Understanding Cash and Cash Equivalents in the Context of the U.S. FAR CPA Exam
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Cash management is the lifeblood of any organization, and cash and cash equivalents are a well-tested topic on the FAR section of the CPA exam.
What are cash and cash equivalents?
Cash is a company's most basic asset — amounts payable on demand, consisting of coins, currency, and available funds held in bank accounts.
Cash equivalents are short-term, highly liquid investments that are easily convertible to known amounts of cash and have original maturities of three months or less. Examples include Treasury bills, money market funds, and commercial paper.
How are they recognized and measured?
Under U.S. GAAP, cash and cash equivalents are initially recognized at fair value, which typically equals the amount paid for them. They're presented on the balance sheet as current assets.
How do you record a cash deposit?
Example: A business owner deposits $50,000 into the company's bank account as a capital contribution.
- Debit Cash $50,000
- Credit Owner's Equity $50,000
How do you record buying a cash equivalent?
Example: A company invests $30,000 in a 2-month Treasury bill, which qualifies as a cash equivalent because its original maturity is three months or less.
- Debit Cash Equivalents $30,000
- Credit Cash $30,000
How do you record a cash equivalent maturing?
Example: The 2-month Treasury bill from the example above matures at $30,300 — the original $30,000 plus $300 of interest.
- Debit Cash $30,300
- Credit Cash Equivalents $30,000
- Credit Interest Income $300
What gets disclosed?
Companies must disclose the nature of their cash and cash equivalents, any restrictions on them, and their policies for managing these assets — giving financial statement users what they need to evaluate the company's liquidity position.
The line between cash and a cash equivalent comes down to original maturity. Anything payable on demand is cash; a short-term, highly liquid investment with an original maturity of three months or less is a cash equivalent — and when it matures, the difference between what you get back and what you paid is interest income.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.