Chapter 6.doc

Chapter6
Cash and Highly-Liquid Investments
goals discussion goals achievement fill in the blanks multiple choice problems check list
and key terms
GOALS
Your goals for this "cash and highly-liquid investments" chapter are to learn about:
 The composition of cash and how cash is presented on the balance sheet.
 Cash management and controls for receipts and disbursements.
 Reconciliation of bank accounts.
 The correct operation of a petty cash system.
 Accounting for highly-liquid investments known as "trading securities."
DISCUSSION
CASH COMPOSITION
CASH: Given its liquid and vital status, cash is typically listed first within the current asset
section of the balance sheet. But what exactly is cash? This may seem like a foolish question
until one considers the possibilities. Obviously, cash includes coins and currency. But what
about items like money on deposit in bank accounts, undeposited checks from customers,
certificates of deposit, and similar items? Some of these are deemed to be cash and some are
not. What rule shall be followed?
Generalizing, cash includes those items that are acceptable to a bank for deposit and are free
from restrictions (i.e., available for use in satisfying current debts). Cash typically includes
coins, currency, funds on deposit with a bank, checks, and money orders. Items like postdated
checks, certificates of deposit, IOUs, stamps, and travel advances are typically not classified as
cash. The existence of compensating balances (amounts that must be left on deposit and cannot
be withdrawn) should be disclosed; if such amounts are very significant, they are reported
separately from cash. Also receiving separate treatment are "sinking funds" (monies that must be

set aside to satisfy debts) and heavily restricted foreign currency holdings (that cannot easily be
converted into dollars). These unique categories of funds may be reported in the long-term
investments category.
CASH EQUIVALENTS: In lieu of reporting "cash," some companies will report "cash and cash
equivalents." Cash equivalents arise when companies place their cash in very short-term
interest-earning financial instruments that are deemed to be highly secure and will convert back
into cash within 90 days. Many short-term government-issued securities (e.g., treasury bills)
meet these conditions. In addition, active markets exist for such securities, and these financial
instruments are usually very marketable in the event the company needs access to funds in
advance of maturity. Cash management strategies dictate that large amounts of cash not be held
in "unproductive" accounts that do not generate interest income. As a result, surplus cash is
often invested in these instruments. Because of their unique nature, they are considered to be
cash equivalents, and are often reported with cash on the balance sheet. Following is an excerpt
from a recent balance sheet of the automotive division of General Motors Corporation. You will
note that the company held over $15 billion in cash:
Cash and cash equivalents (Note 1) $15,187
Note 1 to the financial statements included this additional commentary about cash:
Cash and Cash Equivalent
Cash equivalents are defined as short-term, highly-liquid investments with original maturities of
90 days or less.

CASH MANAGEMENT
PLANNING CASH FLOWS: It is very important to ensure that sufficient cash is available to
meet obligations and to make sure that idle cash is appropriately invested to maximize the return
to the company. One function of the company "treasurer" is to examine the cash flows of the
business, and pinpoint anticipated periods of excess or deficit cash flows. A detailed cash budget
is often maintained, and updated on a regular basis. The cash budget is a major component of a
cash planning system and represents the overall plan of activity that depicts cash inflows and
outflows for a stated period of time. A future chapter provides an in-depth look at cash
budgeting.
You may tend to associate cash shortages as a sign of weakness, and, indeed, that may be true.
However, such is not always the case. A very successful company with a great product or
service may be rapidly expanding via new business locations, added inventory levels, growing
receivables, and so forth. All of these events give rise to the need for cash and can create a real
crunch even though the business is fundamentally prospering. To sustain the growth, careful
planning must occur.
STRATEGIES TO ENHANCE CASH FLOWS: As a business looks to improve cash
management or add to the available cash supply, a number of options are available. Some of
these solutions are "external" and some are "internal" in nature.
External solutions include:
Issuing additional shares of stock -- This solution has a definite advantage, because it allows the
company to obtain cash, without a fixed obligation to repay. As a result, this may seem like a
sure-fire costless option. Unfortunately, the existing shareholders do incur a very real detriment,
because the added share count dilutes their ownership proportions. In essence, it is akin to
existing shareholders selling off part of the business; a solution that may be seen as a last resort if
the future is bright.
Borrowing additional funds -- This solution brings no additional shareholders to the table, but
borrowed funds must be repaid along with interest. Thus, the business cost and risk is increased.

