FAR · Select balance sheet accounts · 9 practice questions
How to Compute Cash and Cash Equivalents From a List
Cash and cash equivalents include unrestricted cash plus highly liquid, low-risk investments that mature within three months of purchase. Below: sort a year-end list, exclude nonqualifying items, and total the rest.
Try one first
Hint
Focus on two questions: what items are cash by nature, and for investments, whether original maturity at purchase was three months or less.
Answer B. Cash includes demand deposits and petty cash. Cash equivalents are short-term, highly liquid investments with an original maturity of three months or less when acquired; the 60-day Treasury bill qualifies, but the 6-month certificate of deposit does not (its original maturity exceeded three months). Therefore, report $582,000 as cash and cash equivalents.
Why not A: This is tempting because both investments mature soon, but classification depends on original maturity at acquisition, not remaining time to maturity. The 6-month CD had an original maturity greater than three months, so it is not a cash equivalent.
Why not C: This reflects an overly broad exclusion of investments. The 60-day Treasury bill had an original maturity under three months when purchased and is a classic cash equivalent that should be included.
Why not D: This combines two common mistakes: petty cash is cash and must be included, and the 6-month CD is not a cash equivalent because its original maturity exceeded three months.
Worked example
At December 31, Vale Co. lists: checking, $260,000; petty cash currency, $5,000; a Treasury bill with 60 days to maturity at purchase, $70,000; a six-month CD purchased August 1, $110,000; a customer check dated January 4 of next year, $10,000; and legally restricted cash, $35,000. Amounts are separate carrying balances. All other items are unrestricted.
| 1 | Add cash by nature$260,000 checking + $5,000 petty cash | $265,000 |
| 2 | Add investments that qualify at purchase$70,000 (60-day Treasury bill) + $0 (six-month CD) | $70,000 |
| 3 | Leave unavailable amounts out$0 postdated check + $0 legally restricted cash | $0 |
| 4 | Sum only included amounts$265,000 + $70,000 + $0 | $335,000 |
Vale should report $335,000 as cash and cash equivalents at December 31.
Check: Cash is $265,000; only the $70,000 Treasury bill passes the acquisition-date test, so the total is $335,000.
Key points
- Measure maturity from your purchase date, not the issuer's original issue date.
- Highly liquid CDs and commercial paper can qualify; the investment's name does not decide classification.
- On-demand money market funds qualify only when convertible to known cash amounts with insignificant value risk.
- Count actual currency and coins in petty cash, not employee IOUs or stamps.
How the exam traps you
- Including a six-month CD because only one month remains at year-end. Use the maturity period at purchase. Time passing does not turn a non-equivalent into an equivalent.
- Counting a postdated or NSF check because the company received it. Exclude postdated checks until their date and NSF checks until collected. Keep the amounts in receivables.
- Adding a compensating balance just because it is in a bank account. Exclude legally restricted balances. An informal arrangement without a legal restriction does not automatically exclude the cash.
Question 2
| Instrument | Amount |
|---|---|
| Unrestricted checking account balance | $120,000 |
| Petty cash on hand | $600 |
| Money market mutual funds held for daily cash management (invested in government securities) | $40,000 |
| Commercial paper purchased 45 days ago (original maturity at purchase = 90 days) | $75,000 |
| Certificate of deposit purchased 30 days ago (original maturity at purchase = 120 days) | $50,000 |
| Marketable common stock (publicly traded) | $25,000 |
| Restricted cash (compensating balance) held under a long-term borrowing agreement; restriction extends beyond one year | $30,000 |
| Restricted cash held in escrow for customer deposits (expected to be disbursed within 60 days) | $12,000 |
Hint
Focus on whether each item is both (a) unrestricted (available for general use) and (b) an original short-term, highly liquid investment (original maturity ≤ 3 months).
Answer C. Cash and cash equivalents include unrestricted cash and short-term, highly liquid investments with an original maturity of three months (90 days) or less. Include the $120,000 checking, $600 petty cash, $40,000 money market funds, and $75,000 commercial paper (original 90-day maturity). Exclude the CD (original maturity 120 days), marketable common stock, and restricted cash (legally unavailable). Total = $235,600.
