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Module 004 Accounting for Cash

Accounting forcash is a very important basic accounting concept and anybody working on it
should have a thorough knowledge and understanding of it since cash and cash equivalents are
the most liquid current assets and one of every business’ and company’s crucial health indicators
is its ability to generate cash and cash equivalents.
At the end of this module, you will be able to:
1. discuss the nature, composition and recognition of cash and cash equivalents;
2. interpret and apply theories of accounting in relation to cash and cash equivalents; and
3. determine the internal controls employed in accounting for cash and cash equivalents.
Definition, Nature and Composition of Cash and Cash Equivalents
Cash
In layman’s term, cash simply means money. Money is the standard medium of exchange in business transactions.
It refers to the currency and coins which are in circulation and legal tender.This includes all bills, coins and currency
notes. A demand deposit is a type of account from which funds may be withdrawn at any time without having to
notify the institution.

There is no specific standard dealing with cash. The only standard is found in PAS 1, paragraph
66d, which provides that “an entity shall classify an asset as current when the asset is cash or
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”.

In accounting, cash connotes more than money. It includes money and other negotiable
instrument that is payable in money and acceptable by the bank for deposit and immediate withdrawal. These
include checks, bank drafts and money orders because these are acceptable by the bank for deposit or immediate
encashment. For instance, when checks, except post-dated checks, are received in full settlement of an account
receivable, cash is immediately debited as the checks may be presented at the bank anytime for deposit or
encashment. Why post-dated checks cannot be considered as cash? It is because these checks are unacceptable by
the bank for deposit and immediate credit or outright encashment. However, this will be part of cash equivalents
until the date of encashment falls due. Then it will now be part of cash.
Examples of cash:
 a. Cash on hand – this includes undeposited cash collections and other cash items awaiting
deposit such as customers’ checks, cashier’s or manager’s checks, traveler’s checks, bank
drafts and money orders.
 b. Cash in bank – this includes demand deposit or checking account and saving deposit which
are unrestricted as to withdrawal.
 c. Cash fund which are set aside for current purposes such as petty cash fund, payroll fund
and dividend fund.
Cash equivalents
According to PAS 7, paragraph 6, cash equivalents are 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 investment must be short-term, usually with a maximum investment duration of
three months or less. If an investment matures in more than three months, it should be classified in the account
named other investments. Cash equivalents should be highly liquid and easily sold on the market.Equity
investments are excluded from cash equivalents unless they are, in substance, cash equivalents, for example in the
case of preferred shares acquired within a short period of their maturity and with a specified redemption date.”

The standard further states that “only highly liquid investments that are acquired three months before maturity can
qualify as cash equivalent”.

Two attributes as define by the Standard:

 They should be “short term” in nature; that is, they are held for meeting short-term cash commitments. In
other words, an investment normally qualifies as a cash equivalent only if it has a short
maturity, say, three months or less, from the date of acquisition.
Example:
A time deposit with a bank (or a fixed deposit, as it is referred to in some countries) with an
original maturity of six months would not qualify as a cash equivalent.

 They should be “highly liquid investments” that are “readily convertible to known
amounts of cash and are subject to an insignificant risk of changes in value.” Example:
Investments in equity shares of another entity would not qualify as cash equivalents because they are
subject to risk of changes in values that could be “significant” depending on how their market values
fluctuate in reacting to economic conditions or other factors. However, investments in redeemable
preference shares acquired within a short period of their maturity and with a specified redemption date
qualify as cash equivalents.
Examples of cash equivalents:
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 a. Three-month BSP treasury bill

 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.  e. Preference shares (less
than 3 months maturity)

Recognition and Measurement of Cash and Cash Equivalents

Cash
Cash is measured at face value while cash in foreign currency is measured at the current exchange rate. However, 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 value if the amount recoverable is estimated to be lower than the face value.

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 rate restriction are included in cash otherwise if
the restriction is material, it should be classified separately among noncurrent assets and the restriction is clearly
indicated in the notes to financial statements.

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 such as petty cash
fund, payroll fund, travel fund, interest fund, dividend fund and tax fund, then it is a current asset. It is included as
part of cash and cash equivalents.

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 these funds are sinking fund, preference share redemption fund,
contingent fund, insurance fund and fund for acquisition or construction of property, plant and equipment.

Note that the classification of a cash fund as current or noncurrent should parallel the classification applied to the
related liability. For example, an insurance fund shall be classified as current asset when the insurance payable is
already due within one year after the end of reporting period.

Bank Overdraft
When the cash in bank account has a credit balance, then it has an overdraft. This means that the credit balance
results from the issuance of checks in excess of the deposits. This bank overdraft is classified as a current liability
and should not be offset against OTHER bank accounts with debit balances. Meaning, offsetting is not allowed on
accounts held at different banks but are allowed if an entity maintains two or more account in ONE bank and one
account results to an overdraft, such overdraft, if not material, can be offset against the other bank account with
debit balance in order to show “cash net of bank overdraft” or “bank overdraft, net of other bank account”.

