Which Of The Following Items Are Not Included In Cash

The term "cash" in accounting and finance has a specific meaning, encompassing more than just physical currency. Understanding what constitutes cash and what doesn't is crucial for accurate financial reporting, analysis, and decision-making. While cash includes readily available funds that can be used for immediate transactions, certain items, though liquid, are excluded from this definition. This article explores the nuances of cash in financial contexts, delineating items that are not considered cash and providing a comprehensive understanding of the concept.

Defining Cash in Accounting

In accounting, cash refers to currency on hand, such as coins and banknotes, as well as demand deposits held in banks or other financial institutions. It includes items that are readily available for immediate use in transactions without any restrictions. Cash is a highly liquid asset, meaning it can be converted into other assets or used to settle obligations quickly and easily.

Key characteristics of cash:

• Liquidity: Cash is the most liquid asset, easily convertible into other assets or used for payments.
• Availability: Cash is immediately accessible for use in transactions.
• Lack of Restrictions: Cash is free from any restrictions that would prevent its immediate use.
• Valuation: Cash is valued at its face value.

Items Typically Included in Cash

Before delving into items excluded from cash, it's essential to identify what is typically included. These items meet the criteria of being readily available and free from restrictions:

• Currency: Physical money, including coins and banknotes, held by the company.
• Checking Accounts: Funds held in checking accounts at banks or other financial institutions.
• Savings Accounts: Funds in savings accounts that are immediately accessible.
• Money Orders: Negotiable instruments purchased for a specific amount and payable to a designated recipient.
• Bank Drafts: Checks drawn by a bank on its own funds, guaranteeing payment.
• Cashier's Checks: Checks issued by a bank, drawn on the bank's own funds, and signed by a bank official.
• Petty Cash: A small amount of cash kept on hand for minor expenses.

Items Not Included in Cash

Several items, although related to cash management, do not meet the strict definition of cash in accounting. These exclusions are due to restrictions, illiquidity, or uncertainty about their value.

1. Restricted Cash:

   • Definition: Cash that is set aside for a specific purpose and not available for general use. This could be due to contractual agreements, legal requirements, or management's intentions.
   • Examples:
     • Compensating Balances: Minimum balances required by banks to be maintained in a company's account as part of a loan agreement.
     • Funds for Plant Expansion: Cash earmarked for the construction of a new facility.
     • Sinking Funds: Funds set aside to repay long-term debt.
   • Accounting Treatment: Restricted cash is classified as either a current or non-current asset, depending on the expected date of its use. If the restriction is expected to last longer than one year, it is classified as a non-current asset. Otherwise, it is classified as a current asset but presented separately from unrestricted cash.

2. Postdated Checks:

   • Definition: Checks that are dated for a future date. These checks cannot be cashed or deposited until the date specified on the check.
   • Reason for Exclusion: Postdated checks are not immediately available for use and are subject to future events.
   • Accounting Treatment: Postdated checks received should not be included in cash until the date on the check arrives. Until then, they are typically treated as receivables.

3. IOUs (I Owe You):

   • Definition: Informal acknowledgments of debt, usually in the form of a signed note promising to repay a certain amount.
   • Reason for Exclusion: IOUs are not considered cash because they are not a standardized form of currency and their value depends on the debtor's ability to repay.
   • Accounting Treatment: IOUs are treated as receivables, representing the amount owed to the company.

4. Stale-Dated Checks:

   • Definition: Checks that are too old to be honored by the bank. Banks typically have a policy of not honoring checks presented after a certain period (e.g., six months).
   • Reason for Exclusion: Stale-dated checks are no longer negotiable and cannot be readily converted into cash.
   • Accounting Treatment: Stale-dated checks should be removed from the cash balance and treated as receivables. Efforts should be made to reissue the checks or find alternative payment methods.

5. Travel Advances:

   • Definition: Funds given to employees for travel-related expenses.
   • Reason for Exclusion: Travel advances are not available for general use and are intended for specific purposes.
   • Accounting Treatment: Travel advances are treated as receivables until the employee submits an expense report detailing how the funds were used.

6. Certificates of Deposit (CDs):

   • Definition: A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate, and can be issued in any denomination.
   • Reason for Exclusion: CDs are not immediately available for use because they have a fixed term and early withdrawal may result in penalties.
   • Accounting Treatment: CDs with a maturity of three months or less can be considered cash equivalents. Those with longer maturities are classified as short-term investments.

7. Money Market Funds:

   • Definition: A type of mutual fund that invests in short-term debt securities.
   • Reason for Exclusion: While highly liquid, money market funds are not considered cash because they are investments and their value can fluctuate.
   • Accounting Treatment: Money market funds are classified as short-term investments.

