Acc 205 – Intermediate Accounting 1

Prepared by: Mark Paul I. Ramos, CPA

Chapter 1
CASH and CASH EQUIVALENTS

This module discusses the concept of cash. It will help the users of this module to
also understand the concept of cash equivalents. This will also aid the users to determine
which items shall be considered as cash and/or cash equivalents. An addition to the
identified focus topics, this module will also discuss accounting treatments for petty cash
fund.

INTENDED LEARNING OBJECTIVES

ILO 1 – Identify the applicable accounting standards for the recognition and measurement
of cash and cash equivalents
ILO 2 – Compute for the amount appropriate for the presentation in the financial
statements
ILO 3 – Understand the concept of petty cash fund, its accounting treatments and
presentation in the financial statements

CASH
Definition of cash
From the point of view of a layman, “cash” simply means money.

Money is the standard medium of exchange in business transactions. Money

refers to the currency and coins which are in circulation and legal tender. However, in the
accounting parlance, the term “cash” has a special and broader meaning. It connotes
more than money.

As contemplated in accounting, cash includes money and any other negotiable

instrument that is payable in money and acceptable by the bank for deposit and
immediate credit.

Accordingly, cash includes checks, bank drafts, and money orders because these
are acceptable by the bank for deposit or immediate encashment. For example, when
checks are received in full settlement of an account receivable, cash is immediately
debited. But, postdated checks received cannot be considered as cash yet because
these checks are unacceptable by the bank for deposit and immediate credit or outright
encashment.

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 to settle a liability for more than
twelve months after the end of the reporting period.
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
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.

Cash items included in cash

1. Cash on hand – this includes undeposited cash collections and other cash items
awaiting deposit such as customer’s checks, cashier’s or manager’s checks,
traveler’s checks, bank drafts and money orders.
2. Cash in bank – this includes demand deposit or checking account and saving
deposit which are unrestricted as to withdrawal
3. Cash fund set aside for current purposes such as petty cash fund, payroll fund,
and dividend fund.

Cash equivalents
PAS 7, paragraph 6, defines cash and 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.
Examples of cash equivalents are:
a. Three-month BSP treasury bills
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. However, preference 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.

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.
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

Classification of investment of excess cash

Investment 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 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.

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

The caption cash and cash equivalents should be shown as the first line item
under 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.

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 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. The cash fund is included as part of cash and cash
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
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 noncurrent purpose or payment
of noncurrent obligation, it is shown as long-term investment. Examples of this fund are
sinking fund, preference share redemption fund, contingent fund, insurance fund, and fund
for acquisition or construction of property, plant and equipment.
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 the reporting period.

However, a cash fund set aside for the acquisition of a noncurrent asset should be
classified as noncurrent regardless of the year of disbursement.

Bank overdraft
When the 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 a current liability and should not
be offset against other bank accounts with debit balances. 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, 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

 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
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.

Under IFRS, bank overdraft can be offset against other bank account when
payable on demand and often fluctuates from positive and negative as an integral part of
cash management.

Compensating balance
A 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 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 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

An undelivered or unreleased check is one that is merely drawn and recorded but
not given to the payee before the end of the reporting period. There is no payment when
the check is pending delivery to the payee at the end of the 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.
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

Journa Cash xx
l Entry: Accounts payable or appropriate account xx

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

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 the reporting period. The original entry
recording a delivered postdated check shall also be reversed and therefore restored to
the cash balance.
Journal Cash xx
Entry: Accounts payable or appropriate account xx

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

A stale check is a check not encashed by the payee within a relatively long period
of time. The question is how long a time must the check remain outstanding?

The Negotiable Instruments Law provides that where the instrument is payable on
demand, presentment must be made within a reasonable time after issue. In determining
reasonable time, consideration should be made regarding the nature of the instrument,
the usage of trade or 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 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 a stop payment order to
the bank for the cancelation of a previously issued check.

If the amount of stale check is immaterial, it is simply accounted for as

miscellaneous income.
Journal Cash xx
Entry: Miscellaneous Income xx
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
However, if the amount is material and liability is expected to continue, the cash is
restored and the liability is again set up.
Journal Cash Xx
Entry: Accounts payable or appropriate account xx

Accounting for cash shortage

Where the cash count shows cash, which is less than the balance per book, a
cash shortage is to be recorded.
Journal Cash short or over xx
Entry: Cash xx

The cash short or over account is only a temporary or suspense account. When
financial statements are prepared, the same should be deposited.

