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Current Assets Chapter 6 Cash and Cash Equivalents Cash is listed first in the current assets section because it is the most liquid of the assets.
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Current Assets Chapter 6
Cash and Cash Equivalents • Cash is listed first in the current assets section because it is the most liquid of the assets. • Liquidity reflects the ability of a firm to generate sufficient cash to meet its operating cash needs and to pay its obligations as they become due.
Cash and Cash Equivalents • A company must be careful to have enough cash on hand to pay its bills but not so much that cash is sitting idle.
Cash and Cash Equivalents • A company also must have internal controls in place to safeguard cash.
Composition of Cash • Cash is composed of funds that are readily available.
Cash includes the following: • Cash on hand • Deposit in checking accounts and saving accounts • Money market funds permitting withdrawal by check • Checks from customers awaiting deposit • Foreign currency which can be converted into dollars.
Cash does not include the following: • Certificates of deposit • Stamps • Post-dated checks • For example, a post-dated check is written on July 6 but dated July 8. • Because the bank should not accept the check until July 8, the check should be classified as an account receivable not as cash.
Composition of Cash • Cash is usually reported as one item on the balance sheet. • If a company has several checking accounts, then they are combined into one number.
Composition of Cash • Cash is usually reported as one item on the balance sheet. • The same is true for petty cash funds, funds kept to pay for small, incidental expenditures, and change funds, which enable cashiers to make change for their customers.
Compensating Balances • Compensating balances are minimum amounts the firm agrees to keep on deposit at the bank in accounts that pay little or no interest.
Compensating Balances • These balances effectively raise the interest rate that the bank is charging the borrowing company.
Compensating Balances • Compensating balances are included in the Cash number and disclosed in the notes to the financial statements.
Cash and Cash Equivalents • Some companies choose to report Cash on the balance sheet as Cash and Cash Equivalents. • Cash equivalents are short-term, highly liquid investments with a maturity date of less than three months. • Examples of cash equivalents are certificates of deposit, treasury bills, and commercial paper.
Control of Cash • Because cash is highly liquid and universally desirable, it behooves a company to have tight internal controls over cash.
How Firms Exercise Control Over Cash • Employees who have control over the cash itself should have nothing to do with the record keeping for cash. • This is called separation of duties.
How Firms Exercise Control Over Cash • A person who has custody and does the record keeping has an excellent opportunity to steal from the company.
How Firms Exercise Control Over Cash • Bank checking accounts provide several control advantages. • First, cash receipts can be deposited daily, critically important since the longer cash stays at a place of business, the higher the chances that it will be stolen.
How Firms Exercise Control Over Cash • Bank checking accounts provide several control advantages. • Second, checks provide a written record of a firm's disbursements.
How Firms Exercise Control Over Cash • Bank checking accounts provide several control advantages. • Third, since only a few individuals will have check-signing authority, the company restricts access to cash and reduces the possibility that it will be used improperly.
How Firms Exercise Control Over Cash • Bank checking accounts provide several control advantages. • Fourth, bank statements provide a monthly listing of deposits and withdrawals.
Analysis of Cash • The most informative analysis of cash pertains to cash flows.
Analysis of Cash • While the statement of cash flows analyzes a firm's inflows and outflows of cash, the balance sheet simply gives a total for Cash as of a given date.
Analysis of Cash • The Cash to Current Liabilities Ratio is calculated by dividing current liabilities into Cash.
Analysis of Cash • Recall that the current and acid-test ratios also have current liabilities in the denominator. • The numerator, however, is all current assets for the former and cash, marketable securities, and net accounts receivable for the latter.
The Need for Cash Planning • Managers must be proactive in ensuring that enough cash is on hand to meet current obligations. • To accomplish this, management must project the amount and timing of future cash flows.
Marketable Securities • Many firms put excess cash balances into short-term investments, known as marketable securities.
Marketable Securities • Marketable securities are the next current asset in order of liquidity.
Marketable Securities • They consist of stocks and bonds easily sold through a broker.
Marketable Securities • A security is considered marketable if it is traded on an exchange registered with the SEC or if its price is available through the National Association of Securities Dealers Automated Quotations (NASDAQ) systems or the National Quotation Bureau.
There are two general types of securities: • Equity securities, which represent ownership interests in other corporations. • Equity securities basically mean stocks. • Debt securities, which are evidence of lending transactions. • Debt securities basically mean bonds or other commercial paper.
Basic Accounting of Marketable Securities • SFAS No. 115 requires that a business classify its short-term equity securities as either trading securities or available-for-sale securities.
Basic Accounting of Marketable Securities • Trading securities are intended to be held for a short period of time.
Basic Accounting of Marketable Securities • The available-for-sale securities category covers all other equity securities.
Accounting for Available-for-Sale Securities • Equity available-for-sale securities must be stated at their market value on the balance sheet date. • This is a departure from the historical cost rule that you have learned.
Accounting for Available-for-Sale Securities • Any difference between the cost and the market value of the security is an unrealized gain or loss.
Accounting for Available-for-Sale Securities • Any difference between the cost and the market value of the security is an unrealized gain or loss. • The word "unrealized" means that a transaction has not actually taken place.
Accounting for Available-for-Sale Securities • Any difference between the cost and the market value of the security is an unrealized gain or loss. • The gain or loss is only a "paper" gain or loss.
Accounting for Available-for-Sale Securities • Unrealized gains or losses do NOT appear on the income statement. • They are put into a special section of shareholders' equity. • A gain will increase equity, while a loss will decrease equity.
Accounting for Available-for-Sale Securities • The adjustment to market value is made to a valuation account, often called Allowance for Unrealized Gain/Loss.
Accounting for Available-for-Sale Securities • Suppose that securities are purchased for $1,000, but at the balance sheet date, the market value is only $980.
Accounting for Available-for-Sale Securities • Two accounts must be created. • An Allowance account is created for $20, and the current assets section of the balance sheet will show the following:
Accounting for Available-for-Sale Securities • Two accounts must be created. • An Allowance account is created for $700, and the current assets section of the balance sheet will show the following: Available-for-Sale Securities $1,000 Less: Allowance for Unrealized Gain/Loss 20 Available-for-Sale Securities, at Market value $ 980
Accounting for Available-for-Sale Securities • Two accounts must be created. • The second account created is Unrealized Loss on Marketable Securities.
Accounting for Available-for-Sale Securities • Two accounts must be created. • It will appear with its $20 balance in the shareholders' equity section of the balance sheet—not on the income statement.
Accounting for Available-for-Sale Securities • When securities are sold, gains or losses on the sale are realized. • The word "realized" means that a transaction has actually taken place.
Accounting for Available-for-Sale Securities • When securities are sold, gains or losses on the sale are realized. • If the securities mentioned above are sold for $990, then there is a $10 realized loss ($1,000 cost - $990 cash received).
Accounting for Trading Securities • Equity trading securities are intended to be held for a short period of time. • They are also accounted for at market value.
Accounting for Trading Securities • They follow the same accounting as mentioned above for available-for-sale securities with one notable exception.
Accounting for Trading Securities • Unrealized gains and losses ARE included in net income on the income statement.
Accounting for Debt Securities • The accounting for debt securities is more complex. • If a firm intends to hold a debt security until the maturity date, the security is valued at historical cost. • Otherwise, the securities appear on the balance sheet at market value.
