CHAPTER THREE

CASH AND RECEIVABLES

PART I: ACCOUNTING FOR CASH

Learning objectives

• Defining cash
• Understand ways of reporting cash
• Explain methods of cash control
• Understand petty cash system
• Prepare bank reconciliation
1. CASH
1.1. What Is Cash?

Cash, the most liquid of assets, is the standard medium of exchange and the basis for measuring and accounting for all other item
Companies generally classify cash as a current asset. Cash consists of coin, currency, and available funds on deposit at the ban
Negotiable instruments such as money orders, certified checks, cashier’s checks, personal checks, and bank drafts are also viewed
cash.

1.2. Reporting Cash

Although the reporting of cash is relatively straightforward, a number of issues merit special attention. These issues relate to the
reporting of:

1. Cash equivalents.
2. Restricted cash.
3. Bank overdrafts.

Cash Equivalents

A current classification that has become popular is “Cash and cash equivalents.” Cash equivalents are short-term, highly liquid
investments that are both (a) readily convertible to known amounts of cash, and (b) so near their maturity that they present
insignificant risk of changes in value due to changes in interest rates. Generally, only investments with original maturities of
three months or less qualify under these definitions. Examples of cash equivalents are Treasury bills, commercial paper, and
money market funds.

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Restricted Cash

Petty cash, payroll, and dividend funds are examples of cash set aside for a particular purpose. In most situations, these fund
balances are not material. Therefore, companies do not segregate them from cash in the financial statements. When material in
amount, companies segregate restricted cash from “regular” cash for reporting purposes. Companies classify restricted cash
either in the current assets or in the non-current assets section, depending on the date of availability or disbursement.
Classification in the current section is appropriate if using the cash for payment of existing or maturing obligations (within a year
or the operating cycle, whichever is longer). On the other hand, companies show the restricted cash in the non-current section
of the statement of financial position if holding the cash for a longer period of time.

Bank Overdrafts

Bank overdrafts occur when a company writes a check for more than the amount in its cash account. Companies should report
bank overdrafts in the current liabilities section, adding them to the amount reported as accounts payable. If material, companies
should disclose these items separately, either on the face of the statement of financial position or in the related notes.

Bank overdrafts are included as a component of cash if such overdrafts are repayable on demand and are an integral part of a
company’s cash management (such as the common practice of establishing offsetting arrangements against other accounts at the
same bank). Overdrafts not meeting these conditions should be reported as a current liability.

1.3. CASH CONTROLS

Cash is the asset most susceptible to improper diversion and use. Management faces two problems in accounting for cash
transactions: (1) establishing proper controls to prevent any unauthorized transactions by officers or employees, and (2)
providing information necessary to properly manage cash on hand and cash transactions.

1.3.1. USING BANK ACCOUNTS

The general checking account is the principal bank account in most companies and frequently the only bank account in
small businesses. A company deposits in and disburses cash from this account. A company cycles all transactions through it. For
example, a company deposits from and disburses to all other bank accounts through the general checking account.

Companies use imprest bank accounts to make a specific amount of cash available for a limited purpose. The account acts as
a clearing account for a large volume of checks or for a specific type of check. To clear a specific and intended amount through
the imprest account, a company transfers that amount from the general checking account or other source. Companies often use
imprest bank accounts for disbursing payroll checks, dividends, commissions, bonuses, confidential expenses (e.g., officers’
salaries), and travel expenses.

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 1.3.2. THE IMPREST PETTY CASH SYSTEM

Almost every company finds it necessary to pay small amounts for miscellaneous expenses such as taxi fares, minor office
supplies, and employee’s lunches. Disbursements by check for such items is often impractical, yet some control over them is
important. A simple method of obtaining reasonable control, while adhering to the rule of disbursement by check, is the
imprest system for petty cash disbursements.

This is how the system works:

1. The company designates a petty cash custodian and gives the custodian a small amount of currency from which to make
payments. It records transfer of funds to petty cash as:
Petty Cash ……………300
Cash …………………………..300
2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash, attaching evidence of
the disbursement to the petty cash receipt. Petty cash transactions are not recorded until the fund is reimbursed; someone
other than the petty cash custodian records those entries.
3. When the supply of cash runs low, the custodian presents to the controller or accounts payable cashier a request for
reimbursement supported by the petty cash receipts and other disbursement evidence. The custodian receives a company
check to replenish the fund. At this point, the company records transactions based on petty cash receipts.
Supplies Expense……………. 42
Postage Expense …………….53
Miscellaneous Expense ……….76
Cash Over and Short………….2
Cash…………………………………….173
4. If the company decides that the amount of cash in the petty cash fund is excessive, it lowers the fund balance as follows.
Cash …………50
Petty Cash …….….50

Subsequent to establishment, a company makes entries to the Petty Cash account only to increase or decrease the size of the
fund.

