Chapter 6 Reading Notes
Purchasing power: cash derives its values from its ability to be exchange for goods
and services in the future
- cash meets the recognition criteria of an asset
several possible cash valuation methods:
- face value
unit of measure assumption: specifies that the results of business activities should
be measured in terms of a monetary unit (eg Canadian dollar) – valuing items in
terms of purchasing power
internal control system: how a company controls its cash (safeguarding,
organization of a company’s assets through different policies and procedures)
- physical measures
- clear assignment of responsibilities
- separation of duties
- independent of verification
- proper documentation procedures
- an effective record-keeping and reporting system
bank reconciliation: ensures that any differences between the accounting records
for cash and the bank records are identified and explained.
A company’s accounting records are based on accrual accounting –
transactions are recorded as they occur
However, bank statement shows transactions when cash is received or paid
out from the bank account.
There can be timing differences between the cash movements at the bank
and the accounting records of a company.
A bank reconciliation is needed to reconcile the two.
Compensating balances: minimum balances that must be maintained in the bank
account to avoid significant service charges or to satisy restrictive loan covenants
Major feature of cash management: minimize cash balance b/c there are no returns
on current or chequing accounts.
> marketable securities: one way to convert cash into an earning asset -
-- publically traded or otherwise easily converted into cash – debt
securities and equity securities
probable value of short-term investments
o periodic payments o value of the security when it is sold in the future
1. historical costs: recording investments at their original acquisition costs – with
this method, changes in an investment’s market value has no effect on the balance
sheet or statement of earnings until the investment is actually sold
> when sold, realized gain or loss: the difference between the original
cost and its final market value is recognized.
2. market values: changes in the market values of the investments would cause
changes in the carrying values reported on the balance sheet and producing
corresponding gains or losses on the statement of earnings.
-- unrealized gains or losses: changes in market values while investments
3. lower of cost and market method: hybrid of the two – uses historical cost
unless the market value is less than the cost, in which case the market value is used.
Short-term investments are recorded at their fair (market) value. This is the
intention to value them at the amount of cash that could be received from selling
them. More relevant information and reconizied that the market values of such
investments are usually easily determinable, objective, and verifiable.
-the one type of investment that is not carried at market value is instruments that
have fixed cash payments and a maturity date – can be carried at cost if the
company intends to hold the investment to maturity and if the company is
financially capable of waiting that long to convert the investment to cash,
4 types of financial instruments
1. held for trading
2. available for sale
3. held to maturity
4. loans and receivables
Subsidiary account: many investments
Control account: short-term investments - holds the sum of all the subsidiary
amounts owed by customers from normal business transactions of selling
goods and services on credit. Either a formal contractual agreement or by
some other less formal documentation, such as a sales invoice.
the value of the cash that is to be received in the future is affected by
uncertainties – and also whether customers will pay the cash as agreed. Defaults are
called bad debts.
other uncertainties --- the customer might return the goods for credit, the
customer might request a price adjustment if the goods are damaged in shipment, or the customer might pay less than what is listed on the invoice if a discount is
allowed for prompt payment.
Present value: the concept that a dollar today is worth more than a dollar in the
future, b/c theoretically the company can invest that dollar to have more than a
dollar in the future.
third method is to consider that the receivable might not be paid.