Why not A: This includes the $50,000 certificate of deposit. A common trap is to use remaining maturity (90 days now) instead of the instrument's original maturity at purchase; because the CD's original maturity was 120 days, it is not a cash equivalent.
Why not B: This adds the $12,000 restricted escrow cash. It's tempting because those funds will be disbursed soon, but restricted amounts that are legally unavailable for general use should be presented separately, not included in cash and cash equivalents.
Why not D: This adds the $25,000 marketable common stock. Although liquid, equity securities are not cash equivalents because their value can fluctuate and they are not guaranteed to convert to a known cash amount on short notice.
Question 3
Hint
Focus on what 'original maturity' means for the reporting entity, not for the issuer.
Answer D. Under U.S. GAAP, cash equivalents are highly liquid, short-term investments that have an original maturity of three months or less when acquired by the reporting entity. The governing factor is the time remaining to maturity at the acquisition date (Dec. 20 for Pella), not the security's original issuance date; if the remaining maturity at acquisition is three months or less and the investment is readily convertible to a known amount of cash with insignificant interest rate risk, it may be classified as a cash equivalent.
Why not A: Small fair-value movements may reflect low interest-rate risk, but slight changes in fair value alone do not determine cash-equivalent classification; the primary requirement is original maturity of three months or less when acquired and ready convertibility to a known amount of cash.
Why not B: Tempting because of the phrase 'original maturity,' but cash-equivalent classification looks at the maturity period from the investor's acquisition date, not the term the issuer originally sold the instrument for.
Why not C: Management intent can matter for other classifications (for example, held-to-maturity designations), but for cash equivalents the key is the short remaining maturity and liquidity when acquired, not the investor's plan to hold the security.
Question 4
Hint
Decide whether GAAP measures maturity from the purchase date or from the reporting date, and recall the three-month threshold.
Answer B. U.S. GAAP classifies cash equivalents as short-term, highly liquid investments that had an original maturity of three months or less from the date of acquisition. The test uses the investment's original maturity when purchased, not its remaining life at the reporting date. Because Reed acquired a six-month T-bill, it is not a cash equivalent at December 31 even though only two months remain.
Why not A: This distractor is tempting because the bill appears short-term at year-end (only two months remain). It is incorrect because GAAP requires assessing the original maturity at acquisition, not remaining maturity on the balance sheet date.
Why not C: Candidates may be misled because management's intent affects other classifications, but intent does not override the original-maturity requirement for cash equivalents, an instrument with an original maturity over three months cannot become a cash equivalent by intent alone.
Why not D: Government backing makes an instrument low credit risk and may suggest liquidity, which is why this distractor is plausible. However, backing alone does not satisfy the cash-equivalent test; the controlling criterion is original maturity (three months or less from acquisition).
Question 5
Hint
Focus on the maturity period at the date the investment was acquired, not just how much time is left until maturity at year-end.
Answer B. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are so near maturity that interest rate risk is insignificant. Under US GAAP, an investment qualifies as a cash equivalent if its original maturity at the date of acquisition is three months or less. The 90-day Treasury bill was acquired with a 90-day original maturity, so it should be reported as a cash equivalent.
Why not A: This distractor is tempting because only two months remain at year-end. However, classification depends on the investment's original maturity when acquired, not the remaining time at the balance sheet date; because the CD was purchased with a six-month original maturity, it does not qualify as a cash equivalent.
Why not C: Marketable common stock may be liquid and held for short-term purposes, but equity securities are not cash equivalents because they are not convertible to a known fixed amount of cash and their value can fluctuate materially.
Why not D: A one-year corporate note has an original maturity greater than three months at acquisition, so it does not meet the cash-equivalent definition; it would be classified as a short-term investment instead.
Question 6
Hint
Remember the 'original maturity at acquisition' rule for cash equivalents and consider whether moving an item from one current‑asset line to another changes total current assets.
Answer B. Under U.S. GAAP cash equivalents are highly liquid investments whose original maturity at acquisition is three months or less. Because this CD's original maturity at purchase exceeded three months, it should be reported as a short‑term investment (current), not as a cash equivalent. Reporting it as a cash equivalent merely shifts the amount between current‑asset line items (overstating cash and understating short‑term investments) and does not change total current assets.
