FAR SEC 4

Question 1

How liquid is cash?

Answer 1

Cash is the most liquid of assets.

Question 2

Why must the control of cash be strong?

Answer 2

Because of that liquidity and the ability to transfer it electronically, internal control of cash must be strong.

Question 3

What is the role of cash in financial accounting?

Answer 3

As the customary medium of exchange, it also provides the standard of value (the unit of measurement) of the transactions that are reported in the financial statements. Cash is the unit of account for financial accounting.

Question 4

When would cash not be considered a current asset?

Answer 4

Cash is classified as a current asset unless its use is restricted to such purposes as payments to sinking funds.
-In this case, cash is reported as a noncurrent asset with an account title such as bond sinking fund.

Question 5

Which items are counted as cash on the cash amount shown on the balance sheet? (4 elements)

Answer 5

To be classified as current, cash must be readily available for use. The cash account on the balance sheet should consist of
1) Coin and currency on hand, including petty cash and change funds
2) Demand deposits (checking accounts)
3) Time deposits (savings accounts)
4) Near-cash assets

Question 6

What are the near-cash assets? (4 elements)

Answer 6

1) They include many negotiable instruments, such as money orders, bank drafts, certified checks, cashiers’ checks, and personal checks.
2) They are usually in the process of being deposited (deposits in transit).
3) They must be depositable (excluding unsigned and postdated checks).
4) Checks written to creditors but not mailed or delivered at the balance sheet date should be included in the payor’s cash account (not considered cash payments at year end).

Question 7

How should checks written to creditors but not mailed or delivered at the balance sheet date be reported? What kind of asset is this type of item?

Answer 7

Checks written to creditors but not mailed or delivered at the balance sheet date should be included in the payor’s cash account (not considered cash payments at year end). These are near-cash assets.

Question 8

What is restricted cash? How should it be reported?

Answer 8

Restricted cash is not actually set aside in special accounts. However, it is designated for special uses and should be separately presented and disclosed in the notes.

Question 9

What are three common examples of restricted cash? Is restricted cash current or noncurrent?

Answer 9

1) Examples are bond sinking funds, new building funds, and restricted compensating balances.
2) The nature of the use determines whether restricted cash is current or noncurrent.
A bond sinking fund used to redeem noncurrent bond debt is noncurrent, but a fund to be used to redeem bonds currently redeemable is a current asset.

Question 10

Is restricted cash current or noncurrent?

Answer 10

It depends. The nature of the use determines whether restricted cash is current or noncurrent.
A bond sinking fund used to redeem noncurrent bond debt is noncurrent, but a fund to be used to redeem bonds currently redeemable is a current asset.

Question 11

What are compensating balances?

Answer 11

As part of an agreement regarding either an existing loan or the provision of future credit, a borrower may keep an average or minimum amount on deposit with the lender. This compensating balance increases the effective rate of interest paid by the borrower.

It also creates a disclosure issue because the full amount reported as cash might not be available to meet general obligations.

Question 12

What are cash equivalents? (5 attributes)

Answer 12

Cash equivalents are
1) short-term,
2) highly liquid investments.

Cash equivalents are
3) Readily convertible to known amounts of cash and
4) So near maturity that interest rate risk is insignificant.
5) Only investments with an original maturity to the holder of 3 months or less qualify.

Question 13

What are three common examples of cash equivalents?

Answer 13

Common examples are Treasury bills, money market funds, and commercial paper.

Question 14

What are the three major categories of noncash items?

Answer 14

1) Noncash receivables - NSF checks, postdated checks, & advances for expenses to employees
2) Noncash liabilities - Overdrafts
3) Noncash short-term investments

Question 15

Which three noncash items are treated as receivables?

Answer 15

(1) Nonsufficient funds (NSF) checks and (2) postdated checks should be treated as receivables.
(3) Advances for expenses to employees may be classified as receivables (if expected to be paid by employees) or as prepaid expenses.

Question 16

What kind of item is an overdraft?

Answer 16

An overdraft is a current liability unless the entity has sufficient funds in another account at the same bank to cover it.

Question 17

How should noncash short-term investments be classified on the balance sheet?

