FINANCIAL ACCOUNTING & REPORTING 1

1
Accounting for Cash Part 1

Module 004 Accounting for Cash

Accounting for cash 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account from which funds may be withdrawn at any time without having to notify the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
Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
2
Accounting for Cash Part 1

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.”

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
3
Accounting for Cash Part 1

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:

 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.

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
4
Accounting for Cash Part 1

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.

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
5
Accounting for Cash Part 1

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

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

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
6
Accounting for Cash Part 1

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.

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
7
Accounting for Cash Part 1

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.
 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.
Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
8
Accounting for Cash Part 1

 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.

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
9
Accounting for Cash Part 1

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.

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:

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
10
Accounting for Cash Part 1

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
Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
11
Accounting for Cash Part 1

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.
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

Course Module
 FINANCIAL ACCOUNTING & REPORTING 1
12
Accounting for Cash Part 1

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/australian-
website/technical-publications/local-technical--financial-alerts/gtal_ta_alert_2012-1-
aasb-7ias-7-statement-of-cash-flows.pdf; October 23, 2017
3. IAS 7 — Presentation of cash equivalents; http://www.ifrs.org/issued-standards/list-
of-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/ifrs-
discussion-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

Course Module