CASH AND CASH EQUIVALENTS

Auditing Problems

Topic 1

By L.J. SZE

CASHCash

Equivalents

&

CASH

In Layman’s term:

Cash simply means money.

Money is the standard medium of exchange in business transaction.

It refers to currency and coins.

In Accounting:

Cash includes “money and any other negotiable instrument that is payable in money and acceptable by bank for deposit and immediate credit”.

CASH

Cash includes:ChecksBank draftsMoney orders

Example:1.Received check in full

settlement of accounts receivables.

Dr. Cash xxx

Cr. Accounts Receivable xxx

2. Received postdated check in full settlement of accounts receivables.

Postdated checks cannot be considered as cash yet because these checks are unacceptable by the bank for deposit.

PAS 1“ 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”.

Accordingly, to be reported as “cash”, an item must be unrestricted in use.

Cash must be readily available in the payment of current obligations.

CASH

CASH

The following cash items are included in “cash”:Cash on hand

• undeposited cash• Customers’ checks• Cashier’s or manager’s checks

Cash Fund

•Set aside for current purposes such as petty cash fund, payroll fund and dividend fund.

Cash in bank

• Demand deposit or checking account •Saving deposit

CASH EQUIVALENTS

PAS 7“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”.

“only highly liquid investments that are acquired three months before maturity can qualify as cash equivalents”.

CASH EQUIVALENTS

3 month BSP treasury bill 3 year BSP treasury bill

purchased 3 months before date of maturity

3 month time deposit 3 month money market

instrument

EXAMPLE:

What’s important is the date of purchase which should be 3 months or less before maturity.

NO

ET

NO

ET

CASH EQUIVALENTS

Equity securities cannot qualify as cash equivalents because shares do not have a maturity date.

Preference shares with specified redemption date and acquired 3 months before redemption date can qualify as cash equivalents.

Valuation of Cash

Cash is valued at face value.

Cash in foreign currency is valued at the current exchange rate.

Financial Statement Presentation

The caption “ cash and cash equivalents” should be shown as first item among the current assets.

Cash and cash

equivalents

Cash on hand

Cash in bank

Petty cash fundCash equivalents

Notes to Financial Statemen

ts

Investment of excess cash

Time period Classification Presentation

3 months or less Cash equivalents

Cash and cash equivalents

more than 3 months w/in

1year

Temporary investment

Current assets

More than 1 year

Long-term investments

Non – currentassets

Excess cash may be invested in time deposits, money market instruments and treasury bills for the purpose of earning interest income.

Compensating Balance

Minimum checking or demand deposit account balance that must be maintained in connection with borrowing arrangement with a bank.

Classification:

Not legally restricted

Legally restricted

Informal agreement “Cash”

“Cash held as

compensating balance”

“Noncurrent investment”

Formal agreement

Short-term

Long-term

Undelivered or unreleased checks

Merely drawn and recorded but not given to the payee.

No payment when the checks are pending delivery to payees .

Undelivered checks are still subject to entity’s control.

Adjusting entry is required to restore the cash balance:

Dr. CashxxxCr. A/P

xxx

Postdated checks delivered

Means that checks are drawn, recorded and already given to the payees but they bear a date subsequent to the end of reporting period.

The original entry should be reversed as follows:

Dr. Cash xxxCr. Accounts payable xxx

There is no payment until checks can be presented to the bank for encashment or deposit

Reason:

Stale checks

When the checks are not encashed by the payee within a relatively long period of time.

In banking practice, checks become stale if not encashed within six months from the time of issuance.

Immaterial:

Dr. Cash xxxCr. Miscellaneous Income xxx

Material: (If liability is expected to continue)

Dr. Cash xxxCr. Miscellaneous Income xxx

Window dressing

Is any deliberate misstatement of the assets, liabilities, capital, income and expense.

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

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

Window dressing

Lapping

Used for concealing a cash shortage.

Misappropriating a collection from one customer and concealing by applying subsequent collection made from another customer.

Poor internal control

Involves series of postponements of the entries for the collection of receivables.

Kiting

Also used for concealing a cash shortage.

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.

IMPREST SYSTEM

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.

Petty Cash Fund

There are occasions when the issuance of checks becomes impractical or inconvenient such as when small amounts are paid. Therefore, it becomes necessary to establish a petty cash fund.

Petty cash fund is money set aside to pay small expenses.

Two methods of handling the petty cash:1. Imprest fund system2. Fluctuating fund system

Imprest Fund System

a. A check is drawn to establish the fund.Dr. Petty cash fund xxxCr. Cash in bank

xxxb. Payment of expenses out of the fund – no entryc. Replenishment of petty cash payments

Dr. Expense xxxCr. Cash in bank

xxxd. At the end of accounting period adjust the

unreplenished expense.Dr. Expenses xxxCr. Petty cash fund xxx

e. Increase in fund. f. decrease in fund.

Dr. Petty cash fund xxx Dr.Cash in bank xxx

Cr. Cash in bank xxx Cr. Petty cash fund xxx

Fluctuating Fund Systema. Establishment of the fund.Dr. Petty cash fund xxxCr. Cash in bank

xxxb. Payment of expenses out of the fund:

Dr. Expenses xxxCr. Petty cash fund xxx

c. Replenishment or increase of fund:Dr. Petty cash fund xxxCr. Cash in bank

xxxd. At the end of accounting period no adjustment is

needed.e. Decrease of the fund.

Dr. Cash in bank xxxCr. Petty cash fund xxx