On a related note, many companies will establish a standing line of credit that enables them to
borrow as needed, and not borrow at all if funds are not needed. This solution provides a ready
source of liquidity, without actually increasing debt levels. Banks typically provide such lines of
credit in exchange for a fee based on the amount of the line of credit.
The company may look within its own operating structure to find internal cash flow
enhancements:
Accelerate cash collections -- If a company can move its customer base to pay more quickly, a
significant source of cash is found! Simple tools include electronic payment, credit cards,
lockbox systems (i.e., the establishment of bank depositories near to the customer for quick
access to funds/thereby avoiding mail and clearing delays), and cash discounts for prompt
payment.
Postponement of cash outflows -- Companies may "drag their feet" on cash outflows, delaying
payment as long as possible. In addition, paying via check sent through the mail allows use of
the "float" to preserve cash on hand. However, you need to know that it is illegal to issue a
check when there are insufficient funds in the bank to cover that item (even if you know a
deposit is forthcoming that will cover the check). Some companies make travel advances to
employees for anticipated costs to be incurred on an upcoming trip; it is better for cash flow to
have the employee incur the cost (perhaps on a credit card) and then submit receipts for
reimbursement.
Cash control -- Systems and procedures should be adopted to safeguard an organization's funds.
Internal control for cash is based on the same general control features introduced in the previous
chapter; access to cash should be limited to a few authorized personnel, incompatible duties
should be separated, and accountability features (like prenumbered checks, etc.) should be
developed.
 The control of receipts from cash sales should begin at the point of sale and continue
through to deposit at the bank. Specifically, cash registers (or other point-of-sale
terminals) should be used, actual cash on hand at the end of the day should be compared

to register tapes, and daily bank deposits should be made. Any cash shortages or excesses
should be identified and recorded in a Cash Short & Over account.
 Control of receipts from customers on account begins when payments are received (in the
mail or otherwise). The person opening the mail should prepare a listing of checks
received and forward the list to the accounting department. The checks are forwarded to a
cashier who prepares a daily bank deposit. The accounting department enters the
information from the listing of checks into the accounting records and compares the
listing to a copy of the deposit slip prepared by the cashier.
 The controls over cash disbursements include procedures that allow only authorized
payments for actual expenditures and maintenance of proper separation of duties. Control
features include requiring that significant disbursements be made by check, performance
of periodic bank reconciliations, proper utilization of petty cash systems, and verification
of supporting documentation before disbursing funds.
The bank reconciliation and petty cash systems referred to above have specific accounting
implications to consider, and are the subject of the following sections of this chapter.
BANK RECONCILIATION
BANK RECONCILIATION: One of the most common cash control procedures, and one which
you may already be performing on your own checking account, is the bank reconciliation. In
business, every bank statement should be promptly reconciled by a person not otherwise
involved in the cash receipts and disbursements functions. The reconciliation is needed to
identify errors, irregularities, and adjustments for the Cash account. Having an independent
person prepare the reconciliation helps establish separation of duties and deters fraud by
requiring collusion for unauthorized actions.
There are many different formats for the reconciliation process, but they all accomplish the same
objective. The reconciliation compares the amount of cash shown on the monthly bank
statement (the document received from a bank which summarizes deposits and other credits, and
checks and other debits) with the amount of cash reported in the general ledger. These two
balances will frequently differ. Differences are caused by items reflected on company records

