Cash and Cash Equivalents

Cash is the lifeblood of any entity. Without it, even a profitable business can fail. This study unit covers how cash is controlled, how to detect differences between the entity’s records and the bank’s records, and how small day-to-day cash payments are managed through petty cash.

1. The nature of cash and cash equivalents

In accounting, cash includes not just physical coins and notes, but also postal orders, cheques, and credit card transactions. Cash equivalents include savings accounts and any short-term investment that can be converted to cash within 12 months. Both qualify as current assets on the statement of financial position.

2. Internal control over cash

Because cash is so easily misappropriated, strong internal controls are essential. The following measures should be in place:

• Segregation of duties — at least two employees must be involved so that one person’s error or dishonesty is caught by another’s normal duties
• Independent records — cash receipts must be recorded so actual cash received can be checked against a daily record
• Daily banking — all cash received must be deposited into the bank daily
• Payments by cheque or EFT — all payments except petty cash must be made by cheque or electronic transfer (never by cash)
• Journal vs bank statement comparison — the cash journals must be compared with the bank statement regularly
• Bank reconciliation — the bank account balance must be reconciled with the bank statement balance at least monthly

3. Why a bank reconciliation is necessary

In theory, since both the entity and the bank record the same transactions, the balance in the entity’s bank account and the balance on the bank statement should always agree. In practice, they almost never do at any given point in time — because of timing differences and items the entity doesn’t yet know about.

A bank reconciliation statement is prepared to explain and account for every difference between the two balances. The process has two steps:

1. Update the entity’s records — record items that appear on the bank statement but not yet in the entity’s cash journals (these require journal entries)
2. Prepare the bank reconciliation statement — list items that are in the entity’s records but not yet on the bank statement (these don’t require journal entries — the bank will deal with them)

4. What appears on the bank statement

The bank statement is prepared from the bank’s perspective. Remember: when you deposit money, you are a creditor of the bank — the bank owes you the money. So on the bank statement:

The bank statement typically shows: opening balance, deposits credited, cheques debited, bank charges, interest on overdraft or credit, direct deposits by third parties, dishonoured cheques, stop orders, and corrections of errors.

5. Key terminology

6. The reconciliation procedure

7. Bank reconciliation statement format

The bank reconciliation statement begins with the balance per bank statement and adjusts to arrive at the balance per bank account in the entity’s ledger. Both sides must agree.

8. Worked example — Benson Traders (July 20.0)

Step 1: Items to add to the cash journals (entity must act)

After comparing the bank statement with the June reconciliation and the July cash journals, the following items were identified on the bank statement but not in the journals:

• CRJ additions: Rental income R850 (direct deposit by R Charles) and Interest received R80
• CPJ additions: Dishonoured cheque — S Swan R200 (R/D) | Dishonoured cheque — P Saxo R300 (R/D) | Insurance stop order R500 | Bank charges R43 | Deposit book error R20 (bank debited entity in error — later corrected as credit)

After updating the journals, the bank account in the ledger shows a closing balance of R18 807 (favourable).

Step 2: Bank reconciliation statement

Items in the entity’s journals but not yet on the bank statement:

• Outstanding cheque No 11 (donation, dated 23/6/20.0) — R200 (still unpresented)
• Outstanding cheque No 18 (Telkom, dated 30/7/20.0) — R180
• Deposit not yet credited (deposited 1/8/20.0) — R1 800

9. Bank reconciliation builder

Enter your bank statement balance and the outstanding items to build a reconciliation statement and verify your bank account balance.

10. The petty cash journal

It is impractical — and inefficient — to write a cheque for every small expense like stamps, tea, or taxi fares. The solution is a petty cash system.

The imprest system

Under the imprest system, the petty cash fund starts with a fixed amount called the petty cash float. Each payment is supported by a petty cash voucher. At regular intervals (or when the float runs low), the fund is restored to its original amount by drawing a cheque from the bank account equal to the total payments made. This means the float is always the same amount at the start of each period.

The petty cash journal (PCJ)

The petty cash journal has two sides: a receipts side (when cash cheques are received to top up the float) and a payments side (recording every payment by category). At month-end, the column totals on the payments side are posted to the relevant expense accounts in the general ledger.

Worked example — Pitsi Dealers (August 20.4)

Float: R200. Payments made during August. Float restored twice (15 Aug and 31 Aug).

11. Worked exercises

Bank reconciliation and petty cash questions in the FAC1502 exam style.

12. Quick quiz

Twelve questions on cash control, bank reconciliation and petty cash.