Illustration for an entity with two different bank accounts with different banks:
Cash in bank – Lorenzo Bank, which is overdrawn by P10,000.
Cash in bank – Luiz 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 – Luiz Bank P100,000
Current liability: Bank overdraft – Lorenzo Bank P10,000

Note that it is not necessary to adjust and open a bank overdraft account in the ledger. In other
words, the Cash in bank – Lorenzo 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.

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 P1,000,000 from a bank and agrees to maintain a
10% or P100,000 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 of the loan extended.

Classification of compensating balance

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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 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 otherwise it is classified as noncurrent
investment.

Undelivered or Unreleased Checks

These refer to checks 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.
This is because the undelivered checks are still subject to the entity’s control and may thus be cancelled anytime
before delivery at the discretion of the entity.
An adjusting entry is required to restore the cash balance and set up the liability as follows:
Dr. Cash xxx
Cr. Accounts payable or appropriate account xxx

Post-dated Check Delivered

This refers to 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 post-dated check shall be reversed and therefore
restored to the cash balance as follows:
Dr. Cash xxx
Cr. Accounts payable or appropriate account xxx

The reason of the reversal is because there is no payment until the check can be presented to the bank for
encashment or deposit.

In banking practice, a check becomes stale if not encashed within six months from the time of issuance but 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 consideration of a previously issued check.

If the amount of the stale check is immaterial, it is simply accounted for as miscellaneous income as follows:
Dr. Cash xxx
Cr. Miscellaneous income xxx

However, if the amount is material and liability is expected to continue, the cash is restored and the liability is again
set up as follows:
Dr. Cash xxx
Cr. Accounts payable or appropriate account xxx

Recognition and Measurement of Cash and Cash Equivalents

Internal Control Over Cash

Although cash may not represent a significant amount compared to total assets in the statement of financial
position, more audit time is devoted to the examination of cash balances because it has a high degree of inherent
risk and management override of controls since they may overstate the amount of cash disclosed in their financial
statements to attract investors, lenders and other users of financial statements.

An important element of cash control is the segregation of custodian function from the record keeping function.
Also, restricting the number of individuals involved in cash transactions and limiting the duties handled by the
person in charge of cash transactions limit the fraudulent activities involving cash.

Control over cash receipts should provide assurance that cash which should have been received was in fact
received, recorded correctly and deposited promptly. The basic principle is that no one person should be allowed
to collect, handle or transport and deposit cash without additional control feature to ensure that all funds are
accounted for. There should be proper segregation of duties among the person who will handle cash transactions,
that is authorization, recording and custody. Meaning, the one who authorize cash transactions should not be the
one to post the transaction entries or do the recording and all cash must be in the custody of other persons or
entities (banks or other financial institutions).
Internal control procedures over cash receipts include the following:
 No one person should be assigned the function of cash handling and record keeping.
 Official receipts must be pre-numbered and sequentially used.
 Deposit each day’s cash receipts intact.
 Deposits should be matched with official receipts.
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 Deposits should be reconciled with the recorded cash receipts. The person making the reconciliation
should not be the same person making the deposit.
 Cash sales should be recorded at the point of sale (point of sale system).
 The function of cash handling should be segregated from the record keeping.
 Cash register totals and credit card machines should be balanced daily. Any resulting cash shortage or
overage should be monitored.

Control over cash disbursement should provide assurance that disbursements are made only for authorized
business purposes and are properly recorded. Internal control procedures for cash disbursement include the
following:
 All disbursement must be properly authorized and accompanied by adequate documentation. The
adoption of the vouchers system, which requires reviews of supporting documents as support for
disbursements, is highly recommended.
 Payments must be made by checks, electronic fund transfer or from petty cash fund.
 Issued checks must be sequentially numbered.
 Checks should be signed by at least two persons to prevent fictitious disbursements.
 The check signing must be vested in persons at appropriately high levels in the organization.
 Checks issued must be payable to specific entities (company or person) and must not be made
payable to “Cash”.
 Bank statements and cancelled checks received must be reconciled by a person independent of the
authorization and check signing function.

To see to it that all deposits and disbursements are properly made and recorded, a bank reconciliation also
monitors the correctness of the bank’s record of deposits received and checks paid.
Window Dressing
Books of an entity should be closed at the end of every reporting period in order that financial statements will
show fairly the financial position and performance of the entity and to avoid window dressing.

Window dressing is a practice of opening the books of accounts beyond the close of the reporting period which
results to manipulation of the books to arrive for a better financial position and performance. It could be increasing
the assets and lowering the liabilities.

This method is usually accomplished by:

 By recording as of the last day of reporting period collections made subsequent to the
close of the period, thus increasing cash shown in the statement of financial position.
 By recording as of the last day of the reporting period payments of accounts made
subsequent to the close of the period, thus decreasing liabilities shown in the statement
of financial position.

Such practices are unacceptable and undesirable. Thus, entries made to window dress must
be reversed back to correct the statements as these entries pertain to the subsequent
period.

This act causes misstatement of the assets, liabilities, equity, income and expense.

Lapping
Another act which causes misstatement in the presentation of the financial statement is Lapping, which is
commonly used in concealing cash shortage.