but not yet recorded by the bank; examples include deposits in transit (a receipt entered on
company records but not processed by the bank) and outstanding checks (checks written which
have not cleared the bank). Other differences relate to items noted on the bank statement but not
recorded by the company; examples include nonsufficient funds (NSF) checks ("hot" checks
previously deposited but which have been returned for nonpayment), bank service charges, notes
receivable (like an account receivable, but more "formalized") collected by the bank on behalf of
a company, and interest earnings.
The following format is typical of one used in the reconciliation process. Note that the balance
per the bank statement is reconciled to the "correct" amount of cash; likewise, the balance per
company records is reconciled to the "correct" amount. These amounts must agree. Once the
correct adjusted cash balance is satisfactorily calculated, journal entries must be prepared for all
items identified in the reconciliation of the ending balance per company records to the correct
cash balance. These entries serve to record the transactions and events which impact cash but
have not been previously journalized (e.g., NSF checks, bank service charges, interest income,
and so on).
COMPREHENSIVE ILLUSTRATION OF BANK RECONCILIATION:
The following illustration provides a detailed example of a bank statement, additional data, the
reconciliation process, and the corresponding journal entries. Conducting a bank reconciliation

requires careful attention to the slightest of details. Even the smallest error will lead to
frustration in trying to bring closure to the reconciliation effort.
ADDITIONAL DATA
The above bank statement is for The Tackle Shop for July of 20X3. The following additional
data is needed to reconcile the account:
 The first check listed above, #5454, was written in June but did not clear the bank until
July 2.
 There were no other outstanding checks, and no deposits in transit at the end of June.
 The EFT (electronic funds transfer) on July 11 relates to the monthly utility bill; The
Tackle Shop has authorized the utility to draft their account directly each month.
 The Tackle Shop is optimistic that they will recover the full amount, including the service
charge, on the NSF check ("hot check") that was given to them by a customer during the
month.

 The bank collected a $5,000 note for The Tackle Shop, plus 9% interest ($5,450).
 The Tackle Shop's credit card clearing company remitted funds on July 25; the Tackle
Shop received an email notification of this posting and simultaneously journalized this
cash receipt in the accounting records.
 The Tackle Shop made the 2 deposits listed above, and an additional deposit of $3,565.93
late in the afternoon on July 31, 20X3.
 The ending cash balance, per the company general ledger, was $47,535.30.
 The following check register is maintained by The Tackle Shop, and it corresponds to the
amounts within the Cash account in the general ledger:
BANK RECONCILIATION
The bank reconciliation for July is determined by reference to the above bank statement and
other data. You must carefully study all of the above data to identify deposits in transit,

outstanding checks, and so forth. Be advised that tracking down all of the reconciling items can
be a rather tedious, sometimes frustrating, task. Modern bank statements facilitate this process
by providing sorted lists with asterisks beside the check numbers that appear to have gaps in their
sequence numbering. Below is the reconciliation of the balance per bank statement to the
correct cash balance. You should try to identify each item in this reconciliation within the
previously presented data. If you need help - click here!
The reconciliation of the balance per company records to the correct cash balance is presented
at left. This reconciliation will trigger various adjustments to the Cash account in the company
ledger. If you need a little help finding the noted items, click here. The identified items caused
cash to increase by $4,968.21 ($52,503.51 correct balance, less the balance on the company
records of $47,535.30). Most of these amounts are fairly intuitive, except for the $462.06 debit
to Accounts Receivable -- which indicates that The Tackle Shop is going to attempt to collect on
the NSF check and related charge. The interest income of $569.34 reflects that posted by the
bank ($119.34) plus the $450 on the collected note.

