Cash and Temporary Investments

1
Cash andTemporary Investments

• Overview
• Definition of Cash
• Cash Valuation and GAAP
• Cash Control (the Bank Reconciliation)
• Temporary Investments

2
Monetary Assets

• The assets of cash, temporary investments,
  accounts receivable are monetary assets.
• Why?

3
Cash

• Definition
• Cash means currency, cheques, money orders,
  amounts in bank accounts that can be used with
  very short notice and deposits ready to be
  deposited into bank accounts.

4
Cash

• Is an asset (It meets the recognition criteria.)
  
• It has probable future value thats measurable.
• Company owns or has the right to use p.f.v.
• Ownership or right arose from a past event.

5
Cash

• Recognition Criteria
• It has probable future value in that it can be
  exchanged for goods and services in the future.
  (purchasing power).
• Its measurable through the face value of the
  money on-hand and/or the companys bank balance.
• Right to use is evidenced by possession.
• A past event is evidenced by the fact that cash
  is present. A past event transferred cash to the
  company.

6
Cash

• Purchasing Power
• The future purchasing power of cash is not the
  same as its current purchasing power.
• Why?

7
Cash

• Purchasing Power
• In the late 70s and the 80s the Canadian
  economy experienced high rates of inflation.
• Briefly, from 1982 until inflation rates returned
  to much lower levels in 1992, the CICA adopted
  guidelines that requested that corporations
  present supplementary information regarding the
  effects of changing price levels on financial
  results.
• Currently, in Canada, there is no systematic
  reporting of the effects of inflation.

8
Cash

• Valuation (under GAAP)
• There is an assumption, under GAAP, that
  specifies that the results of activities of a
  corporation should be measured in terms of a
  monetary unit.
  (unit of measure assumption).
• Therefore, domestic cash is measured at its face
  value.

9
Cash

• Valuation (under GAAP)
• Foreign currencies, however, must be converted to
  Canadian dollars.
• This conversion takes place on the balance sheet
  date at the exchange rate on that date.
• Any gain or loss from one balance sheet date to
  the next is reported on the income statement as a
  foreign currency transaction gain or foreign
  currency transaction loss

10
Cash

• Valuation (under GAAP)
• Foreign currencies exchange rates fluctuate due
  to changes in the purchasing power of the
  individual foreign currencies as well as changes
  in the purchasing power of the Canadian dollar.
• These fluctuations are partially due to changes
  in the inflation rates in the foreign country and
  in Canada.

11
Cash

• Cash Control and Management
• The goal of cash control is to ensure it is not
  lost or stolen.
• Simple policies such as having cash deposited to
  bank accounts at least daily, using secure safes
  to hold cash until its deposited, writing cheques
  and keeping as little cash on hand as possible
  address this goal.

12
Cash

• Cash Control
• One normal control procedure is the bank
  reconciliation.
• This procedure reconciles the bank balance
  recorded by the corporation to that recorded by
  the bank.

13
Cash

• Cash Control (the Bank Reconciliation)
• Transactions that have been recorded in the
  companys general ledger bank account are matched
  with the transactions that have been recorded on
  the bank statement within a given period.
  (usually monthly).
• See steps outlined on handout - Preparing the
  Bank Reconciliation.

14
Cash

• Cash Control (the Bank Reconciliation)
• Ideally, the reconciliation should be conducted
  by someone not in charge of the bank account or
  accounting records. (Separation of Duties)

15
Cash

• Cash Management
• One goal of cash management is to ensure there is
  sufficient cash available in bank accounts to pay
  expenses.
• The second goal is to ensure that there is not
  too much cash on hand.
• Cash does not earn a return. Therefore, the
  corporation will want to keep as much of its cash
  as possible in income earning assets. (e.g.
  savings accounts and short-term investments)

16
Cash

• Additional Considerations
• A corporation may be required, by its bank to
  maintain minimum balances in its bank account to
  minimize service charges or to satisfy bank loan
  covenants.
• A corporation may decide to restrict some cash to
  a specific use. In this case, the restricted
  cash should be segregated from other amounts of
  cash.

17
Temporary Investments

• Cash does not earn a return.
• Temporary Investments are one way to convert
  cash to an earning asset.
• Short-term investments include marketable
  securities (i.e. assets that are publicly traded)
  as debt instruments (Treasury Bills, bonds, or
  Guaranteed Investment Certificates) or equity
  (shares) in another entity.

18
Temporary Investments

• Liquidity is important in managing a
  corporations cash position.
• Securities that are not easily converted to cash
  within the year do not fall under this section.
  They are non-current investments and are not
  considered marketable securities.

19
Temporary Investments

• Recognition Criteria
• They have probable future value in that (1) they
  will produce periodic payments - interest for
  debt securities and dividends for equity
  securities and (2) they will have a value when
  they mature or are sold in the future.
• Its measurable through the face value of the
  debt instrument or the market value of the equity
  security.
• Right to use and past event is evidenced by
  possession. (e.g. paper for bonds and share
  certificates or broker account entries)

20
Temporary Investments

• Risk
• The resale price or future price of a short-term
  investment is very important to a company in the
  management of its cash.
• The issuers of debt may default on payments.
• The value of equity shares is subject to market
  fluctuations. Also, the corporation issuing the
  shares may fail (therefore, value will be zero).

21
Temporary Investments

• Risk (contd)
• Even debt instruments such as bonds have
  experienced volatility recently.
• Corporate bonds, especially those from highly
  leveraged companies, will be subject to the
  greatest volatility. (but offer higher interest
  rates).
• To reduce risk and volatility, a company may
  invest in government bonds. (but lower interest
  rates).

22
Temporary Investments

• Valuation (under GAAP)
• Held in place of cash. Therefore, the intent is
  to show them at the amount of cash expected to be
  received.
• To be conservative, however, theyre shown at
  cost (historical cost).
• The exception is when market prices drop below
  cost. Then, theyre shown at market price.

23
Temporary Investments

• Valuation (under GAAP)
• Lower of cost or market (LCM) valuation is
  consistent with the conservative principle in
  accounting (i.e. losses should be recognized as
  soon as they can be estimated, but gains should
  be deferred until they are realized).

24
Temporary Investments

• Classification (under GAAP)
• If management intends to hold the security for
  less than one year, and the security is readily
  marketable,
• it is classified as a ___?____asset.

25
Temporary Investments

• Classification (under GAAP)
• When market prices drop below cost, shown at
  market price.
• A contra-asset account, Valuation Allowance for
  Temporary Investments, is credited with the
  difference between cost and market.
• Pgs. 345-351 give clear examples of the types of
  entries and accounts that are affected by
  transactions.

26
Temporary Investments

• Disclosure requirements
• Canadian GAAP requires that market values be
  disclosed.
• Information on any unrecorded gains or losses is
  usually disclosed in the notes to the financial
  statements. (i.e. besides individual unrecorded
  gains, there may also be unrecorded losses if
  they are contained in a portfolio and, within the
  portfolio, gains on some securities offset losses
  in others.)

27
Temporary Investments

• Re control of the acquired corporation in
  short-term equity investments
• Purchase of shares normally carry a vote
  entitling the owner to vote for the board of
  directors.
• Normally these are passive investments (i.e.
  the acquiring company has no intention to
  exercise control and, in most cases, doesnt own
  enough shares to allow it to exercise much
  control.)