Cash and Cash Equivalents
Chapter Forty-Six
Syllabus topic 2, "Concept of cash and cash equivalents"
Pages 125 to 127 of 162
In one line
Cash is money; a cash equivalent is an investment so short and so safe that holding it is the same as holding money; and moving between the two is not a cash flow at all.
The definitions, in AS 3's words
| Term | Paragraph | Definition |
|---|---|---|
| Cash | paragraph 5.1 | Cash on hand and demand deposits with banks |
| Cash equivalents | paragraph 5.2 | Short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value |
| Cash flows | paragraph 5.3 | Inflows and outflows of cash and cash equivalents |
The two tests for a cash equivalent
Paragraph 6 turns the definition into a test, and both limbs must be satisfied.
| Test | What it excludes | |
|---|---|---|
| 1 | Readily convertible to a known amount of cash | Anything whose realisable amount is uncertain |
| 2 | Subject to an insignificant risk of changes in value | Anything whose value moves with a market |
And the paragraph gives the practical rule: an investment normally qualifies only when it has a short maturity of, say, three months or less from the date of acquisition.
From the date of ACQUISITION, not from the balance sheet date. A five-year bond with two months left to run is not a cash equivalent, because its maturity when acquired was five years. This is the trap in the definition and it is asked.
Shares are excluded, with one exception
Paragraph 6 again: investments in shares are excluded from cash equivalents unless they are, in substance, cash equivalents, and it gives the example: preference shares of a company acquired shortly before their specified redemption date, provided there is only an insignificant risk of failure to repay.
Why shares are excluded generally. An equity share has no maturity and its value moves with the market, so it fails both tests. The redeemable preference share bought a month before redemption has a fixed amount and a fixed date, so it passes both.
Worked classifications
| Item | Cash equivalent? | Why |
|---|---|---|
| Cash in hand | Cash | Definition 5.1 |
| Balance in a current account | Cash | A demand deposit |
| A 60-day fixed deposit taken today | Yes | Maturity under three months from acquisition |
| A 12-month fixed deposit taken today | No | Maturity over three months |
| A 12-month fixed deposit with 2 months left | No | Maturity is measured from acquisition |
| Treasury bills maturing in 91 days, bought today | Yes | Short, known amount, negligible risk |
| Equity shares of a listed company | No | No maturity and the value moves |
| Redeemable preference shares bought one month before redemption | Yes | Fixed amount, fixed date, negligible risk |
| A bank overdraft | See below |
The bank overdraft
AS 3 does not treat an overdraft as a negative cash balance, unlike the international standard. In Indian practice under AS 3 an overdraft is a borrowing, so:
The rest of this chapter
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