7-31-X3 Cash 4,968.21
Utilities Expense 109.07
Accounts Receivable 462.06
Miscellaneous Expense 30.00
Notes Receivable 5,000.00
Interest Income 569.34
To record adjustments necessitated by
bank reconciliation
Even this fairly simple bank reconciliation demonstrates the pressing need for monthly
reconciliations. Without a reconciliation, company records would soon become unreliable as the
process draws attention to various needed adjustments.
PROOF OF CASH: Many a business prepares a reconciliation just like that above. But, you
should note that it leaves one gaping hole in the control process. What if you learned that the
bank statement included a $5,000 check to an employee near the beginning of the month, and a
$5,000 deposit by that employee near the end of the month (and these amounts were not recorded
on the company records)? In other words, the employee took out an unauthorized "loan" for a
while. The reconciliation would not reveal this unauthorized activity because the ending

balances are correct and in agreement. To overcome this deficiency, some companies will
reconcile not only the beginning and ending balances, but also the total checks per the bank
statement to the total disbursements per the company records, and the total deposits per the bank
statement to the total receipts on the company accounts. If a problem exists, the totals on the
bank statement will exceed the totals per the company records for both receipts and
disbursements. This added reconciliation technique is termed a proof of cash. It is highly
recommended where the volume of transactions and amount of money involved is very large.
Such unauthorized "borrowing" not only steals company interest income, but it also presents a
risk of loss if the company funds are not replaced. Make no mistake, such schemes are highly
illegal!
Also illegal is "kiting." Kiting occurs when one opens numerous bank accounts at various
locations and then proceeds to write checks on one account and deposit them to another. In turn,
checks are written on that account, and deposited to yet another bank. And, over and over and
over. In time, each of the bank accounts may appear to have money, but it is illusionary, because
there are numerous checks "floating" about that will hit and reduce the accounts. Somewhere in
the process of running this scam, the crook makes off with a cash withdrawal (or writes a check
that appears to be good to an unsuspecting merchant) and skips town. That is why you will often
see bank notices that deposited funds cannot be withdrawn for several days; they have been
burned once too often, and want to be sure that a deposit clears the bank on which it is drawn
before releasing those funds. Now, the point of this discussion is not to give you any ideas -- but
to alert you to be careful in your dealings with others. Kiting is complex and illegal, and many a
person is "doing time" in jail for such dealings. Enhanced electronic clearing procedures adopted
by banks in recent years have made kiting far more difficult to accomplish.
PETTY CASH
PETTY CASH: Petty cash, also known as imprest cash, is a fund established for making small
payments that are impractical to pay by check. Examples include postage due, reimbursement to
employees for small purchases of office supplies, and numerous similar items. The
establishment of a petty cash system begins by making out a check to cash, cashing it, and
placing the cash in a petty cash box:

A petty cash custodian should be designated to have responsibility for safeguarding and making
payments from this fund. At the time the fund is established, the following journal entry is
needed. This journal entry, in essence, subdivides the petty cash portion of available funds into a
separate account.
1-31-X4 Petty Cash 1,000
Cash 1,000
To establish a $1,000 petty cash fund
Policies should be established regarding appropriate expenditures (type and amount) that can be
paid from petty cash. When a disbursement is made from the fund by the custodian, a receipt
should always be placed in the petty cash box. The receipt should clearly set forth the amount
and nature of expenditure. The receipts are sometimes known as petty cash vouchers.
Therefore, at any point in time, the receipts plus the remaining cash should equal the balance of
the petty cash fund (i.e., the amount of cash originally placed in the fund and recorded by the
entry above).
REPLENISHMENT OF PETTY CASH: As expenditures occur, cash in the box will be
depleted. Eventually the fund will require replenishment back to its original level. To replenish

