Lecture 01: Cash. [Intermediate Accounting]

Sir Win - Accounting Lectures

6 chapters7 takeaways20 key terms5 questions

Overview

This lecture introduces the concept of cash in accounting, beginning with its historical evolution from barter systems to modern currency. It explains the functions of money as a medium of exchange and its definition as currency and coins that are legal tender. The video then delves into the accounting definition of cash, which includes money, negotiable instruments accepted for deposit, and discusses its presentation as a current asset, with exceptions for restricted cash. The measurement of cash is also covered, emphasizing its initial and subsequent measurement at face value, with considerations for foreign currency and estimated recoverable amounts in specific situations. Finally, the lecture details various cash items and negotiable instruments, such as checks (customer, manager's, cashier's, traveler's), bank drafts, and money orders, explaining their characteristics and accounting treatment.

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Chapters

The barter system, where goods are directly exchanged, suffered from the 'double coincidence of wants' problem.
Gold emerged as an early form of currency because it was universally desired, facilitating trade.
The weight and inconvenience of carrying physical gold led to the development of paper receipts representing gold deposits.
These receipts evolved into paper money and coins, backed by gold reserves (gold standard), and eventually transitioned to fiat currency systems.
The historical development explains why cash is accepted as a medium of exchange and legal tender.

Understanding the history of cash helps appreciate its fundamental role as a medium of exchange and why it is accepted as having value, which is crucial for accounting.

Early trade involved exchanging shoes for meat. When one party wanted meat but only had shoes, and the other party didn't want shoes, the transaction failed. This inefficiency was overcome when gold became a universally accepted item for exchange.

In layman's terms, cash is equivalent to money, serving as a standard medium of exchange.
Money (currency and coins) is a medium of exchange because it facilitates transactions that would otherwise be difficult.
Legally, money is considered legal tender, meaning it must be accepted for payment of debts.
In accounting, cash is defined more broadly to include money, negotiable instruments accepted for deposit, and items credited immediately by a bank.
This broader definition acknowledges the historical link between cash, banking, and the acceptance of various instruments.

Distinguishing between the everyday understanding of cash and its precise accounting definition is essential for accurate financial reporting.

A piece of paper with '1000' written on it is just paper to a layman, but to an accountant, it's cash if it's currency or a negotiable instrument accepted by a bank for deposit and immediate credit.

Cash is typically presented as a current asset, often as the first line item, due to its high liquidity.
Cash is considered unrestricted if it can be used for any purpose; restricted cash, held for more than 12 months, is not classified as a current asset.
Cash is initially measured at its face value (the amount printed on it).
Subsequent measurement of cash also occurs at face value, as its value generally does not change over time.
Foreign currency is converted to the reporting currency using the current exchange rate at the reporting date.

Proper classification and valuation of cash are critical for assessing a company's liquidity and financial health.

If a company has $10,000 in a bank account that is restricted due to a lawsuit for the next 18 months, it would not be classified as a current asset because the restriction exceeds 12 months.

Cash on hand refers to money and negotiable instruments that have not yet been deposited in the bank.
Cash in bank includes funds held in checking accounts (demand deposits) and savings accounts.
Checking accounts are primarily for transactions and are often associated with negotiable instruments like checks.
Savings accounts are primarily for accumulating funds and typically earn interest.
The distinction between cash on hand and cash in bank is mainly based on location.

Differentiating between cash on hand and cash in bank is the first step in managing and accounting for a company's liquid assets.

Undeposited customer checks received by a business are considered cash on hand, while funds in the company's checking account at a bank are cash in bank.

Checks are negotiable instruments that represent a promise to pay a specific amount from a bank account.
Customer checks are those received from customers and not yet deposited; their value is uncertain until cleared.
Manager's checks and cashier's checks are issued by the bank itself, guaranteeing funds and thus considered highly reliable.
Traveler's checks are pre-paid by travelers and are also guaranteed by the issuer, making them reliable.
These instruments are generally considered cash equivalents because they are readily convertible to cash.

Understanding the different types of checks and their reliability is crucial for assessing their immediate cash value and potential risks.

A customer check might bounce if the customer has insufficient funds, but a cashier's check is guaranteed by the bank, making it a safer form of payment.

Bank drafts are similar to cashier's checks, guaranteed by the bank, and are considered very secure.
Money orders are purchased from financial institutions and represent a pre-paid amount, functioning similarly to checks.
Undelivered checks, though prepared, are not yet considered a cash outflow until they are delivered to the payee.
Post-dated checks, dated for a future date, are not considered cash outflows until that date arrives.
Stale checks, which are old and have not been cashed within a reasonable period, may no longer be valid and can be written off or reissued.

Recognizing various negotiable instruments and understanding specific bank transaction scenarios ensures accurate accounting for cash flows and liabilities.

If a check is written for $1,000 but dated for next week, it is a post-dated check and does not reduce the current cash balance until the future date arrives.

Key takeaways

1The historical evolution from barter to gold to paper currency highlights the increasing efficiency and standardization of exchange.
2In accounting, cash is defined broadly to include not just physical money but also instruments readily convertible to cash and accepted by banks.
3Cash is a current asset because of its liquidity, but restrictions can change its classification.
4The measurement of cash at face value is a key principle, with exceptions for foreign currency and specific situations like bank failures.
5Different types of checks (customer, manager's, cashier's, traveler's) have varying levels of reliability and risk.
6Items like undelivered, post-dated, and stale checks require careful accounting treatment to reflect their true cash impact.
7Understanding these nuances is vital for accurate financial reporting and decision-making.

Key terms

Barter SystemMedium of ExchangeLegal TenderNegotiable InstrumentCurrent AssetFace ValueCash on HandCash in BankDemand DepositSavings DepositCustomer CheckManager's CheckCashier's CheckTraveler's CheckBank DraftMoney OrderUndelivered CheckPost-dated CheckStale CheckBank Overdraft

Test your understanding

1Why did the barter system eventually become inefficient, and how did the introduction of universally desired items like gold solve this problem?
2What is the accounting definition of cash, and how does it differ from the layman's understanding?
3Under what circumstances would cash not be classified as a current asset?
4Explain the difference in reliability between a customer check and a cashier's check.
5How should an accountant treat a post-dated check and a stale check in financial reporting?