Based on the International Accounting Standards (IAS 7) and Philippine Accounting Standards (PAS 7), “Cash Equivalents” are short term, highly liquid investments that are readily convertible into cash, and are subject to an insignificant risk of changes in value because of changes in interest rates.
Furthermore, the standard states that, “only highly liquid investments that are acquired three months before the maturity can qualify as cash equivalents.”
Examples of Items Included as Cash Equivalents
- Three-Month Treasury Bill -Treasury bills are those investments issued by the government.
- One-year Treasury Bill Purchased Three- Months Before Date of Maturity - these are short term obligations issued by the government at a discount. Compared to Treasury Notes and Treasury Bonds that are long-term obligations issued also by the government which have a maturity of one year to less than ten years, and a maturity of ten years or more.
- Three-Month Money Market Instrument or Commercial Paper - Money Market Instruments are investments in portfolios of short term securities while Commercial Papers consist of short-term, unsecured notes payable that are issued in large denominations with high credit ratings to other companies and institutional investors. Money Market Instruments usually have a maturity date of less than 270 days thus making them highly liquid. A commercial paper with a maturity of 90 days or less may also be considered as cash equivalents.
- Three-Month Time Deposit - Time Deposit is an interest-earning deposit, normally made in fixed denomination and bears interest higher than that of other deposits, but usually depends on the amount of deposit and the time or maturity period-from 30 days to 5 years. The interest may be paid in advance or at the end of the time period agreed upon.
Examples of Items Not Included as Cash Equivalents
- Checks and bank drafts cannot qualify as cash equivalents since these are not short-term investments. When checks and banks drafts are available for unrestricted and immediate use, they are included as cash but not as cash equivalents.
- Equity securities cannot qualify as cash equivalents because shares do not have a maturity date. However, preference shares with specific redemption date and acquired three months before redemption date can qualify as cash equivalents.
Note that what is important is the date of purchase which should be three months or less before maturity when determining if an item is considered as a cash equivalent.
Cash Equivalents Sample Problem
Pygmalion Company had the following account balances on December 31, 2017:
What total amount should be reported as cash equivalents?