the fund, a check for cash is prepared in an amount to bring the fund back up to the desired
balance. The check is cashed and the proceeds are placed in the petty cash box. At the same
time, receipts are removed from the petty cash box and formally recorded as expenses.
The journal entry for this action involves debits to appropriate expense accounts as represented
by the receipts, and a credit to Cash for the amount of the replenishment. Notice that the Petty
Cash account is not impacted -- it was originally established as a base amount and its balance has
not been changed by virtue of this activity.
2-28-X4 Supplies Expense 390
Fuel Expense 155
Miscellaneous Expense 70
Cash 615
To replenish petty cash; receipts on
hand of $615 -- office supplies ($390),
gasoline ($155), coffee and drinks
($70). Remaining cash in the fund
was $385, bringing the total to $1,000
($615 + $385).
CASH SHORT AND OVER: Occasionally, errors will occur, and the petty cash fund will be out
of balance. In other words, the sum of the cash and receipts differs from the correct Petty Cash
balance. This might be the result of simple mistakes, such as math errors in making change, or
perhaps someone failed to provide a receipt for an appropriate expenditure. Whatever the cause,
the available cash must be brought back to the appropriate level. The journal entry to record full
replenishment may require an additional debit (for shortages) or credit (for overages) to Cash

Short (Over). In the following entry, $635 is placed back into the fund, even though receipts
amount to only $615. The difference is debited to Cash Short (Over):
2-28-X4 Supplies Expense 390
Fuel Expense 155
Cash Short (Over) 20
Cash 635
To replenish petty cash; receipts on
hand of $615 -- office supplies ($390),
gasoline ($155), coffee and drinks
($70). Remaining cash in the fund
was $365, bringing the total to $980
($615 + $365; a $20 shortage was
noted and replenished.
The Cash Short (Over) account is an income statement type account. It is also applicable to
situations other than petty cash. For example, a retailer will compare daily cash sales to the
actual cash found in the cash register drawers. If a surplus or shortage is discovered, the
difference will be recorded in Cash Short (Over); a debit balance indicates a shortage (expense),
while a credit represents an overage (revenue). As a means of enforcing accountability, some
companies may pressure employees to reimburse cash shortages.
INCREASING THE BASE FUND: As a company grows, it may find a need to increase the base
size of its petty cash fund. The entry to increase the fund would be identical to the first entry
illustrated above; that is, the amount added to the base amount of the fund would be debited to
Petty Cash and credited to Cash. Otherwise, take note that the only entry to the Petty Cash
account occurred when the fund was established -- subsequent reimbursements of the fund did
not change the Petty Cash account balance.
TRADING SECURITIES

TRADING SECURITIES: From time to time a business may invest cash in stocks of other
corporations. Or, a company may buy other types of corporate or government securities.
Accounting rules for such investments depend on the "intent" of the investment. If these
investments were acquired for long-term purposes, or perhaps to establish some form of control
over another entity, the investments are classified as noncurrent assets. The accounting rules for
those types of investments are covered in subsequent chapters. But, when the investments are
acquired with the simple intent of generating profits by reselling the investment in the very near
future, such investments are classified as current assets (following cash on the balance sheet).
These investments are appropriately known as "trading securities."
Trading securities are initially recorded at cost (including brokerage fees). However, the value of
these readily marketable items may fluctuate rapidly. Subsequent to initial acquisition, trading
securities are to be reported at their fair value. The fluctuation in value is reported in the income
statement as the value changes. This approach is often called "mark-to-market" or "fair value"
accounting. Fair value is defined as the price that would be received from the sale of an asset in
an orderly transaction between market participants.
AN ILLUSTRATION: Assume that Webster Company's management was seeing a pickup in
their business activity, and believed that a similar uptick was occurring for its competitors as
well. One of its competitors, Merriam Corporation, was a public company, and its stock was
trading at $10 per share. Webster had excess cash earning very low rates of interest, and decided
to invest in Merriam -- intending to sell the investment in the very near future for a quick profit.
The following entry was needed on March 3, 20X6, the day Webster bought stock of Merriam:
3-3-X6 Trading Securities 50,000
Cash 50,000
To record the purchase of 5,000
shares of Merriam stock at $10 per
share
Next, assume that financial statements were being prepared on March 31. Despite Webster's
plans for a quick profit, the stock declined to $9 per share by March 31. Webster still believes in

