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Composition of Cash - Cash Equivalents in Financial Accounting
Cash is composed of funds that are readily available. This includes cash on hand and cash on deposit in bank accounts that do not restrict the withdrawal of cash. Deposits in checking accounts would qualify because those balances can be withdrawn on demand. Because banks rarely enforce restrictions on withdrawals from savings accounts, they are usually classified as cash. Also classified as cash are money market funds permitting withdrawal by check, checks from customers awaiting deposit, and foreign currency (converted to dollars). Items not classified as cash include certificates of deposit, stamps, and postdated checks.
Large corporations may have hundreds of checking accounts. Multiple accounts are needed because firms have numerous physical locations and each location makes expenditures. Firms also find it convenient to use separate accounts for specific purposes. Many firms use one or more checking accounts solely for payroll purposes, for example. All checking accounts are condensed into the one cash item on the balance sheet. Many firms keep petty cash funds on hand to pay for small, incidental expenditures, such as cab fare or delivery charges. These funds are included in the cash amount on the balance sheet. Many retailers also keep change funds. These funds enable cashiers to make change for their customers. Change funds are also included in the cash item on the balance sheet.
As a part of borrowing agreements with banks, firms sometimes agree to maintain compensating balances. These are minimum amounts the firm agrees to keep on deposit at the lending bank in accounts that pay little or no interest. As a result, the bank is able to use these funds interest free. This provides the bank with additional compensation for lending funds to the firm. Compensating balances are usually included in the balance sheet cash amount and are disclosed in the notes to the financial statements.
Instead of showing a cash item on their balance sheets, some firms use the term cash and cash equivalents. Recall from previous chapters that cash equivalents are short-term, highly liquid investments that will mature within three months. Examples include certificates of deposit, treasury bills, and commercial paper (short-term obligations of corporations). Because cash equivalents can readily be converted into known amounts of cash, reporting a combined cash and cash equivalents figure is probably as informative as reporting each figure separately.
OshKosh B’Gosh (OB) follows the practice of reporting a combined figure for cash and cash equivalents. Figure 5.1 contains an excerpt from its financial statement note describing this policy.
Figure 5.1 - Disclosure of Cash Reporting Policy
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