This is done by misappropriating a collection from one customer and concealing this defalcation by applying a
subsequent collection made from another customer. It involves series of postponements of the entries for the
collection of the receivables.

Poor internal control may lead to this scenario especially when the bookkeeper and the cashier are one and the
same person.

Kiting
This is another act of concealing a cash shortage. It is possible when an entity maintains current accounts in
different banks and commonly done at the end of the 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 if the check.
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This fraudulent device is made possible when the check is drawn against the first bank at the end of the month, the
bank statement for such month does not yet show the check drawn because the said check is yet to be cleared or
presented for payment to the first bank. Hence, the cash balance in the first bank at the end of the month is not
affected.

On the other hand, when the check is deposited in the second bank at the end of the month, the bank statement
for such month will already show the deposit thereby increasing the cash in said bank and covering the cash
shortage therein.

Accounting for cash shortage

Where the cash count shows cash which is less than the balance per book, there is a cash shortage to be recorded
as follows:
Cash short or over xxx
Cash xxx

This is only a temporary or suspense account and should be adjusted when the financial statements are prepared.
Hence, if the cashier or cash custodian is held responsible for the cash shortage, the adjustment should be:

Due from cashier xxx

Cash short or over xxx

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

If the amount of the cash shortage is not material, it can be debited to miscellaneous expense.

Accounting for cash overage

On the other hand, when cash count shows more than the balance per book, there is cash overage to be recognized
as follows:
Cash xxx
Cash short or over xxx

The offsetting account used whether for cash shortage or cash overage is “cash short or over”.

If there is no claim as to the overage of cash, then it is treated as miscellaneous income as follows:
Cash short or over xxx
Miscellaneous income xxx
However, if this overage pertains to the money which belongs to the cashier then it should be treated as follows:
Cash short or over xxx
Payable to cashier xxx

Accounting of Petty Cash Fund

As control measures of petty cash fund, the procedures are widely used:
 One person is usually given the responsibility of operating the petty cash fund
 Each time expenditure is made, a source document (called a petty cash voucher) is prepared for
payment evidence. The voucher is signed by the person receiving the cash and by the person in
charge of the fund (petty cashier). The petty cash voucher includes the amount and purpose of the
expenditure.
 A record (usually multi columned) is kept to record each expenditure from the petty cash fund
 Each time the fund is almost depleted and also at the end of every accounting period, a check is
prepared for the amount spent and cashed to replenish the petty cash fund.
Glossary
Cash: refers to the currency and coins which are in circulation and legal tender. Cash equivalents: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.
Check: a written, dated and signed instrument that contains an unconditional order from the drawer that directs
a bank to pay a definite sum of money to a payee.
Commercial paper: unsecured, short-term debt instrument issued by a corporation, typically for the financing of
accounts receivable, inventories and meeting short-term liabilities.
Liquidity: describes the degree to which an asset or security can be quickly bought or sold in the market without
affecting the asset's price.
Marketable securities: financial instruments that are very liquid and can be quickly converted into cash at a
reasonable price.
Money:an officially-issued legal tender generally consisting of notes and coin, and is the circulating medium of
exchange as defined by a government.
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Money market:is where financial instruments with high liquidity and very short maturities are traded.
Negotiable instrument: a document that promises payment to a specified person or the assignee.
Treasury bills: a short-term debt obligation backed by the government with a maturity of less than one year

References and Supplementary Materials

Books and Journals
1. Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards & Application (2014-
2015 ed., Vol. 2).Manila, Philippines.
2. Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1). Manila, Philippines.
3. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol.
2).Manila, Philippines.
4. IAS 7 Identification of cash equivalents
Online Supplementary Reading Materials
1. Cash And Cash Equivalents – CCE; https://en.wikipedia.org/wiki/Cash_and_cash_equivalents; October 23,
2017
2. IAS 7 – Identification of cash and cash equivalents; https://www.grantthornton.com.au/globalassets/1.-
member-firms/australianwebsite/technical-publications/local-technical--financial-alerts/gtal_ta_alert_2012-
1aasb-7ias-7-statement-of-cash-flows.pdf; October 23, 2017
3. IAS 7 — Presentation of cash equivalents; http://www.ifrs.org/issued-standards/listof-standards/ias-7-
statement-of-cash-flows/; October 23, 2017
4. IAS 39 – Classification of cash and cash equivalents; http://www.frascanada.ca/international-financial-
reporting-standards/ifrsdiscussion-group/search-past-meeting-topics/item82076.pdf; October 23, 2017
5. Petty cash accounting; http://ww2.nscc.edu/swanson_l/Acct%201104%20Web/Presentations/Petty%20Ca
shrev.pdf; October 23, 2017
6. Petty Cash; https://fbs.admin.utah.edu/ga/resources/petty-cash-fund-procedures/; October 23, 2017

Online Instructional Videos

Cash and cash equivalents; https://www.youtube.com/watch?v=pvKnbdHGLmU;October 23, 2017
Cash and cash equivalents;https://www.youtube.com/watch?v=8hFpF0pniSs;October 23, 2017
Petty Cash Fund;https://www.youtube.com/watch?v=l34qDYeWfX0;October 23, 2017