the future of this investment, and is holding all 5,000 shares. But, accounting rules require that
the investment "be written down" to current value, with a corresponding charge against income.
The charge against income is recorded in an account called Unrealized Loss on Investments:
3-31-X6 Unrealized Loss on Investments 5,000
Trading Securities 5,000
To record a $1 per share decrease in
the value of 5,000 shares of Merriam
stock
Notice that the loss is characterized as "unrealized." This term is used to describe an event that is
being recorded ("recognized") in the financial statements, even though the final cash
consequence has not yet been determined. Hence, the term "unrealized."
April had the intended effect, and the stock of Merriam bounced up $3 per share to $12. Still
Webster decided to hang on for more. At the end of April, another entry is needed if financial
statements are again being prepared:
4-30-X6 Trading Securities 15,000
Unrealized Gain on Investments 15,000
To record a $3 per share increase in
the value of 5,000 shares of Merriam
stock
Notice that the three journal entries now have the trading securities valued at $60,000 ($50,000 -
$5,000 + $15,000). This is equal to their market value ($12 X 5,000 = $60,000). The income
statement for March includes a loss of $5,000, but April shows a gain of $15,000. Cumulatively,
the income statements show a total gain of $10,000 ($5,000 loss + $15,000 gain). This
cumulative gain corresponds to the total increase in value of the original $50,000 investment.

The preceding illustration assumed a single investment. However, the treatment would be the
same even if the trading securities consisted of a portfolio of many investments. That is, each
and every investment would be adjusted to fair value.
RATIONALE FOR FAIR VALUE ACCOUNTING: The fair value approach is in stark contrast
to the historical cost approach used for other assets like land, buildings, and equipment. The
rationale is that the market value for trading securities is readily determinable, and the periodic
fluctuations have a definite economic impact that should be reported. Given the intent to dispose
of the investments in the near future, the belief is that the changes in value likely have a
corresponding effect on the ultimate cash flows of the company. As a result, the accounting
rules recognize those changes as they happen.
ALTERNATIVE: A VALUATION ADJUSTMENTS ACCOUNT: As an alternative to directly
adjusting the Trading Securities account, some companies may maintain a separate Valuation
Adjustments account that is added to or subtracted from the Trading Securities account. The
results are the same; the reason for using the alternative approach is to provide additional
information that may be needed for more complex accounting and tax purposes. One such
purpose is to determine the "taxable gain or loss" on sale. Tax rules generally require comparing
the sales price to the original cost (you may be surprised to learn that tax rules sometimes differ
from accounting rules -- the mark-to-market approach used for accounting is normally not
acceptable for tax purposes). There are also more involved accounting rules relating to
measurement of the "realized" gains and losses when the securities are in fact sold. Those rules
are ordinarily the subject of more advanced courses.
DIVIDENDS AND INTEREST: Since trading securities are turned over rather quickly, the
amount of interest and dividends received on those investments is probably not very significant.

However, any dividends or interest received on trading securities is reported as income and
included in the income statement:
9-15-X5 Cash 75
Dividend Income 75
To record receipt of dividend on
trading security investment
The presence or absence of dividends or interest on trading securities does not change the basic
mark-to-market valuation for the Trading Securities account.
DERIVATIVES: Beyond the rather straight-forward investments in trading securities are an
endless array of more exotic investment options. Among these are commodity futures, interest
rate swap agreements, options related agreements, and so on. These investments are generally
referred to as derivatives, because their value is based upon or derived from something else (e.g.,
a cotton futures contract takes its value from cotton, etc.). The underlying accounting approach
follows that for trading securities. That is, such instruments are initially measured at fair value,
and changes in fair value are recorded in income as they happen.
QUESTIONS
MULTIPLE CHOICE QUESTIONS
Select the appropriate response.
1. The Cash account on the balance sheet should not include which of the following items?
a. Travel advances to employees
b. Currency
c. Money orders
d. Deposits in transit
HELP ME!
2. A credit memorandum accompanying a bank statement would occur for which of the following items?
a. A previously deposited customer check which was returned NSF.
b. Bank service charges for the month.
c. The proceeds of a note collected by the bank are deposited to the account.
d. Each of the above.

