Cash and Cash Equivalents

'Cash and Cash Equivalents' is an asset that appears on the statement of financial position of a business and includes currency (coins and bank notes) held by a business (in hand and in bank accounts) and cash equivalents. Cash is a medium of exchange, a store of value and a unit of account and a business needs to have sufficient cash in order to be able to pay its liabilities. Higher cash ratio (ratio of cash and cash equivalents to current liabilities) suggests that the business is liquid (i.e. it is expected not to face any difficulty in paying its very short-term liabilities). A business generates cash from sale of products and services, sale of assets, borrowings from banks and other creditors and from capital contributions by its owners. It uses cash to pay for its operating and capital expenditure, its liabilities and in paying dividends to its owners. Information about sources and uses of cash are presented in the statement of cash flows. Businesses keep a small amount of cash (called petty cash) for day to day cash expenses and keep a larger percentage of cash at its bank. Control over cash is vital for efficient and profitable operations of a business that is why businesses prepare their cash and bank reconciliations periodically. Cash equivalents are not precisely coins and bank notes but are marketable securities of very short-term maturity (typically always less than 3 months) which are not expected to deteriorate significantly in value till maturity. They are treated as equivalent to cash under IAS 7 Statements of Cash Flows.

Petty Cash Petty cash fund is a relatively small amount of cash that businesses keep on hand for the purpose of small transactions such as providing change to customers, postage expenses, highway tolls etc. In such transactions, the use of checks is time consuming, costly or illogical. Usually a custodian is appointed to administer the petty cash and it is his/her duty to account for the expenses incurred out of petty cash fund. Whenever the custodian makes any payment from the fund to an employee or a customer etc., he or she must record the amount being disbursed, the name of the person to whom the payment is being made and the reason for the disbursement. Following are the typical transactions connected to petty cash fund. 1. Creation: Petty cash fund may be created by drawing a check on the company's checking account and handing it over to the custodian of the fund. The journal entry is to debit petty cash and credit cash at bank. 2. Disbursements: Individual disbursements from petty cash are not recorded via a journal entry. Instead journal entry is passed at the time of each replenishment and at the end of the period for the total amount disbursed. 3. Replenishment: When the balance in petty cash becomes low, a journal entry is passed debiting various expense accounts and crediting petty cash for the sum of disbursements made. Then petty cash is replenished usually via a check. 4. Raising Fund Level: When the volume of transactions to be handled by the petty cash grows, the fund level is raised. The journal entry is to debit the petty cash and credit cash at bank.

Example
Company A created a petty cash fund of $900 on Jan 1, 2012. The journal entry is:

Petty Cash Cash at Bank

900 900

During January 2012, following disbursements were made from the fund: Office Supplies Highway Toll Postage Freight-In $300 50 30 $350

The journal entry to record the about disbursements from petty cash is: Office Supplies Highway Toll Postage Freight-In Petty Cash 300 50 30 350 730

The company replenished the fund via a check of $730. The journal entry is: Petty Cash Cash at Bank 730 730

Bank Reconciliation
A company's cash balance at bank and its cash balance according to its accounting records usually do not match. This is due to the fact that, at any particular date, checks may be outstanding, deposits may be in transit to the bank, errors may have occurred etc. Therefore companies have to carry out bank reconciliation process which prepares a statement accounting for the difference between the cash balance in company's cash account and the cash balance according to its bank statement. Following are the transactions which usually appear in company's records but not in the bank statement:

Deposits in Transit: Deposits which have been sent by the company to the bank but have not been received by the bank at proper time before the issuance of bank statement.

Checks Outstanding: Checks which have been issued by the company but were not presented or cleared before the issuance of bank statement. Following are the transactions which usually appear in bank statement but not at company's cash account:

Service Charges: Service charges may have been deducted by the bank. Such charges are usually not known to the company before the issuance of bank statement.

Interest Income: If any interest income has been earned by the company on its bank account, it is not usually entered in company's cash account before the issuance of bank statement.

NSF Checks: These are the checks deposited by the company in the bank but are not paid when the bank presents them for payment.

Example
Company A's bank statement dated Dec 31, 2011 shows a balance of $25,394.72. The company's cash records on the same date show a balance of $23,196.79. Following additional information is available: 1. Following checks issued by the company to its customers are still outstanding:
No. 846 issued on Nov 29 No. 875 issued on Dec 26 No. 878 issued on Dec 29 No. 881 issued on Dec 31 $320.00 49.21 275.00 186.50

2. A deposit of $400.00 made on Dec 31 does not appear on bank statement. 3. An NSF check of $850 was returned by the bank with the bank statement. 4. The bank charged $50 as service fee. 5. Interest income earned on the company's average cash balance at bank was $1,250. 6. The bank collected a note receivable on behalf of the company. Amount received by the bank on the note was $550. This includes $50 interest income. The bank charged a collection fee of $10. 7. A deposit of $430 was incorrectly entered as $340 in the company's cash records. Prepare a bank reconciliation statement using the above information. Solution: Company A Bank Reconciliation December 31, 2011

Balance as per Bank, Dec 31 Add: Deposit in Transit

$25,394.72 400.00 $24,994.72

Less: Outstanding Checks: No. 846 issued on Nov 29 No. 875 issued on Dec 26 No. 878 issued on Dec 29 No. 881 issued on Dec 31 $320.00 49.21 275.00 186.50 830.71 Adjusted Bank Balance $24,164.01

Balance as per Books, Dec 31 Add: Interest Income from Bank Note Receivable Collected by Bank Interest Income from Note Receivable Deposit Understated $1,237.22 500.00 50.00 90.00

$23,196.79

1,877.22 $25,074.01 Less: NSF Check 850.00

Bank Service Fee Bank Collection Fee

50.00 10.00 910.00

Adjusted Book Balance

$24,164.0