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Cash & Equivalents

Overview

You may have heard the phrase “cash is king.”  Well, in many ways cash IS KING – if you have any doubts just think about key cash is to your student survival each day – food at the union, money for dates with ripped beans, an much more.  Cash is the most liquid form of asset that can be exchanged for goods or services, or be used to satisfy obligations.  It serves as the basis of most commercial transactions.  In general, the accounting for cash is relatively straightforward with certain issues giving rise to special accounting and disclosure considerations, which are discussed below. Cash is normally shown as a debit balance – negative cash is not a good sign and is many times reclassified as a liability.

What is Cash?

So what is cash?  Cash consists of coin and currency, as well as funds on deposit with financial institutionsthat are readily available for withdraw or other use (demand deposits and all charges and credits to these accounts are included in cash). Cash includes U.S. Treasury Bills, savings and checking accounts, money market accounts, money orders, petty cash (small amounts on hand) and certified checks. The definition looks to the common usage. Remember, certan special restrictions may cause otherwise cash to be classified as something else in the financial statements due to those restrictions – see the few bars we hum on this below!  [look to FASB Codification Topic 305…hint section 20 has a glossary].   

Cash Receipts

Cash receipts represent cash received and may come from customers, supplier or other parties.  In general, cash receipts are recorded as an increase to cash by way of a debit to the respective cash account, with an offsetting credit to an applicable account.  For example, a cash receipt from a customer on account would be recorded as a: (1) debit to Cash and (2) credit to Accounts Receivable. Cash receipts for items other than accounts receivable would be recorded by a credit to another account – including Accounts Payable for a refund from a supplier, Miscellaneous Income for the sale of an asset and Sales for a cash sales (not on account).  

Cash Payments

Cash payments reflect amounts paid to parties for goods, services, obligations and other items.  In general, cash payments are recorded as a decrease to cash by way of a credit to the respective cash account, with an offsetting debit to an applicable account.  For example, a cash payment on account to a supplier would be recorded as a: (1) debit to Accounts Payable and (2) credit to cash. 

When approaching test or homework problems, you may be asked to calculate or identify total cash receipts or payments, or ending cash balance given a number of transactions.  Remember to think in terms of “what cash actually came in or went out the door.” In many cases, the problem may refer to transactions made on account or “accrual” type expenses that impact the income statement and balance sheet, but do not have an impact on cash in the current period.

Special Accounting and Disclosure Issues

Compensating Balances

A compensating balance is a minimum amount that must be on deposit per a loan or other borrowing arrangement.  For example, Panda Inc. signs an agreement with Naperville Trust Bank for $250 million.  The agreement requires Panda to maintain a minimum balance of $500,000 on hand at all times or be in default of the loan agreement. 

A compensating balance is cash since it is funds on deposit at a financial institution.  However, since the amounts is not available for immediate withdraw or use, it must be segregated and reported separately from other cash and cash equivalents on Panda’s balance sheet.  Depending on the length of the borrowing agreement, the compensating balance may be show as either short-term (less than 12 months) or long-term (more than 12 months).  Discussion of the loan agreement in the footnotes should discuss the significant terms, including the $500,000 compensating balance.

Restricted Cash

Restricted cash is cash set aside for a particular use or event.  The restriction can be by either legal means or otherwise.  Whether or not cash is legally restricted is importance for purposes of accounting for it. 

Legally restricted cash is restricted by law, for instance by statute or court order, or per the provisions of a contract.  Legally restricted cash must be segregated and reported separately from other cash and cash equivalents on the balance sheet.  Depending on the length of the restriction, the restricted cash may be show as either short-term (less than 12 months) or long-term (more than 12 months).    

Cash restricted for some other purpose than a legal one, is combined with all other cash and cash equivalents.  Footnote disclosure of the nature and amount of the restriction should be provided. An example of this type of non-legal restriction on cash is an internal plan by management to set aside 2% of all accounts receivable collected for a particular purpose.

Internal Controls over Cash

As we indicated, “Cash is King!” Unfortunately, such notoriety attracts a significant amount of fraud or bad behavior.  Since cash is so liquid, individuals are tempted to divert cash for their own purposes.  As a result, certain internal controls should be implemented to safeguard cash as much as possible.  Such safeguards may include:

  • Bank reconciliation – reconciles the cash per the accounting records to those of the bank. Bank reconciliations should be done and reviewed by someone independent of the daily cash activity;
  • Written policies – a company should have written policies establishing authorized uses of cash, such as procedures over petty cash, manual or other check requests, signature plates and bank reconciliation expectations;
  • Physical controls – a company may keep certain cash on hand to pay bills or other miscellaneous expenditures. Such funds should be protected in a secure location with only authorized individuals able to access the funds. In addition, independent physical inspection of the funds periodically should be done to ensure adequate security and verify funds existence. In addition, any signature plates or access to bank personnel, records or forms must be physically protected; and
  • Other related procedures – as with much of accounting, cash is not accounted for in a vacuum, but part of a companies overall accounting system. Other controls in related areas may have a significant impact on the safeguard of cash. For instances, adequate procedures over accounts payable suppliers, will help ensure an individual does not set up a dummy supplier and pay themselves.
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3 Responses

  1. Luke says:

    super!

  2. Ross says:

    This is an awesome site. I wish I found something like this a long long time ago.

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