Cash equivalents are short-term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with an original maturity of three months or less qualify, and original maturity is measured to the entity holding the investment rather than from the date the issuer sold it. Both halves have to hold at once, so meeting one of them is not enough.
Where the Definition Lives Now
The wording is FASB’s, written into Statement of Financial Accounting Standards No. 95, paragraph 8 (FASB, Statement of Financial Accounting Standards No. 95). That Statement is the origin of the wording rather than its live address. On the effective date of Statement No. 168 all then-existing non-SEC accounting and reporting standards were superseded, except for a short list of named Statements that stayed authoritative until each was integrated into the Codification, and the Codification became the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities (FASB Statement of Financial Accounting Standards No. 168, paragraphs 6 and 15).
The live address is ASC 230-10-20, the Master Glossary term inside the statement of cash flows subtopic. The Codification keeps that guidance in Subtopic 230-10 and carries the old Statement’s cash equivalents language forward there, down to the phrase items commonly considered to be cash equivalents at 230-10-45-5 (FASB Accounting Standards Update 2016-18). A subtopic’s defined terms sit in its section 20 glossary, the way Topic 105’s own glossary is printed at 105-10-20 (FASB Statement of Financial Accounting Standards No. 168). What that same supersession did to the presentation rules standing around this term is worked through in cash flow statement.
Original Maturity Is Measured to the Holder
Original maturity means original maturity to the entity holding the investment (FAS 95, footnote 2). The clock starts when this holder acquired the instrument, not when it was issued, so remaining maturity alone never turns a long-dated holding into a cash equivalent. Both directions of that test are worked through on a real instrument in certificate of deposit accounting.
Qualifying Is Not the Same as Classifying
Not all investments that qualify are required to be treated as cash equivalents. An entity has to establish a policy for which of the qualifying items it treats that way, disclose that policy, and treat any change to it as a change in accounting principle, effected by restating the earlier years presented for comparative purposes (FAS 95, paragraph 10).
The standard’s illustrations run both ways: an enterprise with banking operations might treat everything that qualifies except its trading-account purchases as cash equivalents, while an enterprise whose operations consist largely of investing in short-term, highly liquid investments might treat all of those items as investments instead (FAS 95, paragraph 10). For a firm closing a client’s books, that makes the classification a documented accounting policy the workpapers have to carry, not a judgment made fresh each year.
Where the Balance Sits on a Filed Balance Sheet
The SEC’s balance sheet rule never uses the phrase cash equivalents. Regulation S-X runs the current asset class through numbered captions, caption 1 is cash and cash items, and it calls for separate disclosure of the cash and cash items restricted as to withdrawal or usage, with the provisions of any restriction described in a note. Time deposits and short-term certificates of deposit are not generally included in legally restricted deposits (17 CFR 210.5-02). Further back, the category the balance belongs to is cash available for current operations and items which are the equivalent of cash (ARB No. 43, Chapter 3A, paragraph 4). The rest of the caption set and the other categories are laid out in current assets.
What Cash Equivalents Are Confused With
Restricted cash is the first, and it is not a subdivision of this definition: the total a statement of cash flows reconciles is wider than cash and cash equivalents, a change carried in full by cash flow statement.
Tradability is the second, and the definition never turns on it. The test runs on convertibility to a known amount of cash and on original maturity, so an instrument that trades every day can still fail it (FAS 95, paragraph 8), which is the distinction marketable security sets out.
Common Questions
Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds and, for an enterprise with banking operations, federal funds sold. Cash purchases and sales of those investments are generally part of the enterprise’s cash management activities rather than part of its operating, investing and financing activities, and details of those transactions need not be reported in a statement of cash flows (FAS 95, paragraph 9).
Cash is money already available with no maturity to wait out: currency on hand, demand deposits, and other accounts with the general characteristics of demand deposits, where the customer effectively may withdraw funds at any time without prior notice or penalty (FAS 95, footnote 1). A cash equivalent has a maturity, and it sits beside cash only because that maturity is short enough that interest rate moves present insignificant risk of changes in its value. The currency in a petty cash box is cash; a bill bought with three months to run is not.
No. Gold has no maturity, so it can never be so near maturity that changes in interest rates present insignificant risk of changes in its value, and what it converts into is a market price rather than a known amount. It fails both halves of the test (FAS 95, paragraph 8).
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