Understanding Cash and Cash Equivalents in the Context of the U.S. FAR CPA Exam

One of the primary topics covered in the Financial Accounting and Reporting (FAR) section of the U.S. CPA exam is "Cash and Cash Equivalents." Understanding this audit area is crucial as cash management is the lifeblood of any organization. This article aims to explore what cash and cash equivalents are, how they are recognized, measured, and valued under U.S. Generally Accepted Accounting Principles (U.S. GAAP).

Cash

Cash is the most basic asset of a company and represents amounts that are payable on demand. It consists of coins, currency, and available funds that a company has in its bank accounts.

Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are easily convertible to known amounts of cash and with original maturities of three months or less. Examples include Treasury bills, money market funds, and commercial paper.

Recognition and Measurement

According to U.S. GAAP, cash and cash equivalents should be initially recognized at their fair value, which typically equals the amount paid for these assets. They should be presented in the balance sheet under current assets.

Examples

Example 1: Journal Entry for Cash Deposit

If a business deposits $50,000 into its bank account, the journal entry would be:

· Debit Cash $50,000

· Credit Revenue or Owner's Equity $50,000

Example 2: Journal Entry for Purchase of Cash Equivalents

Let’s say a company decides to invest $30,000 in a 2-month Treasury bill. The journal entry would be:

· Debit Cash Equivalents $30,000

· Credit Cash $30,000

Example 3: Journal Entry for the Maturity of Cash Equivalents

If the 2-month Treasury bill in Example 2 matures at $30,300, the journal entry would be:

· Debit Cash $30,300

· Credit Cash Equivalents $30,000

· Credit Interest Income $300

Disclosures 

Companies are required to provide sufficient information about the nature of their cash and cash equivalents, any restrictions, and the policies for managing these assets. The objective is to provide financial statement users with comprehensive data to evaluate the company's liquidity position.