8. Equity Securities (Stocks):

   • Definition: Securities representing ownership in a corporation.
   • Reason for Exclusion: Stocks are not considered cash because their value is subject to market fluctuations and they are not immediately available for use.
   • Accounting Treatment: Stocks are classified as investments, either short-term or long-term, depending on the holding period and management's intentions.

9. Debt Securities (Bonds):

   • Definition: A debt instrument in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.
   • Reason for Exclusion: Bonds are not considered cash because their value is subject to market fluctuations and they are not immediately available for use.
   • Accounting Treatment: Bonds are classified as investments, either short-term or long-term, depending on the holding period and management's intentions.

10. Cryptocurrencies (e.g., Bitcoin):

    • Definition: A digital or virtual currency that uses cryptography for security.
    • Reason for Exclusion: Cryptocurrencies are not legal tender and their value is highly volatile. Their acceptance as a medium of exchange is limited.
    • Accounting Treatment: Cryptocurrencies are generally treated as intangible assets.

11. Bank Overdrafts:

    • Definition: Occurs when a company's checking account balance falls below zero, creating a negative balance.
    • Reason for Exclusion: Bank overdrafts represent a liability rather than an asset.
    • Accounting Treatment: Bank overdrafts are classified as current liabilities and are typically offset against cash accounts only if they are payable on demand and are part of the company’s cash management.

Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. These are often combined with cash for reporting purposes.

Examples of cash equivalents:

• Treasury Bills: Short-term debt obligations backed by the government.
• Commercial Paper: Unsecured, short-term debt instruments issued by corporations.
• Money Market Accounts: Savings accounts that offer higher interest rates and may have limited check-writing privileges.

The key criterion for an investment to be considered a cash equivalent is its short-term maturity, generally three months or less from the date of acquisition.

Importance of Accurate Cash Classification

Accurate classification of cash and cash equivalents is crucial for several reasons:

• Financial Statement Accuracy: Proper classification ensures that the balance sheet accurately reflects a company's financial position. Misclassifying items can distort key financial ratios and metrics.
• Compliance: Adhering to accounting standards (e.g., GAAP, IFRS) requires accurate classification of assets, including cash.
• Decision-Making: Investors, creditors, and management rely on accurate financial information to make informed decisions. Misclassification can lead to flawed analysis and poor decision-making.
• Cash Management: Understanding what constitutes cash helps in effective cash management and liquidity planning.

Real-World Examples

1. A company has $500,000 in a bank account. Of this, $200,000 is a compensating balance required by a loan agreement.

   • Treatment: $300,000 is classified as cash, while $200,000 is classified as restricted cash. The restricted cash may be classified as current or non-current depending on the term of the restriction.

2. A company receives a check dated one month in the future for $10,000.

   • Treatment: The $10,000 check is not included in cash until the date on the check arrives. Until then, it is treated as a receivable.

3. A company holds $50,000 in Treasury Bills that mature in 60 days.

   • Treatment: The $50,000 is classified as a cash equivalent because it is a short-term, highly liquid investment with a maturity of less than three months.

4. A company has $100,000 set aside in a sinking fund for debt repayment in five years.

   • Treatment: The $100,000 is classified as restricted cash and is presented as a non-current asset because the restriction extends beyond one year.

5. A company holds 100 shares of stock in another corporation.

   • Treatment: The stock is classified as an investment, either short-term or long-term, depending on management’s intentions and the holding period.

Best Practices for Cash Management and Reporting

• Establish Clear Policies: Develop clear policies for defining, classifying, and managing cash and cash equivalents.
• Regular Reconciliation: Perform regular bank reconciliations to ensure the accuracy of cash balances.
• Segregation of Duties: Implement segregation of duties to prevent fraud and errors in cash handling.
• Proper Documentation: Maintain proper documentation for all cash transactions.
• Consult Accounting Standards: Refer to relevant accounting standards (GAAP, IFRS) for guidance on cash classification and reporting.
• Continuous Monitoring: Regularly monitor cash balances and liquidity to ensure financial stability.

Conclusion

Understanding the nuances of what is and isn't included in cash is fundamental to accurate financial reporting and effective cash management. While cash encompasses readily available funds for immediate transactions, several items, such as restricted cash, postdated checks, and certain investments, are excluded due to restrictions, illiquidity, or uncertainty about their value. By adhering to accounting standards and implementing best practices for cash management, companies can ensure the accuracy and reliability of their financial statements and make informed decisions about their financial resources. Accurate cash classification not only enhances financial transparency but also supports sound financial planning and decision-making, contributing to the overall financial health and stability of the organization. Properly distinguishing between cash and other liquid assets allows stakeholders to gain a clear understanding of a company's liquidity position, aiding in risk assessment and strategic planning.