Hence, if the cashier or cash custodian is held responsible for the cash shortage,
the adjustment should be:
Journal Due from cashier xx
Entry: Cash short or over xx

However, if reasonable efforts fail to disclose the cause of the shortage, the
adjustment is:
Journal Loss from cash shortage xx
Entry: Cash short or over xx

Accounting for cash overage

Where the cash count shows cash which is more than the balance per book, a
cash overage is to be recorded.

Journal Cash xx
Entry: Cash short or over xx

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 were
made.

The cash overage is treated as miscellaneous income if there is no claim on the

same.
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

Journal Cash short or over xx

Entry: Miscellaneous income xx

But where the cash overage is properly found to be the money of the cashier, the
journal entry is:
Journal Cash short or over xx
Entry: Payable to cashier xx

IMPREST SYSTEM
The 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.

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.

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

The imprest fund system is the one usually followed in handling petty cash
transactions.

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 fund

No formal journal entries are made.
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
The petty cashier generally requires a signed petty cash voucher for such
payments and simply prepares 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 fund.
The replenishment check is usually equal to the petty cash disbursements.
It is at this time that the petty cash disbursements are recorded.
Expenses xx

Cash in bank xx

It is pointed out that the petty cash disbursements should be replenished

only by means of check 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.
Expenses xx

Petty cash fund xx

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

Petty cash fund xx

Cash in bank xx

f. A decrease in the fund is recorded as

Cash in bank xx

Petty cash fund xx

ILLUSTRATION
2020
Nov 10 The entity established an imprest fund of P10,000
Petty cash fund 10,000
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA
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 journal entry to record the replenishment:

Supplies 5,000

Telephone 1,800

Postage 1,200

Cash in bank 8,000

Dec 31 The fund was not replenished

The fund is composed of the following: currency and coins – P7,000,
supplies – P1,500, postage – P500, miscellaneous expense P1,000.
Supplies 1,500

Postage 500

Miscellaneous expense 1,000

Petty cash fund 3,000

2021
Jan 1 The adjustment made on December 31, 2020 is reversed.
Petty cash fund 3,000

Supplies 1,500

Postage 500

Miscellaneous expense 1,000

Feb 1 The fund is replenished and increased to P15,000

The composition of the fund:
Currency and coins 1,000

Supplies 4,500
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

Postage 3,000

Miscellaneous expense 1,500

Total 10,000

The journal entry for the replenishment and increase is:

Petty cash fund 5,000

Supplies 4,500

Postage 3,000

Miscellaneous expense 1,500

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 is P5,000.

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. The
replenishment checks are simply drawn upon the request of the petty cashier.

Moreover, petty cash disbursements are immediately recorded thus resulting in a

fluctuating petty cash balance per book from time to time:

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 the imprest fund system
where the disbursements are recorded upon the replenishment of the fund.

c. Replenishment or increase of fund

Petty cash fund xx
 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

Cash in bank xx

The replenishment check may or may not be the same as the petty cash
disbursements.

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 reverted to the general cash

Cash in bank xx

Petty cash fund xx

ILLUSTRATION
Nov 10 The entity established a petty cash fund of P10,000
Petty cash fund 10,000

Cash in bank 10,000

Nov 11-28 Petty cash disbursements amounted to P8,000

Expenses 8,000

Petty cash fund 8,000

Nov 29 Issued a check for P10,000 to replenish the fund.

Petty cash fund 10,000

Cash in bank 10,000

At this point, the petty cash balance per book is P12,000.

Dec 1-30 Petty cash expenses amounted to P9,000

Expenses 9,000

Petty cash fund 9,000

Dec 31 Issued a check for P15,000 to replenish the fund

Petty cash fund 15,000

Cash in bank 15,000

 Acc 205 – Intermediate Accounting 1
Prepared by: Mark Paul I. Ramos, CPA

At this point, the petty cash balance is P18,000.

Reference:

Valix, Conrado T., et al, (2020 revised edition), Intermediate Accounting Volume 1