Reviewer 1-Int Acct - Intermediate Accounting PDF

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Nature of Financial Assets Recognition of Financial Assets Cash as Financial Asset Nature and Composition of Cash Equivalents Presentation and Measurement of Cash in the Statement of Financial Position Cash Management At the end of the discussion, the students are expected to: Describe and understan...

Description

1.

Nature of Financial Assets

2.

Recognition of Financial Assets

3.

Cash as Financial Asset

4.

Nature and Composition of Cash Equivalents

5.

Presentation and Measurement of Cash in the Statement of Financial Position

6.

Cash Management

At the end of the discussion, the students are expected to: 1. Describe and understand the nature of cash and identify the items to be included in the account title “Cash” and “Cash Equivalent”. 2. Determine how and at what amount of cash is presented on the statement of financial position and identify some basic features of internal control to safeguard cash. 3. Prepare the bank reconciliation, proof of cash and formulate journal entries and adjusting entries to bring cash account to its correct balance.

As indicated in the Conceptual Framework for Financial Reporting, assets are economic resources controlled by the entity as a result of past events. Such 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.

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 (par. 11, IAS 32). Therefore, from the point of view of the holder, the instrument is a financial asset; while from the point of view of the issuer, the same instrument is a financial liability or a component of shareholders’ equity. A financial asset includes cash and cash equivalents, equity instrument of another entity (investments in equity shares of other entities, contractual right 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 derivative. 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 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 enables holders to acquire entity shares of other entities. Financial assets and financial liabilities are within the scope of IFRS 9 Financial instruments, which takes effect on January 1, 2018. Non-financial assets are discussed in some other specific International Financial Reporting Standards.

RECOGNITION OF FINANCIAL ASSETS Recognition of financial statement elements, according to the new Conceptual Framework, depends on the attributes of Relevance and Faithful Representation. This means that in judging as to whether an economic resource is to be recognized, the likelihood that it

will provide inflow of economic benefits has to be considered. Likewise, the entity must be honest to its users regarding measurement uncertainty which affects presentation and disclosure. In addition to the above consideration, IFRS 9 provides this requirement relating to the initial recognition of financial assets: 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 financial asset Money is the standard medium of exchange in business transactions. It refers to the currency and coins which are in circulation and legal tender. 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. A cash item 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, cash is acceptable by bank or other financial institution for deposit at face value. However, to qualify for reporting as part of the account title “Cash” or “Cash on Hand in Banks” in the statement of financial position, a cash item must be unrestricted and must be immediately available for use in current operations. Cash items are unrestricted if they are on hand, or in the case of deposits with banks, they can be withdrawn immediately. 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. There is no specific standard dealing with cash. 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. Cash funds that are intended for settlement of long-term obligations in the future or for acquisition of non-current assets do not qualify to be reported as part of current assets on the statement of financial position. Cash deposits with banks that have been restricted because of an unforeseen circumstance, are excluded from “Cash”. These deposits must be reclassified as receivable under current assets or non-current assets, depending on the expected timing of settlement. To summarize, “Cash” in the statement of financial position, includes the following: 1. Cash on hand 2. Cash fund / Working funds 3. Cash in bank 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. 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. 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, based on the guidelines provided by IFRS 9.

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.” Examples of cash equivalents: 1.

3-month BSP treasury bill

2.

3-year BSP treasury bill purchased 3 months before date of maturity

3.

3-month time deposit

4.

3-month money market instrument or commercial paper

Presentation and measurement of cash in the statement of financial position On the statement of financial position, Cash is generally measured at face value, which is its fair value. Demand deposits denominated in foreign currency are measured using the spot / current exchange rate in effect at the end of the reporting period. The following summarizes several noteworthy considerations on reposting 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 preferably, as non-current assets. 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 IOUs (“I 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. 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. 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. Therefore, these checks should be reverted to the cash balance. As a result, liabilities that the checks are intended to liquidate still exists and should be reported as current payables. 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

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. 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. 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. If the deposit is legally restricted because of formal compensating balance agreement, the compensating balance is classified separately as “cash held as compensating balance”

under current asset if the related loan is short term. If the related loan is long term, the compensating balance is classified as noncurrent investment. 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. 10. Stale check or check long outstanding is a check not encashed by the payee within a relatively long period of time. In banking practice, a check becomes stale if not encashed within 6 months from the time of issuance. Stale check is immaterial: Cash

XX Miscellaneous Income

XX

Material and liability is expected to continue: Cash

XX Accounts Payable or appropriate account

XX

CLASSIFICATION OF CASH FUND The classification of a cash fund as current or noncurrent should parallel the classification of the related liability.

WINDOW DRESSING It 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. It is accomplished as follows: 1.

By recording as of the last day of the reporting period collections made subsequent to the close of the period.

2.

By recording as of the last day of the reporting period payments of accounts made subsequent to the close of the period.

LAPPING It consists of misappropriating a collection from one customer and concealing this defalcation by applying a subsequent collection made from another customer. It involves postponement of the entries for the collection of receivables.

KITING It is possible when an entity maintains current accounts in different banks. Kiting is usually employed at the end of month. It 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.

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. 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 on complete control of a transaction. Authorization, Record Keeping, and Custody. 2. Imprest system, which is characterized by daily deposit of 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. 4. Internal affairs at irregular intervals. Cash counts conducted by the internal control department are made without advance notice to the cash custodian. A cash count involves test checking of transactions and record-keeping, which prevents connivance among employees and manipulation of cash records. 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 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 Methods of handling petty cash: 1. check.

Imprest fund system-all cash receipts should be deposited intact and all cash disbursements should be made by means of

2.

Fluctuating fund system- checks drawn to replenish the fund do not necessarily equal the petty cash disbursements

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. An imprest petty cash fund provides simple but effective control over small amounts of expenditures.

The petty cash fund works as follows: 1. A reasonable 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. Petty Cash Fund Cash in Bank

xx xx

2. 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. Paying the small amount of expenses: 1. 2.

Petty Cash Custodian disburse money Authorization from officer for payment

To request payment: 1.

Petty cash voucher must be prepared by the petty cash custodian

2. 3.

Voucher must be signed by the approving officer Returned to the petty cash custodian for payment

Upon Payment: 1. 2. 3. 4.

Payee signs the voucher Returns it to the petty cash custodian Receipt or invoice of payment is attached to the signed voucher. 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

3. 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 equal in amount to the sum of the petty cash vouchers submitted. The replenishment of the fund is recorded as: Expenses (various)*

xx

Cash in Bank

xx

4. At year-end, an adjusting entry is made to recognize the payments from the fund that are not replenished. This adjustment updates and 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 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. petty cash fund is inadequate for company’s needs, the fund balance is increased and journal entry is made: Petty Cash Fund

xx

Cash in Bank

xx

CASH SHORT AND OVER Cash short and over is a nominal account. 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 innocent amount, or money from the fund that may have been lost or stolen. A petty cash voucher should be prepared covering the shortage, for transmittal to the general cashier, with 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 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.

ENTRIES FOR CASH SHORTAGE: 1.

Cash count / accounted < balance per book or accountability: Cash short or over

XX

Cash 2.

XX

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

XX

Cash short 3.

XX

If reasonable efforts fail to disclose the cause of shortage: Loss from cash shortage

XX

Cash short

XX

If the amount of cash shortage is immaterial, it can be debited to miscellaneous expense. ENTRIES FOR CASH OVERAGE: 1.

Cash count > balance per book: Cash

XX Cash short or over

2.

XX

Cash overage is treated as miscellaneous income if there is no claim on the same. Cash over