A company uses a Cash Over and Short account when the petty cash fund fails to prove out. That is, an error occurs such as
incorrect change, overpayment of expense, or lost receipt. If cash proves out short (i.e., the sum of the receipts and cash in the
fund is less than the imprest amount), the company debits the shortage to the Cash Over and Short account. If cash proves out
over, it credits the overage to Cash Over and Short. The company closes Cash Over and Short only at the end of the year. It
generally shows Cash Over and Short on the income statement as an “Other income and expense.”

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 1.4. RECONCILIATION OF BANK BALANCES

At the end of each calendar month, the bank supplies each customer with a bank statement (a copy of the bank’s account with
the customer) together with the customer’s checks (or electronic images of the checks) that the bank paid during the month. If
neither the bank nor the customer made any errors, if all deposits made and all checks drawn by the customer reached the bank
within the same month, and if no unusual transactions occurred that affected either the company’s or the bank’s record of cash,
the balance of cash reported by the bank to the customer equals that shown in the customer’s own records. This condition
seldom occurs due to one or more of the reconciling items. Hence, a company expects differences between its record of cash
and the bank’s record. Therefore, it must reconcile the two to determine the nature of the differences between the two amounts.

1.4.1. Reconciling items

1. DEPOSITS IN TRANSIT. End-of-month deposits of cash recorded on the depositor’s books in one month are received and
recorded by the bank in the following month.
2. OUTSTANDING CHECKS. Checks written by the depositor are recorded when written but may not be recorded by (may
not “clear”) the bank until the next month.
3. BANK CHARGES. Charges recorded by the bank against the depositor’s balance for such items as bank services, printing
checks, not-sufficient-funds (NSF) checks, and safe-deposit box rentals. The depositor may not be aware of these charges
until the receipt of the bank statement.
4. BANK CREDITS. Collections or deposits by the bank for the benefit of the depositor that may be unknown to the depositor
until receipt of the bank statement. Examples are note collection for the depositor and interest earned on interest-bearing
checking accounts.
5. BANK OR DEPOSITOR ERRORS. Errors on either the part of the bank or the part of the depositor cause the bank balance
to disagree with the depositor’s book balance.

A bank reconciliation is a schedule explaining any differences between the bank’s and the company’s records of cash. If the
difference results only from transactions not yet recorded by the bank, the company’s record of cash is considered correct. But,
if some part of the difference arises from other items, either the bank or the company must adjust its records.

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 1.4.2. Format of bank reconciliation

Companies prepare adjusting journal entries for all the addition and deduction items appearing in the
“Balance per depositor’s books” section. Companies should immediately call to the bank’s attention any errors
attributable to it.

Illustration

To illustrate, Nugget Mining Company’s books show a cash balance at the Melbourne Bank S.C on November 30, 2015, of
Br20,502. The bank statement covering the month of November shows an ending balance of Br22,190. An examination of
Nugget’s accounting records and November bank statement identified the following reconciling items.
1. A deposit of Br3,680 that Nugget mailed November 30 does not appear on the bank statement.
2. Checks written in November but not charged to the November bank statement are:
Check #7327 Br 150
#7348 4,820
#7349 31
3. Nugget has not yet recorded the Br600 of interest collected by the bank November 20 on Sequoia Co. bonds held by the bank
for Nugget.

4. Bank service charges of Br18 are not yet recorded on Nugget’s books.

5. The bank returned one of Nugget’s customer’s checks for Br220 with the bank statement, marked “NSF.” The bank deducted
Br220 from Nugget’s account.

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6. Nugget discovered that it incorrectly recorded check #7322, written in November for Br131 in payment of an account
payable, as Br311.

7. A check for Nugent Oil Co. in the amount of Br175 that the bank incorrectly charged to Nugget accompanied the statement.

The journal entries required to adjust and correct Nugget’s books in early December 2015 are taken from the items in the
“Balance per books” section and are as follows.
Cash …………..600
Interest Revenue…………….. 600
(To record interest on Sequoia Co. bonds, collected by bank)
Cash…………. 180
Accounts Payable ………….180
(To correct error in recording amount of check #7322)
Office Expense (bank charges) …………. 18
Cash …………………………………………………18
(To record bank service charges for November)
Accounts Receivable…………… 220
Cash ………………………………………….220
(To record customer’s check returned NSF)

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