HELP ME!
3. When reconciling the ending cash balance per the bank statement to the correct adjusted cash
balance, how would deposits in transit be handled?
a. Added to the balance per the bank statement.
b. Subtracted from the balance per the bank statement.
c. Added to the balance per company records.
d. Ignored.
HELP ME!
4. A bank reconciliation sometimes points to the need for adjusting entries. In general, the source of the
adjustments is:
a. the reconciliation of the ending balance per the bank statement to the adjusted cash balance.
b. the reconciliation of the cash balance per the company records to the adjusted cash balance.
c. both a and b.
d. none of the above.
HELP ME!
5. Malory Company provides the following information about the month-end bank reconciliation:
Ending cash per bank statement $1,367
Ending cash per company records 7,383
Monthly bank service charge 25
Deposits in transit at month-end 8,345
Outstanding checks at month-end 2,399
Customer check returned NSF 45
The correct ending cash balance is:
a. $4,914
b. $7,268
c. $7,313
d. $7,383
HELP ME!
6. Malory Company provides the following information about the month-end bank reconciliation:
Ending cash per bank statement $1,367
Ending cash per company records 7,383
Monthly bank service charge 25
Deposits in transit at month-end 8,345
Outstanding checks at month-end 2,399
Customer check returned NSF 45

What journal entry should be recorded to cause the company records to be correct?
a. Cash 70
Cash Short & Over 70
b. Miscellaneous Expense 70
Cash 70
c. Miscellaneous Expense 25
Accounts Receivable 45
Cash 70
d. Miscellaneous Expense 2,399
Cash 2,399
HELP ME!
7. When using a petty cash system, the replenishment of the fund would normally include a debit to:
a. Cash.
b. Petty Cash.
c. Revenues.
d. None of the above.
HELP ME!
8. The trading securities owned by a company are:
a. reported on the balance sheet as a current asset.
b. reported on the balance sheet as a noncurrent asset.
c. reported on the balance sheet as a contra-equity account.
d. reported on the balance sheet as a reduction of liabilities.
HELP ME!
9. During its first year of operation, Lenton Company acquired three investments in trading securities.
Investment A cost $50,000 and had a year-end market value of $60,000. Investment B cost $35,000 and
had a year-end market value of $17,000. Investment C cost $26,000 and had a year-end market value of
$24,000. What amount should be reported as a charge against income in Lenton's income statement for
the first year of operation?
a. $0
b. $10,000
c. $20,000
d. $30,000
HELP ME!
10. During its first year of operation, Lenton Company acquired three investments in trading securities.
Investment A cost $50,000 and had a year-end market value of $60,000. Investment B cost $35,000 and
had a year-end market value of $17,000. Investment C cost $26,000 and had a year-end market value of
$24,000. The journal entry to record the decline in market value would include:

a. a debit to Unrealized Loss on Trading Securities.
b. a credit to Unrealized Gain on Trading Securities.
c. a debit to Trading Securities.
d. At least two of the above.
HELP ME!

1. a. Travel advances to employees are really a nontrade receivable -- the employee either has to return
the money or provide an accounting to indicate how the money was spent. Currency and money orders
are both cash because they are acceptable to a bank for deposit and can be used to satisfy debts.
Deposits in transit are cash; the bank simply has not posted the deposit to a specific account.
2. c. A credit memorandum issued by a bank indicates that a bank account has been increased. Of the
noted items, only answer "c" relates to a transaction which increases cash.
3. a. Deposits in transit must be added to the balance per the bank statement. These are amounts of
cash which belong to the company, but which have not as yet been recorded by the bank. The balance
per company records should already include these amounts, so answer "c" is incorrect.
4. b. The cash balance per company records is the amount of cash in the general ledger account before
the reconciliation. The correct amount of cash actually possessed by the firm is the adjusted cash
balance, per the reconciliation. Logically, the reconciliation of the cash balance per company records to
the correct amount of cash points to the need for a journal entry to update the Cash account.
5. c. The correct ending cash balance is $7,313:
Ending balance per bank statement $1,367
Add: Deposits in transit 8,345
Deduct: Outstanding checks (2,399)
Adjusted cash balance: bank $7,313
Ending balance per company records $7,383
Deduct:
NSF Check -- 45
Service charge -- 25
(70)
Adjusted cash balance: company records $7,313