Answer 17

Noncash short-term investments are usually substantially restricted and thus not readily available for use by the entity. They should be classified as current or temporary investments, not cash. However, they may qualify as cash equivalents.

Question 18

What are the four main types of noncash short-term investments?

Answer 18

1) Money market funds
2) Commercial paper
3) Treasury bills
4) Certificates of deposit

Question 19

What are money market funds?

Answer 19

Money market funds are essentially mutual funds that have portfolios of commercial paper and Treasury bills. However, a money market fund with a usable checking feature might be better classified as cash.

Question 20

What is commercial paper?

Answer 20

Commercial paper (also known as negotiable instruments) consists of short-term (no more than 270 days) corporate obligations.

Question 21

What are treasury bills?

Answer 21

Treasury bills are short-term, guaranteed U.S. government obligations.

Question 22

What are certificates of deposit?

Answer 22

Certificates of deposit are formal debt instruments issued by a bank or other financial institution and are subject to penalties for withdrawal before maturity.

Question 23

How is cash recorded? (4 elements)

Answer 23

1) Cash may be recorded in a general ledger control account, with a subsidiary ledger for each bank account. An alternative is a series of general ledger accounts.
2) On the balance sheet, one account is presented. It reflects all unrestricted cash.
3) Each transfer of cash from one account to another requires an entry.
4) At the end of each period, a schedule of transfers should be prepared and reviewed to make certain all cash transfers are counted only once.

Question 24

What is a bank reconciliation?

Answer 24

A bank reconciliation is a schedule comparing the cash balance per books with the balance per bank statement (usually received monthly). The common approach is to reconcile the bank balance to the book balance to reach the true balance.

-The bank and book balances usually vary. Thus, the reconciliation permits the entity to determine whether the difference is attributable to normal conditions, error, or fraud. It is also a basis for entries to adjust the books to reflect unrecorded items.

-The bank and the entity inevitably record many transactions at different times. Both also may make errors.

Question 25

In bank statement reconciliation, what are the three items known to entity but not known to bank?

Answer 25

1) Outstanding checks. The books may reflect checks written by the entity that have not yet cleared the bank. These amounts are subtracted from the bank balance to arrive at the true balance.
2) Deposits in transit. A time lag may occur between deposit of receipts and the bank’s recording of the transaction. Thus, receipts placed in a night depository on the last day of the month are reflected only in the next month’s bank statement. These receipts are added to the bank balance to arrive at the true balance.
3) Errors. If the bank has wrongly charged or credited the entity’s account (or failed to record a transaction at all), the error will be detected in the process of preparing the reconciliation.

Question 26

For bank statement reconciliation, what are the three items known to the bank but not known to the entity?

Answer 26

1) Amounts added by the bank. Interest income added to an account may not be included in the book balance. Banks may act as collection agents, for example, for notes on which the depositor is the payee. If the depositor has not learned of a collection, it will not be reflected in its records.
-These amounts are added to the book balance to arrive at the true balance.
-They should be recorded on the entity’s books, after which they are no longer reconciling items.
3) Amounts subtracted (or not added) by the bank. These amounts generally include service charges and customer checks returned for insufficient funds (NSF checks). Service charges cannot be recorded in the books until the bank statement is received. Customer checks returned for insufficient funds are not added to the bank balance but are still included in the book balance.
These amounts are subtracted from the book balance to get the true balance.
They should be recorded on the entity’s books, after which they are no longer reconciling items.
3) Errors. Bookkeeping errors made by the entity will likewise be discovered.

Question 27

For bank statement reconciliation, what are the three categories of additions and three categories of subtractions to the book balance?

Answer 27

Additions to Book Balance
1) Interest earned
2) Deposits collected
3) Errors

Subtractions from Book Balance
1) Service Charges
2) NSF Checks
3) Errors

Question 28

For bank statement reconciliation, what are the two categories of additions and two categories of subtractions to the book balance?

Answer 28

Additions to Bank Balance
1) Deposits in transit
2) Errors

Subtractions from Bank Balance
1) Outstanding checks
2) Errors

Question 29

What is shown on the matrix for Common Reconciliation Items?

Answer 29