Why not A: Tempting for those who think reporting something as "cash" increases reported liquidity overall, but incorrect here because the CD would still be a current asset if classified as a short‑term investment; moving it between current‑asset lines does not increase total current assets.
Why not C: This distractor catches those who focus on remaining life at the balance sheet date; GAAP bases the cash‑equivalent determination on the original maturity at acquisition, not the remaining maturity.
Why not D: Some candidates may assume presentation is discretionary, but GAAP provides specific criteria for cash equivalents that management must follow; items that do not meet those criteria cannot be classified as cash equivalents.
Question 7
Hint
Focus on the original maturity at acquisition and whether the asset is unrestricted and readily convertible to a known amount of cash.
Answer C. Shares in a money market mutual fund that are redeemable on demand are highly liquid, readily convertible to a known amount of cash, and subject to insignificant risk of change in value, so they meet the cash and cash equivalents definition. The other items are either restricted, were acquired with original maturities longer than three months, or are nonmarketable receivables.
Why not A: Tempting because the CD matures soon after year-end, but cash equivalents are judged by original maturity at acquisition; this CD had an original maturity exceeding three months when purchased, so it is not a cash equivalent.
Why not B: Although these funds are in a bank account, they are legally restricted and not available for general use; restricted cash is reported separately, not as cash and cash equivalents.
Why not D: A nonmarketable customer promissory note is a receivable and not readily convertible to cash despite its short term, so it does not qualify as a cash equivalent.
Question 8
Hint
Do not anchor on how close the instrument is to maturity at year-end; focus on when the three-month test is applied.
Answer B. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and so near maturity that interest-rate risk is insignificant. The key maturity test is applied at the time the holder acquires the investment, investments must have three months or less remaining to maturity when purchased to qualify. Because Morningside acquired the instrument on 10/1/20X5 when it had more than three months remaining, it would not qualify as a cash equivalent even though only a few days remained at year-end.
Why not A: This is tempting because the instrument is close to maturity at year-end, but the three-month test is applied at acquisition, not at the balance-sheet date; year-end proximity alone is not sufficient.
Why not C: Management's intent to fund near-term operations (e.g., payroll) may make the investment feel cash-like, but classification as a cash equivalent depends on liquidity and remaining maturity at acquisition, not the purchaser's reason for buying.
Why not D: The issuer's original term is irrelevant to the purchaser's cash-equivalent test; the correct focus is the remaining maturity to the reporting entity at the time it acquires the investment.
Question 9
Hint
Think about how 'original maturity' at the date of acquisition affects whether an investment qualifies as a cash equivalent.
Answer B. Under U.S. GAAP, cash equivalents are short-term, highly liquid investments with an original maturity of three months or less from the date of acquisition. Orion purchased the commercial paper with an original maturity of four months, so it does not qualify as a cash equivalent even though fewer than three months remained at year‑end. It should be reported as a current short-term investment separate from cash and cash equivalents.
Why not A: This choice confuses proximity to maturity with original maturity. The instrument's original maturity at acquisition (four months) exceeds three months, so it cannot be classified as a cash equivalent.
Why not C: This distractor appeals to remaining life and liquidity. Cash-equivalent status depends on original maturity at the purchase date (three months or less), not how long remains at the balance sheet date.
Why not D: Restricted cash requires legal or contractual restrictions on use. Nothing in the facts indicates the funds are restricted, so the correct classification is an unrestricted short-term investment.
Common questions
Is the three-month cash-equivalent test based on original or remaining maturity?
Measure from the company's acquisition date to maturity, not from year-end. A security issued for a longer term can qualify if it has three months or less left when purchased and meets the liquidity and risk tests.
Is a certificate of deposit a cash equivalent?
A highly liquid, unrestricted CD can qualify if it matures within three months of purchase and has insignificant value risk. A six-month CD does not qualify just because it matures soon after year-end.
Do petty cash and undeposited customer checks count as cash?
Include actual petty cash and valid checks payable by the balance sheet date, even if not yet deposited. Exclude postdated and NSF checks; they remain receivables.
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