6. c. The correct entry is based on the reconciliation of the ending cash balance per company records to
the adjusted cash balance:
Accounts Receivable 45
Cash 70
To record adjustments necessitated by
bank reconciliation
7. d. Various expense accounts are debited and Cash is credited.
8. a. Trading securities are normally reported as current assets.
9. b. Aggregate cost equals $111,000 ($50,000 + $35,000 + $26,000). Aggregate market value equals
$101,000 ($60,000 + $17,000 + $24,000). The $10,000 difference is a decline which is reported as an
unrealized loss.
10. a. The appropriate entry is to debit Unrealized Loss on Trading Securities and credit Trading
Securities for $10,000. Choice "a" is the only correct choice.
EXAM CHECKLIST
Following is a "checklist" of selected key concepts that are likely to be included on an exam. Review and
check-off each noted item to be certain that important concepts have not been overlooked in your study.
Know which items are properly classified as cash, and which are not.
Why is cash management important?
Define cash planning and cash control.
Discuss ways in which cash flows can be accelerated or delayed.
What are features of a typical cash control system?
Be able to recite at least three typical control features related to both cash receipts and cash
disbursements.
Why are bank reconciliations necessary?
What items are likely to be included on the company records, but not the bank records?

What items are likely to be included on the bank records, but not the company records?
Be able to create and solve a complex problem requiring a bank reconciliation.
Which items on a bank reconciliation require an adjusting journal entry, and why?
What is the benefit of a petty cash system?
Be able to explain the operation of a petty cash system.
Prepare journal entries to establish and replenish a petty cash system, including situations involving
cash shortages.
Be able to explain the enhancement to internal control that results from a petty cash system.
Name several examples of trading securities, how they are initially recorded, and where they are
positioned on the balance sheet.
What method is used to account for trading securities?
Be totally familiar with the operation (journal entries and financial statement impact) of the fair value
method for trading securities, including cases involving increases and decreases in value.
Know how to record dividends received.
KEY TERMS AND DEFINITIONS (with links to discussion in text)
bank reconciliation
A control procedure to establish and verify the correc
balance via identification of errors, irregularities, and
adjustments
bank statement
The document received from a bank which summariz
deposits and other credits, and checks and other deb
bank account
cash
Items acceptable to a bank for deposit and free from
restrictions to satisfying current debts; includes coins
currency, bank deposits, etc.
cash budget
A major component of a cash planning system that d
cash inflows and outflows for a stated period of time
cash equivalents
Short-term interest-earning financial instruments that
deemed to be highly secure and will convert back int
within 90 days

compensating balance
An amount that must be left on deposit and cannot b
withdrawn
deposit in transit
Receipts entered on company records but not yet po
the bank
derivatives
Investments accounted for a fair value that generally
their value from some other item; examples include
commodity futures, options, and so forth
fair value accounting
Sometimes called "mark-to-market;" to record an inv
at its fair value and recognize changes in value as it
NSF check
Nonsufficient funds check; a customer check returne
lack of funds (a "hot check")
outstanding checks
Checks entered on company records but not yet clea
the bank
petty cash
A fund established for making small payments that a
impractical to pay by check; also known as imprest c
fund
proof of cash
A detailed bank reconciliation that verifies not only be
and end balances, but also validates deposits and
withdrawals during the month
trading securities
Investments acquired with the intent of generating pr
reselling the investment in the very near future; class
current assets

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