = is usually employed at the end of the month. = 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 said bank and converting 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. The entry to record the cash shortage is: Dr. Cash short or over xxx Cr. Cash

xxx

The cash short or over is only a temporary account 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: Dr. Due from cashier xxx Cr. Cash short or over

xxx

However, if reasonable efforts fail to disclose the cause of the shortage, the adjustment is Dr. Loss from cash shortage xxx Cr. 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 a cash overage. The entry to record the same is: Dr. Cash xxx Cr. 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 statements are made. The cash overage is treated as miscellaneous income if there is no claim on the same. The entry is: Dr. Cash short or over xxx Cr. Miscellaneous income xxx But where the cash overage is properly found to be the money of the cashier, the entry is: Dr. Cash short or over xxx Cr. Payable to cashier

xxx

Imprest System = is a system of control 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 in cash rather than issue checks. Therefore, it becomes necessary to establish a petty cash fund.

Petty cash fund = is a money set aside to pay small expenses which cannot be paid conveniently by means of check. Two methods of handling petty cash fund: a) Imprest fund system b) Fluctuating fund system

Imprest fund system = is one usually followed in handling petty cash transactions. The pertinent accounting procedures are:

a) A check is drawn to establish the fund. Dr. Petty cash fund xxx Cr. 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 payments and simply prepares a 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: Dr. Expenses xxx Cr. Cash in bank xxx It is to be pointed out that the petty cash disbursements should be replenished only by means of checks 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: Dr. Expenses xxx Cr. 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: Dr. Petty cash fund xxx Cr. Cash in bank

xxx

f) A decrease in the fund is recorded as follows: Dr. Cash in bank xxx Cr. Petty cash fund xxx

Illustration 2012 Nov. 10 The entity established an imprest fund of P10,000 Dr. Petty cash fund 10,000 Cr. 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 entry to record the replenishment is: Dr. Supplies

5,000

Telephone 1,800 Postage

1,200

Cr. 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. Dr. Supplies

1,500

Postage

500

Miscellaneous expense 1,000 Cr. Petty cash fund

3,000

2013 Jan. 1 The adjustment made on December 31, 2012 is reversed. Dr. petty cash fund 3,000 Cr. Supplies

1,500

Postage

500

Miscellaneous expense 1,000

Feb. 22 The fund is replenished and increased to P15,000. The composition of the fund is as follows: currency and coin, P1,000; supplies, P4,500; postage, P3,000, miscellaneous, P1,500. Dr. Petty cash fund

5,000

Supplies

4,500

Postage

3,000

Miscellaneous expense 1,500 Cr. 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 This 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 this resulting in a fluctuating petty cash balance per book from time to time.

a) Establishment of the fund: Dr. Petty cash fund xxx Cr. Cash in bank

xxx

b) Pa...