An auditor sees $4.8 million in "Cash" on the trial balance. Inside that line: $800,000 of compensating balances under a 5-year revolver, a $250,000 sinking fund, and a 6-month T-bill bought at issuance. Restated, true cash drops $1.4 million and the current ratio breaches a loan covenant.
Cash includes currency on hand, demand deposits, savings accounts, money orders, certified and cashier's checks, undeposited customer checks, and petty cash. The line should be what you can actually access on demand for operations.
KEY: Postdated checks and IOUs are not cash, both are receivables.
A cash equivalent is a short-term, highly liquid investment readily convertible to a known cash amount with insignificant interest-rate risk. The operational rule: original maturity of three months or less from the date the entity acquires the instrument. Qualifying items include Treasury bills, commercial paper, money-market funds, and bank CDs, provided remaining maturity at purchase is 90 days or less.
TRAP: "Original maturity" means original to the holder, not original to the issuer. A 6-month T-bill purchased at issuance is not a cash equivalent, 180 days to go.
Common mistakes
- Treating a 6-month T-bill purchased at issuance as a cash equivalent. Original maturity is from acquisition. 180 days = short-term investment. Trap: candidates include the full $50,000 and overstate the line.
- Recording a journal entry for outstanding checks or deposits in transit. Both are bank-side timing items that clear themselves. A journal entry would double-count.
- Leaving a legally restricted compensating balance inside cash. A contractual minimum is restricted. Trap: $800,000 supporting a 5-year revolver belongs in noncurrent assets, not unrestricted cash.
Bottom line
- Cash equivalents require original maturity of three months or less from the date of acquisition, not from issuance
- Legally restricted compensating balances are reclassified out of cash (current if tied to short-term debt, noncurrent if tied to long-term debt); informal balances stay in cash
- Restricted cash must be reconciled into the Statement of Cash Flows beginning and ending balances under ASC 230
- The four-quadrant bank reconciliation produces a single true cash balance on both adjusted columns
Exam shortcut
For "cash and cash equivalents," walk a yes/no through every line: currency or demand deposit, original maturity 3 months or less from acquisition, not legally restricted, not an equity security. Anything that fails gets reclassified. For bank reconciliations: bank balance plus what the bank hasn't seen yet, minus what the bank hasn't paid yet, equals true cash.
The full lesson (about 2,224 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.A1
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