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  Definition of Cash and Cash Equivalents

A Definition of Cash and Cash Equivalents

IAS 7 defines cash like notes and coins in hand and deposits in banks and identical institutions which are accessible to the business on demand. Cash equivalents are short-term, extremely liquid investments which are willingly convertible to known amounts of cash and that are subject to an unimportant risk of changes of value. Cash equivalents are held for the reason of meeting short-term cash commitments than for investment or other purposes.

Activity should describe the sorts of items that fall within the definition of 'cash equivalents'.

ACTIVITY:

At the end of its accounting period, Zeneb plc's statement of financial position included the following items:

1. A bank deposit account in which one month's notice of withdrawal is needed. This deposit was made since the business has temporary cash extra that it will require using in the short term for operating purposes.

2. Ordinary shares in Jones plc (a Stock Exchange listed business). These were obtained since Zeneb plc has temporary cash extra and its directors believed that the shares present a good short-term investment. The funds invested will require to be employed in the short term for operating purposes.

3. A bank deposit account which is withdrawn able instantly. This presents an investment of extra funds that are not seen as being required in the short term.

4. An overdraft on the business's bank current account, which (if any) of these 4 items would be involved in the figure for cash and cash equivalents?

Your reply should have been as follows:

1. A cash equivalent since the deposit is part of the business's normal cash management activities and there is slight doubt about how much cash will be acquired while the deposit is withdrawn.

2. Not a cash equivalent. Even though the investment was made as part of normal cash management, there is a important risk that the amount accepted (hoped for!) when the shares are sold may not in fact be forthcoming.

3. Not a cash equivalent since this presents an investment than a short-term extra amount of cash.

4. This is cash itself, however a negative amount of it. The only exception to this classification would be where the business is financed in the longer term through an overdraft, while it would be part of the financing of the business, than negative cash.

As can be described from the responses to Activity, whether a particular item falls under the definition of cash and cash equivalent relies on two factors:

  • The nature of the item; and
  • Why it has arisen.

Actually, it is not generally hard to decide whether an item is a cash equivalent.

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