Cash and Cash Equivalents 39 Chapter 2 Cash and Cash Equivalents | Learning Objectives | | 1. Define cash and identify the items that are included in the “Cash and Cash Equivalents” line item. 2. Account for petty cash funds and cash shortages/overages. Definition of cash Cash includes money or its equivalent that is readily available for unrestricted use. Money is the standard medium of exchange and the basis of accounting measurements. Other negotiable instruments that can be used to settle obligations and are readily available for unrestricted use may form part of cash. Cash includes cash on hand and in banks. a. Cash on hand - refers to undeposited collections awaiting deposit and other current funds held as of the reporting date. b. Cash in bank — refers to deposits in banks that are available for immediate withdrawal and unrestricted use. Examples of cash: 1. Coins and currencies 2. Demand deposits (checking or current accounts) and savings accounts 3. Bank drafts - guarantees by bank to advance funds on the demand by the party to whom the draft was directed 4. Money orders — similar to bank drafts but are drawn from post offices or other financial institutions. 5. Checks - such as Cashier’s checks, Personal checks, Manager's checks, Traveller’s checks, and Certified checks received from customers or other external parties. 6. Cash funds set aside for use in current operations, such as: a. Petty cash fund Scanned with CamScanner40 > Examples of items not included as cash: 1 2. 3. Revolving fund Payroll fund Change fund Dividend fund Tax fund Travel fund Interest fund other types of imprest bank accounts used in current operations roeaemeaos Revolving fund is a fund similar to the petty cash fund but is | used for a limited or specific purpose set by management (eg, | revolving funds held by sales representatives and revolving funds held by field engineers in a construction firm). Tax fund is a fund set aside to be used in paying taxes. Postdated checks - checks dated at a future date. 10Us or advances to employees Cash funds not available for use in current operations, such as Sinking fund, Plant expansion fund, Depreciation fund, | Preference share redemption fund, Contingency fund, an Insurance fund. Postage stamps Postdated checks and IOU’s (‘I owe you’) or advances to employer | are treated as receivables. Depreciation fund is a form of asset replacement fund whereif | cash payments to the fund are equal to the periodi¢| depreciation charges on the related asset. When the asset i fully depreciated, the fund can be. used to acquire a| replacement. - Restricted funds that are excluded from cash are common!) 4 presented as part of “other assets.” | Unused postage stamps are treated as prepaid supplies. Scanned with CamScannerCash and Cash Equivalents a postdated checks received postdated checks received by an entity do not qualify as cash because postdated checks are not presently available for immediate use. They will only be available for use at a future date. Entities normally record check collections on account by debiting “Cash” and crediting “Accounts receivable,” regardless of whether the checks received are postdated or not. Thus, at the reporting date, an adjustment is necessary to revert back postdated checks to accounts receivable. Example: You received customers’ checks totaling P100,000. The entry to record the receipt of the checks is as follows: Date | Cash 100,000 Accounts receivable 100,000 At the end of reporting period, you determined that a customer’s check of P20,000, included in the collections, is postdated. The adjusting entry is as follows: Date | Accounts receivable 20,000 Cash 20,000 You will report cash of P80,000 (100,000 less postdated check of 20,000) in your financial statements. You might ask “why would I record the postdated check as collection when it is not yet available for use?” Well, it is for internal control purposes and convenience of recording. If not Tecorded, the check might not be presented on time for encashment on due date. You might even forget about the check, misplace it, or someone might take it, and so on. Furthermore, maintaining separate records for postdated checks may be cumbersome. Scanned with CamScannera2 Chapter 2 In practice, all check collections are recorded as cash receipts and adjustments for postdated checks are made only when financial statements are prepared. No separate accounting jg needed for checks that were initially received as postdated but became due and encashed prior to the preparation of financial statements. Unused credit line Unused credit line is not included as cash but rather disclosed only in the notes. Unused credit line is the difference between the amount of line of credit and the amount that was actually borrowed. For example, you applied for a line of credit of P100M ina bank. During the year, you borrowed P70M. The bank automatically credits your account for the P70M borrowed. This is included in your cash. The unused credit line of P30M (P100M less P70M) is disclosed only in the notes because you have not yet received it in cash. Unreleased checks drawn and Postdated checks drawn Entities normally record checks drawn by debiting “Accounts payable” and crediting “Cash.” However, when the checks drawn are either (a) unreleased or undelivered to the payee or (b) postdated, no payment has actually been made. Therefore, an adjusting entry is needed to revert back the unreleased check or postdated check to cash and accounts payable. Example: You wrote the following checks today. © Check #1 is drawn for P10,000 and dated today but yet ! & delivered to payee Mr. A next year. * Check # 2 is drawn for P15,000 and was delivered to payee Mr B today but the check is dated 100 years from now. The entry for the checks drawn is as follows: Scanned with CamScannerCash and Cash Equivalents 43 Date | Accounts payable -MrA Accounts payable = Mr. B 15,000 If financial statements are prepared today, both the checks drawn should be reverted back to cash and accounts payable because: a) There is no way Mr. A can eneash check #1 because you still hold it. b) Mr. B holds check #2 but he cannot yet encash it until after 100 years (if he’s still alive¥). In both cases, you have reduced the balance of cash but no payments have actually been made. Therefore, the following adjusting entry is necessary: Date | Cash 25,000 Accounts payable — Mr. A 10,000 Accounts payable - Mr, B 15,000 You might ask again “why would I record the unreleased check and postdated check as payments when the, payee cannot yet encash them?” Well, again, it is for internal control purposes. (This will be explained on the discussion of “voucher system.”) Or you might ask “why would I draw a check and not deliver it to the payee? or “why would I draw a postdated check in the first place?” Well, in practice, checks drawn by companies should be signed by at least two authorized signatories. Either one of those signatories might not be around when the checks are needed, so some checks are drawn in advance. Stale checks : When checks delivered to payees are not encashed within a relatively long period of time, normally 6 months or more, the checks are referred to as “stale.” It should be noted though that Scanned with CamScannerthe period of time before checks become company policy. Stale checks are reverted back to cash. ale is a matter of ber the following concepts: ts equivalent that is rea sh includes money or available icted u: for unre > Postdated check received w Exelude from cash, from customer. » Undelivered heck drawn. @ Include in cash. > Postdated check drawn. Include in cash. > Stale checks Include in cash. Cash equivalents Cash equivalents are “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.” (PAS 7.6) Only debt instruments acquired within 3 months or less before their maturity date can qualify as cash equivalents. Examples of cash equivalents: a. Treasury bills, notes, or bonds acquired 3 months before maturity date > Treasury bill is a short-term obligation issued by the government at a discount. Treasury bills normally have a maturity of 90 days to less than a year. > Treasury notes and treasury bonds are long-term obligations issued also by the government. Treasury notes have 4 maturity of 1 year to less than 10 years. Treasury bonds have a maturity of 10 years or more. b. Money market instrument or commercial paper acquired 3 months before maturity date > Money market instruments are investments in portfolios of short-term securities. » Commercial papers consist of short-term, unsecured, notes payable issued in large denominations by large companies with high credit ratings to other companies aM institutional investors. The maturity date of commer¢ Scanned with CamScanner