17   ASC 305 CASH AND CASH EQUIVALENTS

Perspective and Issues

Subtopic

Scope

Overview

Definitions of Terms

Concepts, Rules, and Examples

Cash

Compensating balances

Example of compensating balance disclosure

Cash not immediately available.

Overdrafts

Petty cash

PERSPECTIVE AND ISSUES

Subtopic

ASC 305, Cash and Cash Equivalents, contains one subtopic:

  • ASC 305-10, Overall, that provides implementation guidance on cash on deposit at a financial institution.

Scope

ASC 305 applies to all entities and has no scope exceptions.

Overview

Assets displayed on the statement of financial position are the resources available to the reporting entity to support its current and future operations. To provide information about liquidity, the assets are often divided into current and noncurrent assets. Current assets consist of cash and other assets that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. When the normal operating cycle is less than one year, a one-year period is used to distinguish current assets from noncurrent assets. If the operating cycle exceeds one year, the operating cycle is the proper period to use for current asset identification. When information about current assets is accompanied by information about current liabilities, readers of the financial statements can assess the amount of net working capital (current assets less current liabilities) possessed by the reporting entity and its current ratio (current assets divided by current liabilities). Each of those measures provides useful information about the liquidity of the reporting entity.

Cash is the most liquid of assets, and cash items are generally classified as a current asset.

DEFINITIONS OF TERMS

Source: ASC 305-10-20

Cash. Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank's granting of a loan by crediting the proceeds to a customer's demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made.

Cash Equivalents. Cash equivalents are short-term, highly liquid investments that have both of the following characteristics:

  1. Readily convertible to known amounts of cash
  2. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).

CONCEPTS, RULES, AND EXAMPLES

Cash

To be included as cash in the statement of financial position, funds must be represented by coins, currency, undeposited checks, money orders, drafts, and demand deposits that are immediately available without restriction. Recognition and measurement of cash is generally straightforward. However, it is necessary to inform readers of the financial statements about any limitations on the ability to use cash in current operations.

Cash whose use is restricted would not be included with cash unless the restrictions on it expire within the year (or the operating cycle, if longer). Thus, cash contractually required to be held in a sinking fund is classified as a current asset if it will be used to retire the current portion of long-term debt. However, if material, it would be reported on a separate line rather than within cash. Cash in a demand deposit account that is being held for the retirement of long-term debts that do not mature currently is excluded from current assets and shown as a noncurrent investment. Cash in transit to the reporting entity (e.g., checks already mailed by the customer) cannot be included in cash because it is not under the control of the reporting entity.

Compensating balances.

An entity will often be required to maintain a minimum amount of cash on deposit, generally in connection with having a borrowing arrangement with a financial institution (compensating balance). The purpose of this balance may be to substitute for service fees foregone by the bank (or fees at a rate less than market) or simply to increase the yield on a loan to the lender. Since most organizations must maintain a certain working balance in their cash accounts simply to handle routine transactions and to cushion against unforeseen variations in the demand for cash, borrowers often will not find compensating balance arrangements objectionable. Nevertheless, the compensating balance is not available for unrestricted use and penalties will result if it is used. If material, the portion of the reporting entity's cash account that is a compensating balance must be segregated and shown as a separate caption on the statement of financial position, and this should be included in noncurrent assets if related borrowings are noncurrent liabilities. If the borrowings are current liabilities or if the compensating balance reduces fees that would have been incurred in the next year, it is acceptable to show the compensating balance as a separately captioned current asset.

Example of compensating balance disclosure

The Arkansas Billboard Company (ABC) has obtained a short-term, $10 million line of credit with Premier Bank. The loan agreement with Premier includes a requirement that ABC maintain a compensating balance of 5% of the maximum amount of the line of credit (5% × $10 million = $500,000). ABC also has a loan with First National Bank involving a single balloon payment of $200,000 due in two years, and requiring a compensating balance of 10%. (10% × $200,000 = $20,000) At year-end, ABC has cash balances of $782,000 at Premier and $28,000 at First National. ABC's reporting of cash on its statement of financial position is as follows:

Current assets:

Cash 290,000
Restricted cash compensating balances 500,000

Noncurrent assets:

Restricted cash compensating balances 20,000

Cash not immediately available.

Cash in savings accounts subject to a statutory notification requirement and cash in certificates of deposit maturing during the current operating cycle or within one year may be included as current assets but, if material, is to be separately captioned in the statement of financial position to avoid the misleading implication that these funds are available immediately upon demand. Typically, such items will be included in the short-term investments caption, but these could be labeled as time deposits or restricted cash deposits.

Overdrafts.

A reporting entity may issue checks with a dollar value exceeding the balance in its checking account. If the excess amount of these checks over the checking account balance has not yet cleared the bank, the overage is called a book overdraft, since the overdraft only exists in the reporting entity's accounting records. For reporting purposes, although the bank is yet unaware of this situation, the overdraft is reported as a liability, since the checks have already been released and are thus no longer under the control of the reporting entity. If the checks have cleared the bank, and the bank has advanced the reporting entity the funds (sometimes marketed as “automatic overdraft protection”), then this borrowing is also reported as a liability.

Petty cash.

Petty cash and other imprest cash accounts are usually combined in financial statements with other cash accounts.

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